Effects of Demonetization

Effects of demonetization

1. Immediate impact: is expected to be negative all round: a. In the short term it will be a logistical nightmare to manage the cash replacement in banks and smooth functioning of the banking system b. slowdown in consumer spending due to limited cash availability c. severe liquidity issues in cash based sectors like Real Estate and Jewellery d. GDP will decline in the next 2 quarters due to reduction in overall spending

2. Over the next 4-5 months:Those having legitimate income will deposit it in banks and apart from the initial hassles associated with the banking system, they will have nothing to worry about. However, those having unaccounted money will face several problems as follows: a. Those who choose to do nothing with the money, their notes will expire worthless. Every note is a liability of the Government (RBI) and thus notes becoming worthless will benefit the Government by extinguishing its liability. b. Those who declare their unaccounted unacco unted money, approx 60- 70% of the money mo ney will go to the Govt in the form of taxes and penalties. c. There will be a third category who will try to launder their money, but which will entail severe risks including penalties and prosecution. However, the money sought to be laundered will anyway enter into circulation and remain therein.

It is expected that even if 50% of the around 14 lakh crores of old notes are legitimate, the remaining 50% or around Rs 7 lakh crores of unaccounted money will see around 60 to 80 % thereof or approx Rs 5 lakh crores coming to

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the government in the form of extinguished RBI liability (point a above) and taxes and penalties. This Rs 5 lakh crore is enough to take care of India's entire fiscal deficit for one year or more.

3. Overall Economic Impact: a. GDP growth is expected to be negative for around 6 months. However, subsequent 2 years will see sharp "hockey stick" revival in growth. b. Inflation is expected to fall sharply with fall in Real Estate prices and transaction costs thereof. c. Government Deficit will see a huge windfall in the next 2 years. d. Currency is expected to strengthen as inflation drops and economy gets a boost. e. Banking System will get a boost, as around Rs 7-8 lakh crores base money (new legal money) will enter the system, which will further create around 3-4 times more money due to re-circulation. f. Real Estate and Jewellery sectors, though battered initially will stabilize in the next 6 months.

4. Effect on various Asset classes: a. Bond prices will rise as interest rates drop. b. Real Estate is expected to fall fal l by around 20 -25 % and stabilize s tabilize thereafter. c. Effect on Gold is a bit uncertain and may be neutral/ negative. The lower black money will depress demand, but at the same time, Gold is a hedge against uncertainty and those still wanting to park black money may prefer to



Two, the organized sector (corporates, especially listed ones) will benefit due to fewer cash transactions. Lastly, lower inflation and interest rates will benefit listed corporates through lower borrowing costs, thereby increasing their profitability and valuations.

Thus Asset Allocation and re balancing thereof will now play an even more important role, making proper financial planning imperative.

Lastly, the question may arise as to whether the new Rs 2000 Rupee notes will create a black money or not. While that is always a possibility, it should be noted that this demonetization would have created a psychological impact especially on large scale evaders who will definitely think twice before taking such action

Effects of Demonetization

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