Demonetisation. Riding out India’s 9/11

India had its own 9/11, as it woke up to the demonetisation of high-value currency notes. It is arguably the boldest, newest, largest, riskiest and most influential reform since 1991. This exercise would cause inconvenience to everyone in the country in the short term but prove helpful in the medium to long term. Due to its unprecedented nature and scale, it is difficult to quantify its impact with a high level of accuracy.

The growth in GDP may be hit for the next 3-4 quarters to the tune of 50-100 bps (basis points) as cash transactions, which account for 40-45 per cent of GDP, are affected. In FY18, implementation of the GST would also impact growth as the system takes time to re-adjust. Once that happens, the movement from informal to formal economy with increased productivity will lead to higher GDP growth.

The tax to GDP ratio, which is currently at 16.6 per cent, would improve taking it closer to the Emerging Market average of 21 per cent. The improved fiscal condition could help the government allocate resources to build infrastructure, aid rural growth and provide sops for housing.

Due to the dis-inflationary nature of the event, the scope for the RBI to cut rates further has increased.

The sectors that have established supply chains like consumer staples, agri-products, telecom, etc. would see their working capital increase in the very short term (few weeks) as they manage their channels which are facing lack of availability of currency notes.

Retail NBFCs and micro finance institutions can see a short term (2-6 months) impact due to the lack of availability of currency. The intent and ability of their customers to repay and later borrow remains intact.

As land prices and real estate prices correct, there will be a negative wealth effect. This could impact purchase of white goods, home improvement products and two-wheelers for more than a year.

The four-wheeler segment would get affected in the medium term (six months to a year) as 20 per cent of its sales is through cash that would go down due to the negative wealth effect. The impact on commercial vehicles would also be medium term due to the slowdown in the business of fleet operators, though 95 per cent of sales are through financing.

The banks are clear beneficiaries, both in the short term and long term, as their CASA and deposits increase significantly. In addition, new customers could access banks for other needs like government subsidies, loans, transfers, payments and other services that are revenue-generating for the banks. In the short term, the fall in bond yields would lead to treasury gains for the banks. However, on the flip side, the increase in pension liability would affect some of the banks. The increase in NPAs in loans against property, wholesale loans, MSME loans would impact the asset quality of banks as well as housing finance companies in the medium term.

The long-term negative impact would be felt by real estate, jewellery and luxury goods sectors where usage of cash is the norm. The cement sector that derives over 60 per cent of its demand from real estate would also see a long-term impact. As prices become more affordable and interest rates fall, revival in the sector may be expected.

We expect the recovery in earnings to be pushed back into FY18 (from H2 FY17) until the impact of demonetisation wears off and implementation of the GST is done.

With the additional fiscal space, the government would increase expenditure to sectors related to infrastructure and rural India. The fall in land price across the country could add to the success of the initiative in housing. Growth from these segments would partly offset slowdown in consumption and private capex and create jobs in the economy.

Due to the demonetisation-induced slowdown and the risk-off emanating from the dollar strength and Fed rate hikes, markets could be weak in the short term. Now that correction is here, markets are providing a good entry point to investors with a medium to long-term view. In fact, the India story has just got even better.

The writer is a Co-Chief Investment Officer, Birla Sun Life Asset Management Company

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