Demonetisation

Assessment of Macro & Sectoral Impact

November 2016

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 Index
 Macro Impact…………………………………………………………………………………………………3

 Sectoral Impact……………………………………………………………………………………………..9
 Financials
 Real Estate
 Oil & Gas
 Consumption
 Infra
 Hospitality
 Auto
 Others

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 Macro Impact

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Brief Background on the 2016 Demonetisation Announcement…
 The government on 8th November announced that INR500 and INR1000 notes will cease to
be legal tender immediately

 The move is aimed at controlling black-money, fake currency circulation and terror
financing

 India has amongst the highest levels of currencies in circulation at 13% of GDP (vs. EM
average of 4%)

 Some important numbers to bear in mind:

 Notes in circulation as of Nov 4, 2016: Rs. 17,742 bn (13% of GDP)

 Value of 500/1000 notes in circulation (@86.5% of notes in circulation): Rs.15,347 bn

(11% of GDP)

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India’s Past Experience with Demonetisation…
 India has carried out demonetisation exercises twice before, in 1946 and 1978
 In the Jan-1978 episode, currency worth INR1.46bn (1.7% of total notes in circulation)
was demonetised. Of this INR1.0bn (or 68%) was tendered back
 The impact of the demonetisation exercise was as follows:
Variable Impact
Deposit Growth Rose sharply
Currency in Circulation Moderated sharply
SLR securities Sharp increase in investment in government securities by banks
Credit Growth Initially subdued but started picking up after 4 months (by May 1978)
No major impact as high-denomination notes which were cancelled
GDP Growth
only accounted for 0.1% of GDP

In 1978 the value of demonetisation was very small (only 0.1% of GDP).
However, the 2016 demonetisation efforts covers 86% of the total currency in
circulation (11% of GDP). Hence, this is a substantially more widespread
exercise which will have far reaching implications
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Impact on Macro Variables in the near-term (3-6 months)…
Impact (3-6
Variable Comments
months)
In the near-term, this move will hurt economic activity across sectors with
pronounced slowdown across sectors irrespective of the extent of usage of cash. Risk
GDP Negative aversion is likely to inch up manifold. Over the next 6 months, most sectors (exceptIT
& Pharma) will face growth challenges, and in particular hurt discretionary spends,
gold and real estate purchases.

Downward pressure on prices due to lower demand, especially in rural areas where
Inflation Positive
share of cash transactions is high

Improved liquidity in the banking system will be positive for lending rate cuts. The
Liquidity & possibility of 50bps of rate cut by the RBI has also opened up if demand slowdown
Positive
Rates becomes severe. This should further support decline in G-sec yields (10 year G-sec
yield has already declined 30bps)
Neutral to Discretionary consumption slowdown is likely to impact non-oil non-gold imports.
Current Account
Slightly After the initial surge in gold demand (as cash is converted to gold), gold imports
Deficit (CAD)
Positive should also start to slow. Thus, the decline in imports should be positive for CAD
Most of the gains (higher direct tax collections and RBI surplus if any) will accrue in
FY18. On the other hand, indirect tax collections is likely to be impacted in the near-
Fiscal Deficit Negative
term due to demand slowdown. Thus, there is going to be near-term pressure on
government finances

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Impact on RBI’s Balance Sheet and its Implications…(1/3)
 The RBI balance sheet as of Nov 4th is given below:
Liabilities Rs. Bn Assets Rs. Bn
Notes in Circulation 17,742 Foreign Currency Assets 23,156
Deposits 5,743 Gold Coin & Bullion 1,368
- Govt. 1 Govt. Securities 7,562
- Scheduled Commercial Banks 4,095 Loans & Advances 468
- Others 1,647 - Govt. 43
Other Liabilities 9,217 - Scheduled Commercial Banks 371
- Others 54
Other Assets 147
Total 32,702 32,702

 To understand the impact on RBI’s balance sheet, we first put out some numbers and
assumptions:
 Value of notes in circulation as of Nov 4, 2016: Rs. 17,742 bn
 Value of 500/1000 notes in circulation (@86.5% of notes in circulation): Rs.15,347 bn
 Assuming 20% of the 500/1,000 notes are not tendered back (“black money”): Rs.3,069 bn
 Amount flowing back to banking system after demonetization: Rs.12,277 bn
 Durable deposits (assuming 20% of the money deposited in banks is not withdrawn as cash):
Rs.2,455 bn

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Impact on RBI’s Balance Sheet and its Implications…(2/3)
 The impact on RBI’s balance sheet is likely to be as follows:
 We have assumed ~Rs. 3 trillion will disappear from the system. So currency in circulation will
come down by the same amount
 We have also assumed that the remaining Rs.12 trillion will get deposited with banks. However,
of this 80% will be eventually withdrawn while 20% will remain with the banks as deposits
 Thus currency in circulation will further come down by Rs.2.4 trillion (80% of Rs.12 trillion)
 Thus, total decline in currency in circulation = Rs.3 Trillion + Rs.2.4 Trillion = Rs. 5.4 Trillion
 Banks will get durable deposits of Rs.2.4 Trillion (20% of Rs. 12 Trillion). Thus, Scheduled
Commercial Bank deposits with the RBI will increase by Rs.2.4 Trillion
 Thus, the net effect is that RBI’s liabilities will decline by Rs. 3 Trillion
 New RBI Balance Sheet
Liabilities Rs. Bn Assets Rs. Bn
Notes in Circulation 12,218 Foreign Currency Assets 23,156
Deposits 8,198 Gold Coin & Bullion 1,368
- Govt. 1 Govt. Securities 7,562
- Scheduled Commercial Banks 6,550 Loans & Advances 468
- Others 1,647 - Govt. 43
Other Liabilities 9,217 - Scheduled Commercial Banks 371
- Others 54
Other Assets 147
Total 29,633 32,702
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Impact on RBI’s Balance Sheet and its Implications…(3/3)
 We know that RBI’s liabilities will decline by Rs.3 trillion. Now two options are available to the
RBI to ensure that assets match liabilities:

 Option 1: The RBI gives Rs. 3 trillion to the Govt. as “special dividend”. In this case, Govt.
deposits with the RBI increases by that amount and thus total RBI liabilities match total
assets

 Option 2: RBI cancels old debt of government on its balance (its assets decline by Rs.3
trillion) or creates a contingency reserve (its liabilities increase by Rs.3 trillion)

 If Option 1 plays out, then the drag on growth is likely to be short-lived and we are likely to
seen a sharp rebound in economic activity in FY18 as govt. is likely to undertake significant
fiscal stimulus

 If Option 2 plays out, then the drag on growth could extend beyond two quarters

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Can a “Special Dividend” be provided to the government?

 The only answer that will determine whether growth (after the initial slowdown) can
see a sharp rebound in FY18 is: Will the Government get large windfall gains to
undertake fiscal stimulus?

 As per Ex-Governor Rangarajan, the profits that are made by the RBI are essentially
out of the current transactions

 There is “no capital gain or capital loss” as far as the RBI is concerned. Therefore
there is no scope for any extra dividend to be declared to the Government. The
RBI act has to go through amendments to make it possible

 Globally also, in the past demonetisation episodes, Central Banks have chosen to
reduce the asset side of their B/S. Thus, there is little precedence of windfall gains
accruing to the Government

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Growth subdued but domestic liquidity bazooka to banks……
 While the demonetisation exercise is growth negative, a major positive is the improvement in
domestic banking system liquidity

 The improvement in domestic liquidity conditions is visible in the following:

 Indian govt. bond market has rallied sharply since Trump’s victory in sharp contrast to
the negative bond action seen globally (36bps decline in 10-year G-sec so far)

 Money market rates (3M and 12M CP rates) have also declined by 50bps

 Banks have cut MCLR rate by 20bps

 With RBI looking increasingly likely to cut policy rate, lending rates should come down
further

 Thus, the next couple of months appears to be a good time for Corporates to raise money

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 Demonetisation Impact on relevant sectors

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Demonetisation - Sectoral Impact – Summary

Sector Medium Term Impact

Financials - Banks Marginally Positive

Financials – NBFCs Mixed – Divergent across Segments

Real Estate Negative

Oil & Gas Neutral

Consumption – Staples Neutral

Consumption – Discretionary Negative

Infrastructure Slightly Negative

Hospitality Negative

Autos & Auto Ancillaries Negative

Others Divergent across Segments

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Demonetisation Impact
Financials Real Estate Oil & Gas Consumption Infra Hospitality Auto Others

Sector Impact Comments

 Increased share of savings moving to banks; high CASA ratio (lower

cost of funds)
Marginally  Lower bond yields resulting in high treasury gains (particularly PSU
Banks
Positive banks)
 However, negative from credit growth perspective and asset quality
challenges (banks with high SME exposure)
 Housing Finance: Negative: LAP/developer loans may see increased
delinquencies ; underlying demand slowdown to affect credit growth
 Auto Finance: Negative: ~60-70% transactions are done in cash; resale
values likely to come down for vehicles; Asset quality issues to worsen
Divergent
NBFCs impact on  Gold Finance: Positive in medium term – Near term disbursements to
sub-sectors get hit as high cash dealing; However, ~75% of gold lending is from
unorganized segment which will gradually shift to organized players
 Micro finance: Positive in medium term – ~70% transactions done in
cash; Near term disbursements/collections to get hit; However,
positive in medium to long term as borrowers shift to bank accounts

Views compiled from Jefferies, CLSA, CSFB, CRISIL, ICRA & management interactions
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Demonetisation Impact
Financials Real Estate Oil & Gas Consumption Infra Hospitality Auto Others

Sector Impact Comments

 Very negative for residential space, land deals. Limited impact on

commercial transactions, hospitality or retail
 Greater impact on small builders, and in specific cities / (Tier 2/3 cities,
NCR etc.) / micro markets where cash dealing was more prevalent.
Resale properties impacted more than primary sales.
 Organized builders may also face demand slowdown in near term.
Another view is, if supply of resale properties declines due to price crash,
Real Estate Negative it may favourably impact primary sales.
 Registered prices in residential may go up to adjust for cash component
 Execution of ongoing projects will be affected, and some developers
may face serious fund crunch
 Positive in long term: De-monetisation coupled with Real Estate
Regulation Act, Benami Act and GST, will transform RE sector in longer
term. Key positives expected - increased transparency, improved
investor confidence, better access to funding, higher FDI likely.

Consensus views compiled from Real Estate consultants - Knight Frank and JLL; analysts – Jefferies, Edelweiss; rating agencies – Crisil, Fitch
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Demonetisation Impact
Financials Real Estate Oil & Gas Consumption Infra Hospitality Auto Others

Sector Impact Comments

 Temporary pick up in demand due to significant pre-buying of

auto fuels
a) Petroleum &
Slightly negative  Over medium term, demand, especially for personal
petroleum products
transportation could be somewhat negatively impacted due to
high proportion of cash transactions

 Largely unimpacted, the demand for CNG might get slightly hurt
b) Citi Gas Neutral
where cash transactions are high

Views compiled from Edelweiss & Jefferies

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Demonetisation Impact
Financials Real Estate Oil & Gas Consumption Infra Hospitality Auto Others

Sector Impact Comments

 Given the need based demand and small purchase tickets, the
impact on demand would be muted
a) Consumer Staples Neutral
 However, the move should benefit organized retail and hamper
the market for local counterfeit goods
 Sales likely to be hampered over short-term, especially sales
b) Consumer through unorganized channels as cash purchases (~70-75% of
Slightly negative the overall sales) take a hit
Durables
 However sales through online retail should pick up relatively

 The adverse wealth effect will likely hurt higher end

c) Consumer discretionary demand.
Negative
Discretionary  At the same time lower rates should provide a buffer in the
medium term

 Most of the purchases by retailers are through cash which may

d) Liqour Slightly negative
bring down volume in the near term

Views compiled from Edelweiss, Jefferies & Crisil

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Demonetisation Impact
Financials Real Estate Oil & Gas Consumption Infra Hospitality Auto Others

Sector Impact Comments

 Most of these projects have big ticket sizes and revenue is from
larger corporate houses and government authorities, which do
a) EPC/ bank transaction
Construction Neutral
 However, for small contractors, due to cash crunch there will be
some disruption in medium term
 Toll collection, which are mainly done in cash, may see some
hiccups in short-term
 Likely to be negatively impacted as the underlying real estate
b) Building Material demand (~60-65% of consumption) will be severely impacted
Negative due to curtailment of black money
(Cement , Paint ,
Tiles etc.)  Large part of transactions done in cash in segments like paints,
hence likely to be negatively impacted

Views compiled from Edelweiss, Jefferies & Crisil

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Demonetisation Impact
Financials Real Estate Oil & Gas Consumption Infra Hospitality Auto Others

Sector Impact Comments

 Demand to be impacted due to slowdown in Domestic

Travel
Hotels Negative
 Near Term Impact on Corporate Travel whereas
Inbound demand to remain unaffected
 Domestic Leisure Travel: Severely impacted as majority
of spending is in cash
 Corporate Travel: There maybe temporary slowdown in
corporate travel due to cash crunch
Tour Operators Negative
 Inbound: Inbound travel to remain unaffected
 Outbound: Outbound travel through unorganized
players impacted as foreign exchange usage abroad is
mostly in cash

Views compiled from Edelweiss & management interactions (Cox & Kings)
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Demonetisation Impact
Financials Real Estate Oil & Gas Consumption Infra Hospitality Auto Others

Sector Impact Comments

 Two Wheelers: High impact on 2 wheeler sales as large % of rural 2W

transactions are in cash, % transactions backed by loans is lower
 Passenger Vehicles: Short term impact due to purchase deferment;
demand will revive in medium term.

Autos & Auto

Ancillaries
Negative Text
 Luxury cars & SUV: Sales will see significant impact due to wealth
deterioration and decline in rural transactions (cash based)

 Commercial Vehicles: Negatively impacted. 2nd hand truck sales, which

had higher % of cash transactions, will decline sharply (both number of
transactions and pricing)

 Tractors: Demand to be materially impacted; plus questionable trade

practices like over-invoicing to moderate

Consensus views compiled from analysts - Jefferies, Edelweiss; rating agencies - Crisil and Fitch
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Demonetisation Impact
Financials Real Estate Oil & Gas Consumption Infra Hospitality Auto Others

Sector Impact Comments

 Elongated working capital cycles for Multi System
Operators (MSOs) due to cash dealings of Local cable
Media – Cable TV Negative operators (LCOs)
 ARPU growth may be delayed and Bad debts may
increase due to payment delays by LCOs
print) will impact ad revenue growth fo
Media – Print T  Slowdown in real estate (major advertiser in regional
Negative e
media x print) will impact ad revenue growth for Print media
t

Demand slowdown
 Demand slowdown from from endsuch
end consumers consume
as auto,
white goods and construction(residential) is likely to
Metals
white
Negative
goods anddomestic
result in lower construction(resident
volumes.

result in Pressure

lower domestic
on debt volumes.
servicing for leverage
companies due to drop in volumes
metal

Pressure on debt servicing for leverage

Views compiled from Edelweiss & Ambit Capital

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