Demonitization – Myths and Realty

Narendra Modi’s bold move on demonetisation of  Rs 500 and  Rs 1000  currency  note has resulted in a lot of misinformation that is being put out by the ignorant as well as by those opposed to demonetisation.

Right from the move hurting the common man to benefiting industrialists and banks writing off loans to a surge in government revenue, the misinformation has resulted in leaving many in a state of confusion on what to make out of the demonetisation move.

I have tried to put some of them at rest. The Myths and Realities of Demonetisation are given below.

Myths & Realities 

1. Myth – Demonetisation affects the common man , not the rich and the corrupt.

Reality –  The common man apart from being inconvenienced to stand in queue to deposit and withdraw cash is not affected. The common man has no undeclared income and demonetisation in no way affects him. However the rich and the corrupt who have undeclared income held in cash are affected substantially as the cash is worthless and if deposited in a bank is subject to 200% penalty plus regular taxes.

2. Myth- Banks are writing off loans of corrupt businessmen.

Reality– When an individual or a business does not pay back loan or service the interest on the loan to a bank, the bank makes provisions in its books. If the bad debt stays in the books for a certain period and still remains a bad debt, the bank takes the losses and writes off the loan. However in no way the bank has let the defaulter go. It will pursue the defaulter as long as the defaulter is alive. Demonetisation and bank bad debt write offs have no connection to each other.

3.Myth – Banks will make a lot of money on demonetisation.

Reality – Demonetisation results in cash which is outside the banking system coming back in the form of deposits. Given that there is a cap on withdrawal limit, initially deposits will surge but once the cap is removed, the money will go out as cash. For example if you hold Rs 50,000 are cash for various needs, you deposit Rs 50,000 in the bank but you can withdraw less than Rs 50,000 from your account, till the limits are removed. Since you need Rs 50,000 in cash, you will withdraw the Rs 50,000 fully and bank deposits will go down. Banks make money to the extent that deposits stay in savings account as they can deploy that money in treasury bills and gsecs or lend to the RBI. Since deposits are not likely to stay, banks profits on demonetisation are limited.

4. Myth – Government will see surge in Revenues as dividend from RBI

Reality – The demonetised Rs 500 and Rs 1000 notes account for over Rs 14 trillion of the Rs 17.5 trillion of currency in circulation. As mentioned earlier, all cash with the public that has been accounted for taxation, will be deposited with banks while cash that is unaccounted for taxation will not be deposited. At this point of time, there is no hard statistic on the amount of cash that is unaccounted. However for example if Rs 7 trillion is accounted and is deposited with banks and Rs  7 trillion is unaccounted and becomes worthless, RBI has to account for the Rs 7 trillion that it has printed but has now lost its legal tender status. RBI act does not allow the RBI to declare this as profit and pay the government a dividend. RBI will in all probability leave this money in its books and pass an accounting entry to account for the Rs  7 trillion of currency that has lost its legal tender.

5.Myth – Black money is held outside India, held as gold and real estate and demonetisation will not hurt the rich and corrupt

Reality – Black money is black money unless it comes back into the banking system in one form or another. A businessman taking money outside the country or buying gold or real estate, pays for the transaction in cash. The cash stays as cash as most of the counterparties in these transactions also do not pay tax. Unless the money is laundered, which is possible but not in huge scale, the black money stays black, only it changes hands. Demonetisation will hit all black money holders hard.

6.Myth – Rich are not standing in queue to deposit and draw cash, they are not affected.

Reality – The corrupt rich never stood in queues, they bought their way in through bribes. However, they are the most affected as all their wealth held in cash is now extinguished unless it is laundered. Laundering of money means more lies and more lies means more stress as explaining many lies to authorities is extremely difficult. The corrupt rich are sweating profusely.

True Impact of Demonetisation

The demonetisation move has been widely applauded by all sections of the society as an effective measure to curb counterfeit money, stop terror funding and penalise individuals who conceal income and not pay tax on it.

Real Estate and Jewellers are supposed to be the hardest hit as a major part of their business is in cash which may be undeclared by their customers.

While this may create some amount of distress in short term and some business may be impacted overall it is very good for the economy and businesses.

A cash cleanup will result in a slowdown and a decline in real estate prices , speculative forces in the commodities will reduce , inflation will fall which is highly positive for economic growth.

Political bigwigs and large hoarders of cash will not be able manage their huge cash pile which will be unreturned.The government’s liability of those unreturned notes to that extent will be  extinguished.

It depends on how it is accounted for as these are unusual events with few precedents  , but if it is a windfall gain to the government, one possibility is that they take a a huge dividend, which can be utilised either for infrastructure development or recapitalising PSU banks.

Huge infra spend along with fear of corruption is hugely positive for equity markets as there will be very little or no leakages in the system.

The Prime minister has also promised further measures to curb black money and it is expected that measures on benami property will come soon.

Gold is another avenue to store unaccounted cash so it is possible that they may come up with stringent action on jewellers accepting cash without Pan details.

If all the loopholes are eventually plugged, there will be less incentive to deal in cash in future and citizens will be forced to go the honest way whether it is out of compulsion or out of patriotism, the outcome  is the same.

There are unsubstantiated reports of the government intention to reduce corporate income tax slabs this budget if the fiscal math permits it. If that happens it will be big boost to corporates.

Banks are going to be flushed temporarily with funds, which will boost their bottom line to some extent. This psunami of cash which the banks will receive will force them to transmit the lower rates.

RBI also may be in a better position to cut rates if inflation falls and transmission will be quick.

Bond yields are supposed to rally as lower rates, increase in bank deposits will spur demand.

This is not to say all is well immediately. There will be pain which may get protracted for a while. The parallel cash economy is unofficially estimated to 40% of the GDP. Not all of it is black economy. Rural consumption is going to be hit at least for two to three weeks.

It will take time for people to go digital and cashless and get comfortable with it.

Also the unaccounted cash economy consumes too and that consumption will hit a roadblock forever. Some businesses are going to be affected adversely going forward, some may also go under. Businesses are fragile and some may not have access to equity or to credit to tide over a huge revenue loss for a few days.

Liquidity is the lubrication of trade and business, a complete dry up of cash liquidity is going to paralyse the unorganised sector at least for one quarter. A new business model will emerge and then there will be winners and losers which we will have to monitor closely.

But all in all a crackdown on black money and putting the fear of God on citizens of conceal income is going to be a positive for the long term and any opportunity market gives,you should buy on dips.

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