Demonetization: India's economy unlikely to improve till mid-2018, says Motilal Oswal

 

Motilal Oswal, one of India’s topmost financial services firms, has predicted that the economic growth of the economy is likely to slow down in the second half of 2017, and is unlikely to improve in the next one year because of demonetization of Rs 500 and Rs 1000 notes. In a sector update, it says, “Overall, while economic growth in the second half of 2017 could be lower than expected, fundamentals of the economy should improve from the second half of 2018.”
Noting that on two earlier times when demonetization was announced – in 1946, just before Independence, and 1978 – it had little impact, as the notes that were withdrawn, of Rs 1,000 and Rs 10,000 (both in 1946 and 1978) and of Rs 5,000 (in 1978) were of high-value and “rarely held by the common public.”
Thus, in 1978, the macroeconomic impact was “negligible”, the firm recalls. “Real GDP growth was 7.7% in financial year 1978 and 7.5% in financial year 1979”, while the “industrial sector grew ~6% and 11% in these two years.”
As for the current demonetization of Rs 500 and Rs 1,000 notes, the firm says, they account for over 86% (or Rs 15 trillion) of the total currency in circulation (over Rs 17 trillion). Unlike in 1946 or 1978, these are held by almost every Indian for day-to-day purchases.”
“The weekly household grocery bill in a tier-II city could easily be INR500”, it says, adding, “Given the ubiquity of the demonetized notes, this time, the impact could be significant.”

Therefore, the firm says, “For a common household, virtually everything from grocery to maid services is paid for in cash. According to some estimates, almost 80% of the economy still runs on cash. The decision will, therefore, leads to some suffering for all in the next few weeks.”
It adds, “Not only Indian citizens, but foreigners (traveling in India) too will face difficulty – tourism might be adversely affected.”

At GPO Ahmedabad

“Our interactions with the management of non-banking financial companies (NBFCs)/ Banks and people in the value chain suggest that the loans against property and construction finance segments are more vulnerable to the demonetization Rs 500/1,000 notes”, the firm points out.
“In the microfinance (100% cash), and gold and vehicle finance (partially in cash) segments, collections and disbursements will be impacted”, it says, adding, “NBFCs and banks are contemplating suitable representations to the RBI.”
“For banks, near-term administrative hassles and resultant loss of management bandwidth would impact near-term asset growth”, the firm says, adding, “Reserve Bank of India (RBI) decision on allowing NBFCs to accept old denomination notes and normalization of liquidity in the market with circulation of new denomination notes are the key things to watch out for in the near term.”
“As many NBFCs, especially those in rural and semi-urban geographies, deal in cash, there could be temporary issues with respect to disbursements and collections”, the firm says, adding, “Growth could slow down and there could be asset quality problems in the shorter term.”
It further says, “Cash collections could get delayed. NBFCs whose collections come from post-dated cheques (PDC)/ electronic cash systems (ECS) would not be impacted much.”
In case of banks, the firm says, “administrative hassles are likely to take maximum bandwidth, impacting asset growth in the near term. Some risk in loan against property (LAP) and vehicle finance segments NBFCs, housing finance companies (HFCs) and Banks dealing in loans against property (LAP) could see some volatility with respect to collections, as most of their borrowers are small traders who do a significant portion of their business in cash.”
“This is also true for vehicle finance players in semi-urban and rural markets, where cash is the primary source of repayments. This could pose temporary asset quality issues”, the firm predicts, adding, “However, disbursements/ collections by cheque/ electronic transfer would be unaffected.”
“Resumption of business as usual would depend on how quickly and effectively the new currency comes into circulation, as liquidity is key for most borrowers”, the firm says, adding, “Most small traders deal in cash on a day-to-day basis. We expect some uncertainty over the medium term. We also await clarity from RBI on developments of the same.”
“On the positive front”, the finance firm notes, the step would “encourage electronic transactions”, adding, “Over time, the tax base should widen, boosting tax collection”, though noting, it would “dampen purchase of high-ticket items.”