Demonetization: Merging into the mainstream


For last few weeks, Demonetization has hogged the headlines. So much so that the most talked event for the year US Presidential Election has faded in the background. The election outcome, despite being completely unexpected, has not been able to wrestle back the attention.

What does “Demonetization” mean for us as investors?

Let us start with the basics:

As you are reading this, why not pick a note from your wallet and look at it closely. You will notice a statement (I promise to pay the bearer the equivalent sum) signed by the RBI Governor. This essentially mean RBI owes this much amount to you.

In total, almost Rs 18 lakh crore was owed in cash, by RBI to all of us. 85% of this cash (in the form of Rs 500 and 1000 note) has been demonetized which means it has lost its status as valid money. The consequence of this will be dependent on how people behave in next 50 days.
So how would people possibly behave in next few days? They could

Option 1: Exchange and run their daily lives (analyst are expecting it could be in the range of 7 lakh crore)
Option 2: Dump the money (estimates are in the range of 5 lakh crore)
Option 3: Launder but bring it back in the banking system (balance to make up the rest)

If the news of money being burnt is correct, analysts estimate this dumping bucket could be around 25% of total. This means almost 5 lakh crore of RBI’s liability will be gone from the balance sheet (almost same as India’s Fiscal Deficit last year).

This will also mean close to 10 lakh crore will be deposited in the banking system. (almost double of the total NPA across all banks in India).

It is not going to be all rosy though. In short term, liquidity crunch will have an impact on the demand. Some of the sectors, such as real estate, consumer durables, luxury etc, are going to be hit badly. Overall GDP is also expected to take a hit in short term.

To stimulate demand, RBI is expected to cut the interest rates down further. Government is also expected to take fiscal measures by increasing infrastructure spending.

Some of these expectations are already reflecting in the market. Long Term Debt is doing phenomenally well. Equity, has shown some volatility in last few days, is expected to do well as unorganized economy will start getting merged into the mainstream.

Unorganized to organized, side stream to mainstream – will play out not just in the cashflows but also in investment world.

Question you have to ask yourself – are my investments aligned the right way?

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