Government action on currency to affect economy

Curb on black money to lead to drop in consumption levels

by Janhavi Behere

The government on Tuesday announced that Rs.1,000 and Rs.500 currency notes would not be legal tender with effect from 9th November 2016[see]. This announcement aims to curb corruption and limit black money in India.

Economic Affairs Secretary Shaktikanta Das stated that the rise in circulation of high-value currency was higher than India’s GDP. During 2011-2016, the circulation of all notes grew by 40 per cent. The circulation of Rs.500 rupee notes went up by 76 per cent and Rs.1,000 notes by 109 per cent. On the other hand, during 2011-2016, the economy expanded by just 30 per cent. Hence, the government decided to de-monetise notes of higher denomination.

The impact of this move can be categorised into the following broad areas:

  • Aggregate demand

    The immediate effect of the announcement led to a spurt in demand for gold. As investors tried to convert cash into gold, wholesalers increased gold prices by almost 23 per cent, as per media reports. During the previous de-monetisation scheme in 1978, jewelers had back-dated the sale of gold which helped in the conversion of black money and resulted in a spike in gold demand.

    However, the demand for gold will subside as cash reserves with people die down and black money transactions are curtailed. The PAN (permanent account number) disclosures have already curbed cash transactions over Rs.0.2 million. This move is likely to affect demand negatively in the long-run.

    Luxury cars are expected to see a dip in demand in the short-term.[see] Demand for two-wheelers is likely to be pushed over. Normally, demand rises during this period as farmers receive crop money after the harvest has reached the markets.

    Heavy amount of black money is also circulated in transactions for demerit goods such as liquor and tobacco. Stocks of Delta Corp, India’s only listed casino company, plummeted by 20 per cent.

    Investment demand is likely to be impacted as building material companies will see a slow down. Liquidity crunch coupled with a weakness in construction activity is likely to adversely impact real estate demand for metals. MSME/SME borrowers are also expected to see their cash flow getting impacted in the short term.

  • Banking and interest rates

    The de-monetisation move is expected to result in a temporary decline in money supply. As amount held in higher denomination ceases to be legal tender, currency in circulation will reduce.

    However, once the currency goes into the banking system, bank deposits will see a rise. If the magnitude of deposits exceed the rate at which notes are exchanged, money supply will rise.

    In case of a significant rise in money supply, the RBI is expected to engage in bond sales to reduce the excess liquidity as opposed to its present practice of buying bonds to keep liquidity neutral.

    Another fallout of this move will be its effect on bank lending rates. The credit-deposit ratio stood at 74.4 per cent by end-August 2016. As deposit mobilisation accelerates, banks will have to increase their credit offtake. In order to spur demand for credit, banks may reduce their MCLRs.

  • Inflation

    Decline in money supply in the short-term may lead to a deflationary trend across items. In addition, the shadow economy, which generates inflation, will also be affected by the move.

    Also, the housing component of the CPI may come under pressure. Share of housing in CPI stands at 10.1 per cent. Demand for real estate which was already muted is likely to be hit as the sector is pulled into the institutional framework.[see]

CMIE STATISTICS
Unemployment Rate
Per cent
5.5 -0.0
Consumer Sentiments Index
Base September-December 2015
94.7 0.0
Consumer Expectations Index
Base September-December 2015
96.5 0.0
Current Economic Conditions Index
Base September-December 2015
91.9 0.0
Quarterly CapeEx Aggregates
(Rs.trillion) Mar 16 Jun 16 Sep 16 Dec 16
New projects 3.31 1.54 2.34 1.42
Completed projects 2.26 0.90 2.15 0.76
Stalled projects 1.04 1.32 0.35 0.44
Revived projects 0.63 0.42 0.51 0.17
Implementation stalled projects 0.92 0.50 0.57 0.79
Updated on: 23 Feb 2017 9:20AM
Quarterly Financials of Listed Companies
(% change) Mar 16 Jun 16 Sep 16 Dec 16
All listed Companies
 Income -0.2 -0.9 2.1 6.4
 Expenses 0.9 -0.4 1.8 6.7
 Net profit -29.1 -3.5 15.3 36.9
 PAT margin (%) 4.9 6.9 7.0 6.0
 Count of Cos. 4,395 4,353 4,313 4,204
Non-financial Companies
 Income -2.1 -2.5 0.6 6.1
 Expenses -3.9 -2.9 -0.2 7.7
 Net profit 4.8 10.3 27.5 21.0
 PAT margin (%) 6.2 7.4 7.0 6.1
 Net fixed assets 3.8 -9.2
 Current assets 3.1 8.1
 Current liabilities 10.6 11.5
 Borrowings 6.7 3.1
 Reserves & surplus 7.9 8.6
 Count of Cos. 3,455 3,426 3,393 3,316
Numbers are net of P&E
Updated on: 23 Feb 2017 9:28AM
Annual Financials of All Companies
(% change) FY13 FY14 FY15 FY16
All Companies
 Income 11.9 9.3 4.3 0.2
 Expenses 12.1 9.2 4.3 0.3
 Net profit 1.0 -4.2 2.7 -12.1
 PAT margin (%) 3.6 3.2 3.3 3.4
 Assets 14.1 12.2 8.9 7.7
 Net worth 9.5 9.4 8.2 6.2
 RONW (%) 6.8 6.0 6.1 5.7
 Count of Cos. 23,087 20,259 18,916 14,317
Non-financial Companies
 Income 11.1 8.9 3.3 -1.1
 Expenses 11.4 8.6 3.4 -1.9
 Net profit -8.9 -5.6 -3.6 14.1
 PAT margin (%) 2.4 2.1 2.2 3.1
 Net fixed assets 12.9 11.3 12.3 10.8
 Net worth 7.7 8.3 6.6 5.0
 RONW (%) 5.4 4.8 4.8 6.1
 Debt / Equity (times) 1.1 1.1 1.1 1.0
 Interest cover (times) 2.0 1.9 1.9 2.1
 Net working capital cycle (days) 71 69 68 68
 Count of Cos. 17,721 15,860 14,813 11,415
Numbers are net of P&E
Updated on: 21 Feb 2017 3:48PM

Low government spending and low consumer expectations to keep growth subdued

Modest increase in capital expenditure; no incentive to private players

Rs.5.34 trillion or 3.2% of GDP