There have been several negatives that have been spread about DEMONETIZATION over the last few days, largely by opposition politicians and some by left leaning economists. The primary among them are, how will the introduction of Rs 2000 notes by replacing Rs 1000 and 500 notes address the issue of Black Money generation. The second being that most of the black money lies in the form of assets i.e. land and gold and as such Demonetization will not help as such. I will address both of these points. The other issue is of sensationalism by a few brokerages that are playing on the public’s mind by pushing out growth figures of 3-4% and also shouting RECESSION. I will address that too in this article.
- If Rs 2000 notes replace higher denomination notes how does that help – This is the big myth being floated around by many. The total value of Rs 1000/500 notes in the system is around Rs 15 Lakh Crores. Out of this Rs 6 lakh crores has already been deposited in just 10 days (a big achievement). Many estimate that Rs 300000 Cr will not come into the system and will get extinguished. That means that 50% of what was to come in 50 days has come in just 10 days. Now what everyone needs to understand is that once the entire money comes into the banking system the replacement into new Rs 500/2000 notes will now happen through the banking channel. This means to start with as on 1st of January almost the entire stock of old cash becomes “White Money”. Now black generated over decades suddenly will become entirely white. It does not matter what denomination of notes replace the old notes at least for the next 10-15 years. Why will people want to convert their white money into black? It makes no sense. As such if the note replacement is accompanied by institutional changes to control corruption and discretionary powers then new generation of black money will be extremely slow and muted. As such do not believe the sensationalism around the Rs 2000 note.
- Since most of the black assets are in assets how will converting cash help- This is a very important point to understand. Now there might be a huge stock of undeclared assets that people hold. However the transactions in these assets happen via currency. For example if someone built a black asset like land which costs Rs 100 by giving Rs 30 in cheque and Rs 70 by cash. Now after DEMONETIZATION he will not be able to sell this land to a buyer in the same proportion. The buyer after the currency exchange would have all the money via the bank i.e. white money. So why would a purchaser want to convert his white into black. He would not. Also if demonetization is followed up by measures like monitoring high value cash withdrawals and potentially putting some limit on cash in hand holdings then this will become even tougher. Let’s take another example of Gold. There is a huge stock of Gold bought by cash in India. However this is the stock of gold. After the DEMONETIZATION process a new buyer who has all the new money via the bank accounts will not want to buy gold in cash. If PAN declaration norms are followed strictly this route of parking black money will also become unattractive and difficult to implement. As such the stock of assets does not matter much when the currency or the mode of transacting those assets has been addressed.
The next big sensationalism is around the dramatic predictions around growth slowdown due to demonetization. While it is true that the initial slow down has been severe, mainly due to the shock impact the sensationalism around the slowdown is unlikely to play out. As more and more people realize that their wealth has not gone down and as the liquidity of new notes comes back into the system the restoration of confidence will be very swift. Already we see that in the metros people have started going back to their normal consumption patterns. It is true that the impact in rural areas which are under banked and in many cases unbanked has been quite severe, however it will also normalize very fast as people realize that they have got back their money in the form of new currency. As such the impact will not go beyond a couple of months vis a vis 15-18 months that many are propounding. The other factor is that demonetization will create huge disinflationary conditions in the Indian Economy and as such lead to much lower interest rates, easier liquidity and possibility of lower personal income taxes as well as a potential Fiscal Stimulus.
The forecasters of doom conveniently forget these positives and are just extrapolating what they see today into the future by making projections like- it will take more than six months to replace the currency, consumption will come back only after 12-18 months etc. The fact is that many people were holding much more cash than they needed and this will lead to them holding only as much as required right now. This will bring in sustainably higher liquidity into the banking system. All of you need to realize that your wealth remains the same. Today there is low confidence as people cannot freely access their money. As that confidence returns over the next 10 days, combined with lower interest rates and lower inflation the bounce back in consumption will be fast.
I will write more later, however I have tried to address some relevant issues in this article. The main issue in the mind of people is that the corrupt will remain the corrupt and the main target of this exercise might not be achieved. Let see what Narendra Modi does on this front. However I will logically not make that assumption as this exercise will have a significant follow up to achieve the targets. In any case the facts related to better wealth impact due to pay commission implementation, better farm incomes on good crop and stronger prospects as well as economic activity boosting actions by the government post 1st of January will be real factors which will come in. There is no doomsday; the future is much brighter than what many think.