Decoding Demonetization: The Balanced View

December 2, 2016 0

In the last blog I talked about how demonetization looks like a TRUE socialist movement or policy created in independent India. The last 3 weeks has indeed been a rollercoaster ride for all of us. As politicians, activists, common people discussed, debated, criticized and accepted the move, memes, conspiracy theories and obnoxious WhatsApp messages and Facebook statuses spread like wildfire.

Even today the nation stands polarized and the good, bad and ugly about the move has rented our peace of mind.

After much conversation, coffee and analysis, my point of view now has some fineprints*. No, I am not releasing videos revolting against and abusing nor am I stupidly relating it to being anti-islamic (yes, high-end functioning brains have called it so), I am simply making amendments to it. The move is first in the line of some major changes we will see soon but for it to be truly impactful it needs to be followed up with some major reforms.

Before I jump to plausible reforms, let’s first look at demonetization at the base level followed by the effect it will bring around in various aspects.

DEMONETIZATION AT THE BASE LEVEL

There is nearly 15 lacs crore of Rs 500 and Rs 1000 notes which were in circulation when this began

Out of that, nearly 25% is accounted for i.e. white cash that people could explain

Additional 20% is now being converted into white money through various mechanisms by variety of Modi supporters, law abiding people (sometimes called cowards, sometimes victims) and others who have some option available to convert rupee for rupee

Of the remaining 55%, nearly 35-40% will get converted into new currency notes, albeit at a loss

The remaining 15-20% of currency will go out of circulation i.e. the owners losing this money

THE IMPACT THAT DEMONETIZATION WILL HAVE

Despite the euphoria, the move doesn’t really target black money all by itself. Currency notes are only 5-10% of the total black market. Considering a small percentage of this currency is being targeted, the total percentage impact of this change is minimal. All it does is render 15-20% of currently circulated currency worthless and convert another 20% currency into white. Please note that a lot of conversion happening right now is pure note change (black remaining black). And you could later withdraw money you just converted into white and make it black money anyway.

Though black money as cash is a small amount, all transactions take place through currency only. We don’t deal in gold or barter or any other mechanism while trading. Hence, controlling currency does provide a great deal of visibility into the entire market. Lesser currency available for transactions indeed acts as a huge catalyst to change.

Yes, this causes turmoil and by definition, inflation goes up. But this will be short term. In the long term, it will become a huge deflationary move.

This will break the back-bone of terrorism for the time being. How the government gears itself up to ensure it doesn’t crawl back up remains to be seen.

This is a huge catalyst to remove corruption from normal everyday middle class lives. And that’s the most significant of challenges facing Indian society today. By comparison, I think corruption is the biggest deterrent to a more improved standard of living. People, who have already started becoming more sensitive and less indulgent in corruption, will feel this as a shot in the arm.

By definition, this will lead to huge unemployment due to reduced labor hiring in the short term. Whether this causes base level fundamentals to shift or not is something that I am not able to predict at this point of time. Nevertheless, this will by far be the biggest challenge this government or the next government will face going forward.

There is a huge industry involved in black money management, which will cease to exist. Also, there is a large industry called as interest (people save money and businesses survive because of the owners having a fixed household income through interest).

Discretionary spending will do down tremendously. We are a hoarders’ economy and would never be comfortable spending white money for luxuries. And this fact alone should scare those in the luxury business. Restaurants, premium cars, luxury travel, fashion-branded clothing – everything will take a hit.

PLAUSIBLE REFORMS TO MAKE THE SHIP SAIL

Major tax reforms: Including simplification of tax structure and lower tax slabs. I expect highest tax slab to be 20% in 2018-19

Lowering of interest rates: Expect REPO rate to come down to 5% and housing loans to be available around 6%

De-regularizing of Rupee: Which means I can buy or sell Rupee anywhere

Real estate rates down to affordable levels, as defined above: I expect 30%+ drop in residential, 20% drop in commercial

Indian financial cycle to be changed to January-December: Keep up with the global cycle

Another demonetization to roll-outRs 2000 notes: Hence, all those who have converted black money to black end-up losing it all. I expect this change to happen in 6-9 months. It’s a Tom & Jerry show, only this time Tom wins!

Having said all this, I fear the fact that more money with government is more governance, which historically has always been a deterrent to growth. We come from a license based economy and will require a huge mindshift. I also fear about skills upgrade. I see the Skills India initiative but am not sure if it’s doing enough to get the right kind of trainings for the shift we are seeing here. If not done right, this can cause mayhem. With this, education will become way bigger of an industry than anything else.

Phew! I know this piece has become a tad bit long! But trust me, this is the perfect food for thought that you need while waiting in bank/atm lines!

I am planning on converting this blog post into a demonetization white paper and will appreciate your thoughts and inputs. Please provide them and I will consolidate it all.