Demonetization of currency (1)

Demonetisation
Assessment of Macro & Sectoral Impact
November2016

Index
Confidential 3
 Macro Impact 3
 Sectoral Impact 9
 Financials
 Real Estate
 Oil & Gas
 Consumption
 Infra
 Hospitality
 Auto
 Others

Brief Background on the 2016 Demonetisation Announcement…
Confidential 5
 The government on 8th November announced that INR500 and INR1000 notes will cease to
be legal tender immediately
 The move is aimed at controllingblack-money, fake currency circulation and terror
financing
 India has amongst the highest levels of currencies in circulation at 13% of GDP (vs. EM
average of 4%)
 Some important numbers to bear in mind:
 Notes in circulation as of Nov 4, 2016: Rs. 17,742 bn (13% ofGDP)
 Value of 500/1000 notes in circulation (@86.5% of notes in circulation): Rs.15,347 bn
(11% of GDP)

 India has carried out demonetisationexercises twice before, in 1946 and 1978
 In the Jan-1978 episode, currency worth INR1.46bn (1.7% of total notes in circulation)
was demonetised. Of this INR1.0bn (or 68%) was tenderedback
 The impact of the demonetisationexercise was as follows:
Confidential 6
India’s Past Experience with Demonetisation…
Variable Impact
Deposit Growth Rose sharply
Currency in Circulation Moderated sharply
SLR securities Sharp increase in investment in government securities by banks
Credit Growth Initially subdued but started picking up after 4 months (by May 1978)
GDP Growth No major impact as high-denomination notes which were cancelled
only accounted for 0.1% of GDP
In 1978 the value of demonetisation was very small (only 0.1% of GDP).
However, the 2016 demonetisation efforts covers 86% of the total currency in
circulation (11% of GDP). Hence, this is a substantially more widespread
exercise which will have far reaching implications

Impact on Macro Variables in the near-term (3-6 months)…
Confidential 7
Variable Impact (3-6
months)
Comments
GDP Negative
In the near-term, this move will hurt economic activity across sectors with
pronounced slowdown across sectors irrespectiveof the extent of usage of cash. Risk
aversion is likely to inch up manifold. Over the next 6 months, mostsectors (exceptIT
& Pharma) will face growth challenges, and in particular hurt discretionary spends,
gold and real estatepurchases.
Inflation Positive
Downward pressure on prices due to lower demand, especially in rural areas where
shareof cash transactions is high
Liquidity&
Rates
Positive
Improved liquidity in the banking system will be positive for lending rate cuts. The
possibility of 50bps of rate cut by the RBI has also opened up if demand slowdown
becomes severe. This should further support decline in G-secyields (10 year G-sec
yield has already declined 30bps)
CurrentAccount
Deficit(CAD)
Neutralto
Slightly
Positive
Discretionary consumption slowdown is likely to impact non-oil non-gold imports.
After the initial surge in gold demand (as cash is converted to gold), gold imports
should also start to slow. Thus, the decline in imports should be positive for CAD
FiscalDeficit Negative
Most of the gains (higher direct tax collections and RBI surplus if any) will accruein
FY18. On the other hand, indirect tax collections is likely to be impacted in the near-
term due to demand slowdown. Thus, there is going to be near-term pressure on
government finances

 The RBI balance sheet as of Nov 4th is given below:
 To understand the impact on RBI’s balance sheet, we first put out some numbers and
assumptions:
 Value of notes in circulation as of Nov 4, 2016: Rs. 17,742 bn
 Value of 500/1000 notes in circulation (@86.5% of notes in circulation): Rs.15,347 bn
 Assuming 20% of the 500/1,000 notes are not tendered back (“black money”): Rs.3,069 bn
 Amount flowing back to banking system after demonetization: Rs.12,277 bn
 Durable deposits (assuming 20% of the money deposited in banks is not withdrawn as cash):
Rs.2,455 bn
Impact on RBI’s Balance Sheet and its Implications…(1/3)
Liabilities Rs. Bn Assets Rs. Bn
Notes inCirculation 17,742 Foreign CurrencyAssets 23,156
Deposits 5,743 Gold Coin &Bullion 1,368
-Govt. 1 Govt.Securities 7,562
- Scheduled CommercialBanks 4,095 Loans & Advances 468
- Others 1,647 -Govt. 43
Other Liabilities 9,217 - Scheduled CommercialBanks 371
- Others 54
Other Assets 147
Total 32,702 32,702
Confidential 8

 The impact on RBI’s balance sheet is likely to be as follows:
 We have assumed ~Rs. 3 trillion will disappear from the system. So currency in circulation will
come down by the same amount
 We have also assumed that the remaining Rs.12 trillion will get deposited with banks. However,
of this 80% will be eventually withdrawn while 20% will remain with the banks as deposits
 Thus currency in circulation will further come down by Rs.2.4 trillion (80% of Rs.12 trillion)
 Thus, total decline in currency in circulation = Rs.3 Trillion + Rs.2.4 Trillion = Rs. 5.4 Trillion
 Banks will get durable deposits of Rs.2.4 Trillion (20% of Rs. 12 Trillion). Thus, Scheduled
Commercial Bank deposits with the RBI will increase by Rs.2.4 Trillion
 Thus, the net effect is that RBI’s liabilities will decline by Rs. 3 Trillion
 New RBI Balance Sheet
Confidential 9
Liabilities Rs. Bn Assets Rs. Bn
Notes inCirculation 12,218 Foreign CurrencyAssets 23,156
Deposits 8,198 Gold Coin &Bullion 1,368
- Govt. 1 Govt. Securities 7,562
- Scheduled CommercialBanks 6,550 Loans &Advances 468
- Others 1,647 - Govt. 43
Other Liabilities 9,217 - Scheduled CommercialBanks 371
- Others 54
Other Assets 147
Total 29,633 32,702

 We know that RBI’s liabilities will decline by Rs.3 trillion. Now two options are available to the
RBI to ensure that assets match liabilities:
 Option 1: The RBI gives Rs. 3 trillion to the Govt. as “special dividend”. In this case, Govt.
deposits with the RBI increases by that amount and thus total RBI liabilities match total
assets
 Option 2: RBI cancels old debt of government on its balance (its assets decline by Rs.3
trillion) or creates a contingency reserve (its liabilities increase by Rs.3trillion)
 If Option 1 plays out, then the drag on growth is likelytobe short-livedand we are likely to
seen a sharp rebound in economic activity in FY18 as govt. is likely to undertake significant
fiscal stimulus
 If Option 2 plays out, then the drag on growth could extendbeyond two quarters
Confidential 10

 The only answer that will determine whether growth (after the initial slowdown) can
see a sharp rebound in FY18 is: Will the Government get large windfall gains to
undertake fiscal stimulus?
 As per Ex-Governor Rangarajan, the profits that are made by the RBI are essentially
out of the current transactions
 There is “no capital gain or capital loss” as far as the RBI is concerned. Therefore
there is no scope for any extra dividend to be declared to the Government. The
RBI act has to go through amendments to make it possible
 Globally also, in the past demonetisation episodes, Central Banks have chosen to
reduce the asset side of their B/S. Thus, there is little precedence of windfall gains
accruing to the Government
Confidential 11
Can a “Special Dividend” be provided to the government?

Growth subdued but domestic liquidity bazooka to banks……
Confidential 12
 While the demonetisation exercise is growth negative, a major positive is the improvement in
domestic banking system liquidity
 The improvement in domestic liquidity conditions is visible in the following:
 Indian govt. bond market has rallied sharply since Trump’s victory in sharp contrast to
the negative bond action seen globally (36bps decline in 10-year G-sec so far)
 Money market rates (3M and 12M CP rates) have also declined by 50bps
 Banks have cut MCLR rate by 20bps
 With RBI looking increasingly likely to cut policy rate, lending rates should come down
further
 Thus, the next couple of months appears to be a good time for Corporates to raise money

Demonetisation Impact on relevant sectors
Confidential 13

Demonetisation - Sectoral Impact –Summary
Confidential 14
Sector Medium Term Impact
Financials - Banks Marginally Positive
Financials – NBFCs Mixed – Divergent across Segments
Real Estate Negative
Oil & Gas Neutral
Consumption – Staples Neutral
Consumption – Discretionary Negative
Infrastructure Slightly Negative
Hospitality Negative
Autos & Auto Ancillaries Negative
Others Divergent across Segments

DemonetisationImpact
Sector Impact Comments
Banks
Marginally
Positive
 Increased shareof savings moving to banks;high CASA ratio (lower
cost offunds)
 Lower bond yields resulting in high treasurygains(particularlyPSU
banks)
 However, negative from credit growth perspective and asset quality
challenges (bankswith high SME
exposure)
NBFCs
Divergent
impact on
sub-sectors
 Housing Finance:Negative: LAP/developerloans maysee increased
delinquencies ;underlyingdemand slowdown to affectcredit growth
 Auto Finance:Negative: ~60-70% transactionsare done in cash; resale
values likely to come down for vehicles; Asset qualityissues to worsen
 GoldFinance: Positive in medium term – Near term disbursementsto
get hit as high cash dealing; However, ~75% of gold lending is from
unorganized segment which will gradually shift to organizedplayers
 Micro finance: Positive in medium term – ~70% transactionsdone in
cash; Near term disbursements/collections to get hit; However,
positive in medium to long term as borrowers shift to bank
accounts
Financials Oil &Gas HospitalityInfraConsumption AutoReal Estate Others
Confidential 15
Views compiled from Jefferies, CLSA, CSFB, CRISIL, ICRA & management interactions

Real Estate Negative
 Very negative for residential space, land deals.Limited impact on
commercial transactions, hospitality or retail
 Greater impact on small builders,and in specific cities / (Tier 2/3 cities,
NCR etc.) / micro markets where cash dealing was more prevalent.
Resale properties impacted more than primarysales.
 Organized builders may also face demand slowdown in near term.
Anotherview is, if supply of resale properties declines due to price crash,
it mayfavourablyimpactprimarysales.
 Registered prices in residentialmay go up to adjust for cashcomponent
 Execution of ongoing projects willbe affected, and some developers
may face seriousfund crunch
 Positive in long term: De-monetisation coupled with Real Estate
Regulation Act,Benami Act and GST, will transform RE sector in longer
term. Key positives expected - increased transparency, improved
investor confidence, better accessto funding, higher FDI likely.
Confidential 16
Consensus views compiled from Real Estate consultants - KnightFrank and JLL; analysts – Jefferies, Edelweiss; rating agencies – Crisil, Fitch

a) Petroleum &
petroleum products
Slightly negative
 Temporarypick up in demand dueto significant pre-buying of
autofuels
 Over medium term, demand, especially for personal
transportationcould be somewhat negatively impacteddue to
high proportion of cash transactions
b) Citi Gas Neutral
 Largely unimpacted, the demand for CNG might get slightlyhurt
where cash transactionsarehigh
Confidential 17
Views compiled from Edelweiss & Jefferies

a) Consumer Staples Neutral
 Given the need based demand and small purchasetickets, the
impact on demand would be muted
 However, the move should benefit organized retail and hamper
the market for local counterfeit
goods
b) Consumer
Durables Slightly negative
 Sales likely to be hampered over short-term, especially sales
through unorganized channelsas cash purchases (~70-75% of
the overall sales) takea hit
 However sales through online retail should pick up relatively
c) Consumer
Discretionary
Negative
 The adversewealth effect will likely hurt higher end
discretionarydemand.
 At the same time lower rates should provide a buffer in the
mediumterm
d) Liqour Slightly negative  Most of the purchasesby retailers are through cash whichmay
bringdown volumein the near term
Views compiled from Edelweiss, Jefferies & Crisil
Confidential 18

a) EPC/
Construction Neutral
 Most of these projects have big ticket sizes and revenue is from
larger corporate housesand government authorities, which do
banktransaction
 However, for small contractors, due to cash crunch there will be
some disruptionin medium term
 Toll collection, which are mainly done in cash, maysee some
hiccups inshort-term
b) Building Material
(Cement , Paint ,
Tiles etc.)
Negative
 Likely to be negativelyimpacted as the underlyingreal estate
demand (~60-65% of consumption) will be severely impacted
dueto curtailment of black money
 Large part of transactionsdone in cash in segments like paints,
hence likely to be negativelyimpacted
Views compiled from Edelweiss, Jefferies & Crisil
Confidential 19

Hotels Negative
 Demand to be impacted dueto slowdown in Domestic
Travel
 Near Term Impact on Corporate Travel whereas
Inbound demandto remain unaffected
Tour Operators Negative
 Domestic Leisure Travel:Severely impacted as majority
of spendingis in cash
 Corporate Travel:There maybetemporaryslowdown in
corporatetravel dueto cashcrunch
 Inbound:Inbound travel to remain unaffected
 Outbound: Outbound travel through unorganized
playersimpacted as foreign exchange usage abroad is
mostly in
cash
Views compiled from Edelweiss & management interactions (Cox &Kings)
Confidential 20

Autos & Auto
Ancillaries
Negative
 Two Wheelers: High impact on 2 wheeler sales as large % of rural 2W
transactions are in cash, % transactions backed by loans is lower
 Passenger Vehicles:Short term impact due to purchasedeferment;
demand will revive in medium term.
 Luxury cars & SUV: Sales will see significant impact due towealth
deterioration and declinein rural transactions (cash based)
 Commercial Vehicles: Negatively impacted. 2nd hand truck sales, which
had higher % of cash transactions, will decline sharply (both number of
transactions andpricing)
 Tractors: Demand to be materially impacted;plus questionable trade
practices like over-invoicing to moderate
Consensus views compiled from analysts - Jefferies, Edelweiss; rating agencies - Crisil andFitch
Confidential 21

Media – Cable TV Negative
 Elongated working capital cycles for Multi System
Operators (MSOs) due to cash dealings of Localcable
operators (LCOs)
 ARPU growth may be delayed and Bad debtsmay
increase due to payment delaysby
LCOs
Media – Print
media Negative
 Slowdown in real estate(majoradvertiserin regional
print) will impact ad revenue growth for Print media
Metals Negative
 Demand slowdown from end consumers such as auto,
white goods and construction(residential) is likely to
result in lower domesticvolumes.
 Pressureon debt servicing for leveragemetal
companiesdue to drop in
volumes
Views compiled from Edelweiss & Ambit Capital
Confidential 22

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