Many of those holding Rs 500 and Rs 1,000 notes are unlikely to come forward to exchange or deposit notes in banks, fearing detection and action by the Income Tax Department, bankers and analysts said.
There is a possibility that 20 per cent of the notes are unlikely to be exchanged, which could convert them into worthless paper. “There could be permanent wealth destruction of Rs 3 trillion (or Rs 3,00,000 crore) if 20 per cent of these notes are not exchanged which could impact inter-personal lending, real-estate, jewellery and banks with such exposure,” said Ritesh Jain, chief investment officer, Tata Asset Management.
However, all in all, this would be more than outweighed in the medium term by the positive impact on improved transparency and tax compliance (tax revenues) significantly and consequently benefit public finances, Jain said. The government action will push the country to go cashless and get into the digital economy at the earliest, he said.
The move to withdraw Rs 500 and Rs 1,000 notes could hurt economic activity in the near term, particularly in the rural economy, where a large proportion of transactions are still conducted using cash, and spending on big ticket items such as white goods, autos and property. “This will positively impact the share of financial savings within the economy in the longer term as households could reduce their allocation towards physical assets like gold and property,” said Chetan Ahya of Morgan Stanley Research.
The Indian economy had Rs 17.3 trillion (Rs 17,30,000 crore) of currency in circulation as of September 2016. As per March 2016 data, Rs 500 and Rs 1,000 notes comprised 86 per cent of the value of currency in circulation, or 10.4 per cent of GDP.
Currency in circulation has increased by 15 per cent in the last one year and 42 per cent over the last three years, ahead of nominal GDP growth. “As per the Economic Affairs Secretary, the growth in Rs 500 and Rs1,000 notes has been higher than that of the aggregate currency in circulation and the size of the economy. Part of this, if unaccounted for and becomes illegal tender, also means wealth destruction with its accompanied impact on business activity,” said Gautam Chhaochharia, head of India Research, UBS Securities India.
As much as 86 per cent of outstanding currency value in circulation is being demonetised which is a significant step towards the transition to a non-cash economy. In the immediate term, cash liquidity in the large parts of the economy will freeze temporarily, till the new notes are fully introduced.
Jain said inflation will undershoot RBI’s medium-term target of 5 per cent inflation, resulting in 50-75 bps rate cuts in next 6-9 months. “This is a strong and bold step taken by the government to curb the black money; however the ripple effects of this cannot be understated. There are major industries in India thrive on a parallel economy funded by black money. How will this affect the more legitimate and normal economy? The weeks and months ahead will tell,” Jain said.
It is expected that over next three years, the current PoS (point of sale) base installed will increase from 1.5 million terminals in over 750,000 retail touch points — predominantly in urban areas — to about 5-7 million PoS with penetration in sub-urban and rural markets. India has close to 15 million merchants of which only 7,50,000 have electronic payment acceptance infrastructure.
Sunil Kulkarni, Deputy MD, Oxigen Services, said: “This is a master stroke which will majorly change India’s digital payments infrastructure.” The recent announcement by the government to remove surcharge on electronic transactions for government payments, announcement of Acceptance Development Fund to boost electronic payment infrastructure for retail merchant network and lastly GST with April 1 2017 are all clear direction of move towards large scale digitisation of payments.
Porush Singh, country corporate officer, India, Mastercard, said,” Mastercard welcomes and supports Prime Minister Narendra Modi’s announcement regarding the ban on high value currency notes as it fundamentally addresses the underlying ‘cash engine’ that drives the shadow economy.”