Modi’s daring reform move gets little notice

Added 15th November 2016

Overshadowed by the US presidential election last week was a “bold and historic” move by the Indian government to ban 500 and 1000 rupee currency notes, which is expected to be “transformational” for the economy in the medium term, asset managers said.

Modi’s daring reform move gets little notice

The action is part of the reform agenda promised by prime minister Narendra Modi and is aimed at weeding out corruption and transforming a predominantly cash-based society into a country that uses more digital currency.

The banned rupee notes made up about 85 percent of the currency in circulation, sources said. People are allowed to exchange the notes for smaller ones to the end of the year. Nonetheless, the move caused panic and long lines at banks, emptied ATMs and hit consumer transactions.

“This is undoubtedly a very bold move – one that requires significant political courage and capital,” said Rahul Chadha, co-chief investment officer at Mirae Asset Global Investments in Hong Kong. “While there is certainly a near-term impact on consumption, it is a long-term positive for the economy."

Karun Marwah, head of international business at Mumbai-based Motilal Oswal, called it “a bold and historic move.

“Lauded by many economists, the impact of it is transformational for India in the years to come, as it effectively kills the parallel economy and brings a big part of the economy into the tax bracket.”

In August, Modi managed to smooth the passage of the Goods and Services Tax Bill, a landmark reform, sources said. The GST is expected to "replace at least 17 state and central taxes, simplifying the current arcane tax structure with hundreds of exemptions and cascading tax-on-tax", Mirae AM said earlier.

“Along with the recently-passed Goods and Services Tax bill, [last week’s de-monetisation] is  a catalyst to move India’s black market into the organised economy," said Chadha, from Mirae.

Short term pain

Motilal Oswal said in a research note that the de-monetisation will negatively impact consumption in the short term. For example, people will buy fewer high price items.

“Property transactions, where 20-50% of the value gets transacted in cash, will be impacted. The wedding season has almost begun – jewelry purchases and payments to various parties (caterers, bands,priests, etc) will become difficult.

“As  consumption  will  be  hurt,  there  will  be  pressure  on  the  repaying  capacity  of producers/sellers. Short-term lenders might witness a rise in non-performing loans, hurting their ability to lend more.

“On the positive front, this will encourage electronic transactions. Over time, the tax base should widen, boosting tax collection.”

Also over time, the move should be beneficial to banking and financial services, as more of the economy comes into the formal economy, the firm said.

Additionally, as consumption falls, household savings could increase. But one big risk is reduced household income, the firm wrote.

“With the unorganised sector witnessing radically adverse changes, the weak employment situation might worsen, changing the entire equation."

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The top five performing India equity funds (over the last 12 months) were hit by the surprise currency ban last Tuesday, but sources expect benefits will accrue to the economy in the medium and long term:

 

 

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