Trump victory & scrapping of Notes. Near term jitters provide opportunitiesMahesh Singhi - 2nd December 2016
While scrapping of Rs500- and Rs1,000 notes is an attempt to eradicate fake notes, India still seems positive about the banking sector.
The combination of US election results and the launch of the demonetization of Rs500 and Rs1,000 bills in India has triggered a substantial tribulation. The European reacted at the US election result as market participants considered Donald Trump’s victory as an adverse outcome. Indian markets too suffer from the fears of the implication of the demonetization move which griped sentiment along with global cues.
In my view, sharp reactions to such events typically present good value opportunities to buy into targeted stocks and other investments. With regards to the demonetization event, I believe that this move will extend the long term trend of declining currency holding by the public and is eventually beneficial for the economy over time.
Importantly, over the past two years the declining trend somewhat reversed with a peculiar surge in currency holding growth to a high of 18% from a low of 8-9% in 2014.
The key concerns people have is that demonetization of the Rs500 & Rs1000 currency notes will compress transactions and hurt business in a significant way. This emanates from the understanding that the attack on black money will impact the demand in the sectors ranging from real estate, consumer durables, building material, etc.
The impairment of the currency holding will effectively be around 32% from last three month average of Rs16.8tn or around Rs5.4tn.
Overall, money supply is unlikely to decline as significant portion of currency will convert into bank deposits and supply of currency will be partly compensated by the new currency bills of Rs500 and Rs2000.
Effectively the money multiplier will rise due a change in mix of money supply in favour of bank deposits, especially demand deposits.
It is estimated that currency holding/total deposit will decline from 15.7% to 10.1% and time deposit/total deposit will also decline from 89.8% to 87%. Resulting in a massive rise in money multiplier from current 5.8x to over 7.5x assuming a constant effective cash holding at 4.2% (vs mandatory Cash Reserve Ratio at 4%).
Clearly, increased proportion of currency holding will enhance the banking system to generate monetary transmission as it contains the leakage.
Aside from the short term disturbances, the decline in currency holding will enhance the monetary mechanism, by extending the rising proportion of transaction thorough banking and formal financial channels.
Having said this, it is important to note that substantial portion of decline in currency holding with public as percentage of money supply (55% to 18%) which happened between mid-1960s to early 1990s is due to nationalization of banks, increased penetration of banks, ingress of banking technology and subsequently also due to greater financial inclusions. Currently, at 13-14% it is probably at a level consistent with the level of transaction demand for money and possibly further substantial decline can happen with greater push to payment technology platforms like Paytm, valet etc.
Potential spike in money and deposit multiplier could stimulate counterbalancing response from the Central bank of India
Themes to play
Banks will end up gaining: Expect CASA (ratio of a bank is the ratio of deposits in current and saving accounts to total deposits) of banks to improve both in the immediate term as well as over longer period due to rise in money multiplier in the economy and deposit multiplier for banks. We see positive impact for banks with strong retail franchise that can channelize enhanced deposit mobilization for retail lending. Small & Medium Enterprises may face near term payment issue due to sudden scrapping of high currency notes. This would increase demand for working capital loan.
Staples to remain largely unscathed: No impact here since the items are low ticket. Goods & Service Tax (GST) rates are likely to be favourable for them. Potential adverse impact could be from the spillover effects of further retardation of construction activities in urban areas in the form of lower transfers by construction workers. Higher government spending and bank accounts in rural area to boost demand.
Consumer discretionary: erosion of wealth effect could prolong – Rural and most urban areas have already seen erosion of wealth effect due to decline in real estate prices (land and property). Expunging of Rs500 & Rs1000 currency notes can possibly prolong it. In my view the impact on small ticket discretionary spending will likely be minimal, while high value item can experience longer impact.
Real Estate and allied sector: This is major negative for real estate sector which has huge unsold inventory and prices have been under pressure. Rub off effect would be felt in tiles and ply as well. There has been demand softening for cement as well.
Trump’s electoral win could sustain de-globalization
Notwithstanding the characteristic fiscal hawkishness that goes with a complete Republican sweep, the intent expressed by Donald Trump in his victory speech indicates a move away from fiscal rectitude. The prominent focus of Trump’s economic policy framework is to spend aggressively on domestic capital formation, including infrastructure projects and active containment of US current account deficit. Clearly, the slant is towards protecting US jobs and re-establishing US economic hegemony. This would imply furtherance of US protectionism. The broader implication would emerge in the form of restricted access to US market for global trade of goods and services, higher supply of treasuries, higher inflation and a more strident trade policy approach towards China.
A chain of adverse reciprocal trade policies could diminish growth impetus attributable to external trade for countries like India. From Indian stand point, challenges for IT industry will likely continue in the form of tighter immigration laws and higher salary levels for onsite staffs. Likewise, Indian manufactured products can face challenges, especially if they have to compete with Chinese goods originally meant for US exports.
Managing Director - Partner,
Singhi Advisors Pvt. Ltd.