Wednesday, November 09, 2016

How the ban on Rs 500 and Rs 1000 notes will affect the common man

November 8th 2016  will go down in Indian history as a red letter day. It marks the day, Indian economy moved from Black economy to white.

In what will be known as a ground breaking, historical move, On November 8th,  Prime Minister Narendra Modi  announced the demonetization of Rs 500 and Rs 1000 currency notes.

So what does this mean for the common man?

India had been a cash based economy. Nearly 14 Lakh Crore Rupees is in currency notes - about $220 billion worth, is held in cash notes of Rs 500 & Rs 1000. This implies that the impact to Indian economy will be huge - very huge.

Impact on Common Man

Day-1-10: Near panic in local markets. Number of transactions drop by more than 50%. Today on November 9th, almost all businesses have reported more than 50% drop in transactions. I chatted with a Uber driver and a small coffee shop owner. Both reported the same. Uber driver was willing to give me 10% discount for cash payment in Rs 100 notes vs PayTM!

Common people in cities will rush towards digital payments like PayTM.

Immediate impact: Deep Deflation. The amount of money in circulation will drop dramatically while supply of goods will remain stable - hence prices of goods will drop.

Gold prices, stock prices, commodity prices will drop. People will congratulate government for making this bold move. BJP will win elections in UP and Punjab.

Day-10-50: People who have legally earned cash, will start depositing it in bank. This will help improve bank's Cash Reserve Ratios and increase bank deposits. This will lead to more lending. Increase lending activity will make it easier for legal businesses to raise capital and economy will grow.

People who have earned their money illegally, such as bribes, smuggling, Narcotics etc. will have a big problem on their hands. These people will be afraid to deposit it in a bank.  Some of them will find ways to deposit this money into a bank, and will declare it as income and pay taxes on it.

Many of these guys - who had easy money flowing will continue to stay out of legal system and will count on their luck or bad luck and sit on their stash of Rs.500 and Rs.1000 notes. This money will be effectively taken out of circulation and that aids deflation.

Day 50-200: Deflation will ease out, and inflation will return. Inflation will happen slowly because lending activities will not happen overnight and will take time. Lending will broaden money supply, creating demand for raw materials and capital goods. This leads to a steady growth of Indian economy.

Real Estate prices will crash. Builders & developers who were eager to sell for cash can no longer sell. They will be forced to lower the price by 10-20%. Already by 1 PM on November 9th, Share prices of DLF is down 21%!

Real estate developers will have to wait for demand from white economy to pick up. Once the economy picks up and with easy availability of bank loans, real estate prices will come back to pre Nov. 8th levels, and by end of 2017, the robust demand will ensure real estate prices to go up.

Real estate developers will be forced to go with legal transactions and play in white economy.

Big Losers

The biggest losers in this are corrupt government officials & Politicians who are sitting on tonnes of cash. They cannot convert the older de-monitized notes to newer ones to avoid risk of tax investigations, and will be willing to lose their illegal money.

Real Estate businessmen, who cannot convert all their hordes of cash will also be hurt by low demand.

Other illegal business owners: Money lenders, hawala finance transactions. These people will find it difficult to conduct their business in the new system. Particularly when government can track newer Rs 2000 currency notes via RF chips.

Closing Thoughts

This is just my opinion based on my knowledge of economy. I may be wrong in some aspects, but overall I am sure Indian economy will go through a cycle of deflation, followed by robust growth and the some creeping inflation.

Let's wait and see how things pan out!



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