9th November, 2016

Need for demonetisation

As of 8^th November 2016, currency notes of denominations Rs500 and Rs1000 has ceased to be a legal tender, approx. 25% by volume and 86% by value of currency in circulation. The stated objective of the Govt. is to curb black money, curtailing prevalence of fake currency, and countering terrorism financing.

The RBI will issue new currency notes of denominations Rs500 and Rs2,000, which will be made available for exchange starting 10 Nov until 31 Dec 2016. Electronic model of transfers have no restrictions. Restriction on cash withdrawals will slowly be eased over the next fortnight.

Transitory impact is huge

• In the near-term, this move will hurt economic activity with pronounced slowdown across sectors irrespective of the extent of usage of cash. Risk aversion is likely to inch up manifold.
• Over the next 1-3 months, we think all sectors barring IT & Pharma will face growth challenges, and in particular hurt discretionary spends, gold and real estate purchases. We are particularly worried about businesses that still need to operate in cash with little access to valid legal tender.
• We think banks will benefit from higher savings account accretion.

Medium term (4-6 months) implication will still be negative

• While the black- economy will certainly shrink, the second-derivative impact of the wealth-destruction on the real-economy will still be meaningful, in our view.
• Financial sector could face higher stress levels in the small & mid-corporate segment which currently is challenged by an extended working capital cycle.
• Even where cash is accounted for, we expect risk-aversion will remain high for conspicuous consumption items e.g. expensive watches, jewellery, upper end of alcoholic beverages, higher end cars etc.

Long term (12 months) looks positive for few sectors

• The biggest benefit will be on the fiscal & monetary side. Assuming 25% of CIC amounting to US$ 53bn (83% of net market borrowing) remain untraced (possibly the unaccounted money) and does not get exchanged could have a dual impact of lowering market borrowings or increased fiscal spending.
• We believe Private sector banks along with Payment and Small Finance Banks will benefit from the increased transparency and from a shift of cash transactions to online channels.
• We expect Staples sector to recover from the slower demand conditions. From an overall perspective, we remain neutral on discretionary consumption, Car/2W, CV, Cement and EPC/construction.
• We remain negative on gold and real estate.

An eye on election funding

• Demonetisation is also likely to impact upcoming state elections in India, with elections in UP, the largest state accounting for nearly 15% of Lok Sabha seats, expected in February, 2017.
• A significant part of election financing and spending in India is believed to happen in cash and would to be impacted by the move. As per data available with the Election Commission, 63% of even the declared funding for political parties ahead of assembly elections over the last decade was in cash.

What investments to stay away from (in short term)

• Gold
• Real Estate
• Automobiles / two wheelers
• Banks
• Cement
• FMCG
• Metals & Mining
• Tractors

What stocks to buy for the long-term

• EPC / Construction
• Private Banks
• Staples

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