DEMONETIZATION & FINANCIAL STABILITY - THE RICHY RICH GUIDE

People often spend most of their lives working hard chasing financial stability.

We Indians are now going through such an economic phase,

which made attaining financial stability and staying financially stable for an individual really difficult, due to banning of INR500 and INR1000 existing currency notes and replacing them with new INR500 and INR2000 currency notes.

Whenever there is a change in currency or modification in currency notes, 'DEMONETIZATION' takes place, which is the act of stripping a currency unit of its status, as a legal tender.

An interesting side effect of demonetization plan is that,

it’s bringing interest rates down.

Since money is being infused into Indian banking system via demonetization,

banks will have a surplus monetary supply,

thereby reducing interest rates.

For example - State Bank of India reduced rates on deposits from one year to 455 days to 6.90%, down 15 basis points, lending rates are likely to follow suit in a few weeks, possibly giving credit expansion a much-needed boost.

Lower interest rates should, all else being equal, produce a stimulus to the economy and reduce inflation.

It will decrease money in circulation,thus decreasing liquidity 

and as liquidity decreases inflation will come down.

Decreased money circulation means decreased demand

which will lead to decrease in prices of goods and services.

Thus, decreasing inflation.

Some amount of black money will reach banks, so that banks could give more loans,

more loans means more consumption.

More consumption will lead to increased demand

which will ultimately lead to more productivity. Increased productivity of a nation will increase it's Gross Domestic Production.

India has been suffering from high inflation problem since a decade.

As per World Bank 2010 report,

black money constitutes 20% of Indian GDP. So assuming, 20% of the INR 18 lakh crore worth of INR 500 and INR 1,000 notes, been scrapped,

is unaccounted or black money and unlikely to be changed,

roughly INR 3 lakh crore would not be exchanged for new notes ever.

This entire amount will be booked as profit to the Reserve Bank of India,

and transferred to the central government as special dividend in their budget book.

With INR 3 lakhs disappeared from INR 18 lakh of Indian currency,

money supply will reduce,

which will thereby reduce inflation.

Huge amounts of cash deposited in the banks will enhance the liquidity in banks multi-folds,

thereby reducing the need for the banks to raise liquidity through foreign currency loans/ bonds etc.

This, in the long run,

is expected to help reduce the interest rates of loans to customers

since the cost of loans for the banks will decrease.

Better accounting of money in the future since people will refrain from accumulating huge piles of cash foreseeing more such moves in the future. Every transaction will have an audit trail.

 Well this move played by our Prime Minister Mr. N.Modi,

has also been aimed majorly at eliminating counterfeit currency from the system,

which is mostly believed to be produced by and is used to fund terror organizations.

 Though it has been very inconvenient for people who operate on cash basis, in the longer run, it is for the benefit of the country

and that’s why is being praised globally.

It is reasonably clear that the economy stands to benefit on several terms.

So those who are worried about their financial stability, they must consider the following portion of this particular post,

very important.

Global agencies have pegged the size of the parallel economy in India at close to 23% as of 2007. Basis this, we estimate unaccounted cash in the economy to the tune of INR4500 billion, of which a certain significant proportion will make its way to the banks, thus boosting deposit base as well as financial savings:

• The banks' deposit base is expected to receive a fillip of 0.5-1.4% of GDP.
• In turn, financing savings can be expected to rise by close to this proportion due to switch from savings from unproductive physical assets to financial assets

• A rise in deposit base will allow banks to lower the blended cost of funds as higher CASA (current accounts, savings accounts) deposits help to replace the high cost of borrowing and lower overall cost of funds. We expect banks to reduce deposit rates by ~125 bps over the next six months.
• The new regime of MCLR (Marginal Cost of Funds based Lending Rate )will immediately take into account the lower cost and will thereby lead to a decline in lending rates, which will boost economic activity in the medium term.

• With improved monetary transmission, economic efficiency and structural moderation in currency in circulation, there is likely to be a greater room for the RBI to ease monetary policy rate further. I am hopeful that the RBI will ease by another 100 bps in 2017-18 to a repo rate of 4% by March 2018.
• The piecemeal liquidity support from OMO (Open Market Options) purchases will now to a larger extent be addressed by the structural change in currency demand

Over the last two years, while the number of Jan Dhan accounts has recorded a stellar growth, the share of these accounts in total deposit base of the banking system has remained under 1%. The demonetization drive of higher denominated notes should give a push to cash deposits in Jan Dhan accounts, of which close to 43% so far have remained dormant. In addition, the move will help to inculcate banking habits among the large unbanked population in the country.

• The latest move will move the economy from the unorganized to organized sector, dovetailing into the GST architecture that is expected to come on board next year. This is likely to enhance the government's ability to tax commercial transactions resulting in a structural improvement in tax to GDP ratio in the economy.

• Improvement in bank deposit base leads to higher SLR (statutory liquidity ratio) demand.
• On the supply side, with tax buoyancy seeing an improvement, supply of g-secs (govt. security) is likely to get more rationalized due to gradual reduction in fiscal deficit over time as the impact of FRBMA (Fiscal Responsibility and Budget Management Act) is underway.
• Anticipation of monetary easing to further support bonds.

While there are short-term implications for growth in cash-intensive sectors such as real estate, construction, and discretionary household consumption in general, but fear not my firend,long-term benefits for GDP growth will outweigh the short term transitional impact.

We are now surely heading towards a 9% GDP growth by Financial Year 2018-19.

In a single master stroke, the government has attempted to tackle all three malaises currently plaguing the economy—a parallel economy, counterfeit currency in circulation and terror financing.

In addition, the Indian economy has been provided a new lease of life—a "reset" if you will—with huge positive implications for liquidity, inflation, fiscal and external deficit in the short term.
Over the next two-three years, improvement in India's position on transparency and corruption in the global stage will further add to its investor appeal.
With Goods & Sales Tax on the state of preparation, India is now on the way to a higher growth in the medium term—to be steered by the organized sectors including MSMEs (Ministry of Micro Small and Medium Enterprises) and the revival of the private sector capex (Capital expenditure) cycle.

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