Update 1: 12 Dec 2015 :
1. 34 days have passed since the announcement by PM Modi and as expected almost all of 14 lakh cr is going to be deposited in line with my prediction. India is a jugged country and people always figure out a way to beat system due to our long history of surviving in a hostile system.
2. I still stand by positive contribution to GDP but all assumptions were based on the idea that the situation will normalize in 10-15 days. As of now, it is not looking to normalize even in the next ½ months and hence impact is going to be negative now.
3. Big lesson – Indian middle class – bureaucracy, bank officials etc will boomerang any big reform and hence its high time output focus on reforming them.
Demonetisation has happened. 500 and 1000 rupee notes are banned. There are serpentine queues outside banks / ATMs and experts are busy. There are high pitched videos, columns, tweets and Facebook posts by every expert about how poor are hurt and how this will kill the trade. Roll back demands are being made from every armchair economist, citizens dining in five-star hotels but extremely concerned about poor, many chief ministers. Overall air of the nation is thick with not only smog but also with pro-poor and small business friendly experts and politicians.
There is a view propelled by a gang of astrologers masquerading as economists that demonetization is going to hit the hard economy as cash will be sucked out of system and trade will stop. This hypothesis does ring true if one notices the plugging sales at e-com ventures, lack of crowd in markets and drop in footfalls at malls. No wonder all Captain Obvious is at top of lungs on the incoming slowdown hitting Indian economy due to this demonetization.
History tells us that events rarely follow an obvious path and are shaped by unforeseen and unpredicted. Demonetization is such an event. It is not going to slow down the economy but going to put this economy in the high pedestal of growth. A jump by 2% to 3% in GDP if not more by demonetization is very much possible and for the first time in the world, we will see trickle up effect in the economy than usual trickle down.
The first foremost and obvious effect of demonetization is the elimination of the cash economy and shift towards banking system. Lot of people even without illegal money were not using banks and were saving in cash at home for a variety of reasons. Now all this money will go informal banking channels and will find its way to formal earning mediums like mutual funds, fixed deposits, savings accounts etc. This will create a push and boom as the cash lying idle at home will be at work and will create a contagion effect. Those dormant Jan dhan accounts will now be kicking with life and in a big way. Even if 10% cash lying idle at the household level, translates into 1.4 lakh crore ( $ 21 billion). Now this $21 billion will be available in the banking system and hence available to Govt/ Industry to kick-start new projects / build infrastructure. To get a relative perspective, FDI inflow in India in FY2015-16 was $40 bn while in FY 2014-15 it was $30 bn so the amount coming from dormant accounts to banking system alone is 53% of this year FDI and almost 70% of FY14-15 FDI.
The second kicker to the economy will come from fall in real estate prices. As per experts and general perception, real estate prices are going to fall by 20% to 30% in general (a black component of a deal). In India, in FY 2015-16, if one just takes top 8 cities, $14 bn worth (90,000 Cr) was invested in the real housing ( 3 lakh houses in 8 cities at a 30 lakh average price though in real numbers are much higher). As per experts, real estate prices are expected to crash by 20% to 25%. This drop in prices even if we take 50% drop in a number of transactions will leave more than 9000 Cr ($1.3 bn) money at the hand of these end users in just 8 cities and this amount will be 10x higher if one account for the whole country. This extra cash available with the consumer will go in other discretionary consumption and will either build the saving rates or drive consumption of services as well as consumable goods.
The third and not so obvious kicker will come from the attempt of all back money hoarders trying to convert it in white. As per data released by RBI, India has 14 lakh Cr ($ 210 bn) in circulation in 500/1000 bank note denominator. For a moment if we assume on a very aggressive basis that 50% of it is white and declared income ( fully tax paid), still there is INR 7 lakh Cr ($105 bn) in black money. Now, these cash hoarders will try to use people with low income to transfer 2.5 lakh into account. Now as per financial ministry data, India has opened 25 Cr (250 million) Jan dhan account for poor people as on today. Now if black money hoarder were able to use 50% of these accounts (12.5 Cr) to deposit cash in Jan dhan bank accounts, one just needs to deposit INR 70,000 in each account. So apparently all this cash will flow back in the system in next 50 days without any collateral damage to these money bags. However, the cost of organizing this deposit program will range anywhere from 20% to 40% ( as per the figures being circulated in media/social media). Even if we take a nominal cost of this transaction at 10% being paid to these Jan dhan accounts(against 30%), it will be a commission of INR 70,000 Cr ($11 bn) ( 10% of 8 lan crore) or 8,000 per Jan dhan account (12.5 Cr). This 8,000 will immediately find its way to consumption as this is massive cash for these account holders and even if just 50% is spent, Indian economy will see pumping of $6 bn (40,000 Cr) being spent in next 3/5 months. This class will binge on clothes, consumer goods and will create a massive multiplier effect. However for the first time multiplier will not trickle down but will trickle up as rural or low-cost goods will drive the industry. So in a way, PM Modi has imposed huge wealth tax on the rich people and accomplished direct cash transfer to poor people.
Foreign investors pumped $10 bn in 20 months in Indian startup which put India on the world map as a top 3rd country for startups and changed the whole mood of the nation while creating many multi-billion enterprises. Payout of $6 bn in arrears to Govt employees in 2008 as per sixth pay commission, triggered a consumption boom in India and insulated it from the economic crisis which impacted every country. Hence this total amount of $40 bn hitting the banking sector/consumption in next 3/6 months is not just going to finish the black economy but going to put India on an autobahn of economic growth.
PM Modi in his usual total out of box thinking, has just put India on growth orbit of a different level where a minimum jump in GDP by 2% to 4% is not ruled out.
Gear up, the age of India has arrived.
This article appeared at Times of India here.