NewsCanvass

Capturing News with an Analytical Edge

[Link]
Date: 12/11/2016

DEMONETISATION OF CURRENCY
Event: Government has decided to demonetize Rs.500 & Rs.1000 notes in India.

For the second time in its modern history (the first one was in 1978), Indian government has gone in for
de-monetization. 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 clear objective of the Govt. is to
curb black money, curtailing prevalence of fake currency, countering terrorism financing and mainly
promote a cashless economy.

India is a cash intensive economy with various studies pointing to ~95%/65% (volume/value) of consumer
transactions in cash against 45%/15% (volume/value) for advanced economies. Cash to GDP ratio is over
12% against 4% for UK and 7% for USA.

Some Guidelines on this Move:

a) Existing notes of Rs.500/Rs.1,000 became invalid from Nov 8th midnight,

b) New notes of Rs.500 and Rs.2,000 have been released and circulated from Nov 10th
c) Citizens have 50 days (from 10th Nov to 30th Dec) to deposit existing Rs.500/Rs.1,000 in any
bank/Post office, Post that, till Mar'17 the existing Rs.500 and Rs.1,000 notes could be exchanged at
declared offices (have to be accompanied by a declaration form and ID proof).
d) From 10th Nov to 25th Nov – Rs.4,000/day could be exchanged and afterwards the amount/day would
be reviewed.
e) Cash withdrawal from an account over the counter will be restricted to Rs.10,000/day (overall weekly
limit of Rs.20,000) till 24th November; from ATM’s the cash withdrawal will be restricted to
Rs.2,000/day per card up to Nov 18, 2016 and then raised to Rs.4,000 per day per card from Nov 19,
2016.
f) Electronic model of transfers have no restrictions.

This document is authorized for use only in career Launcher

Various Initiatives Taken By Government To Curb Domestic And Foreign Black Money

1. Special Investigation Team (SIT) On Black Money -- The Supreme Court-appointed SIT was formed to
investigate assets abroad and come up with guidelines to curb generation & circulation of black
money. SIT had recommended various administrative and institutional measures through various
reports
2. Foreign Black Money Compliance Window: A 90-day window was provided in 2015 to declare
undisclosed foreign assets; Rs42bn was disclosed at a penal tax rate of 60%
3. Black Money Act, 2015-This was Aimed to create a framework to tackle and ensure compliance with
regards to black money abroad by residents. CBDT is the currently the administrative authority.
Stringent provisions: Undisclosed foreign assets to be taxed at 30%; penalty at 3X of tax payable with
imprisonment from 3-10 years
4. Income Declaration Scheme, 2016: A one-time window was provided for resident Indians to declare
their undisclosed assets and pay taxes on them without incurring punitive actions. More than Rs650
bn was disclosed under this scheme
5. Mandatory PAN Requirements- Government has made it mandatory to use PAN for all transactions
done through cash or prepaid cards, including jewelry, above Rs0.2mn. PAN is mandatory for
purchases of immovable properties above Rs1 mn
6. New DTAAs Signed Along With Renegotiation Of Old Ones: India has signed DTAAs with Cyprus,
Mauritius and Singapore, which are aimed at limiting round-tripping of money into capital markets.
Government has negotiated an automatic information exchange agreement with Switzerland and is
negotiating similar treaties with other tax havens
7. Using FEMA To Regulate Exports Earnings: In line with the recommendations from the SIT nearly 788
exporters (as of July 2016) were being probed for not bringing back earnings to India within the
stipulated timeframe
8. Amendments to Prevention of Money Laundering Act 2002, vide Finance Act, 2015: The act has been
amended to enable attachment and confiscation of equivalent assets in India wherever assets located
abroad cannot be confiscated
9. Enforcement Measures: Ministry of Finance notified that surveys (until May 2016) over past two years
have led to disclosure of around Rs450 bn of undisclosed income. There has also been a significant
rise in criminal prosecutions filed.
10. And the latest one is Ban of Rs. 500 & Rs.1000 notes

This document is authorized for use only in career Launcher

A Well Thought Plan:

It is one of the boldest moves by Modi government so far and is expected to curb fake currency and black
money existing in the system. When one try’s to connect the dots for all initiatives by government like
curbing black money, GST, Pradhan Mantri Jan Dhan Yojna, DBT etc, it points towards making India an
economy with more of digital cash and minimal black money. Also, with above mentioned initiatives,
government has put required infrastructure to achieve the same already. 87% of the population is covered
under Aadhar, 20% has PMJDY accounts (Approx. one account per family)

Also, demonetization move comes at a right time after voluntary income declaration scheme (IDS) is
closed (Rs1.2 trillion recovered), giving government space to impose heavy penalties and taxes on black
money that would be recovered now. With a sudden move and keeping all the developments regarding
this under wrap, government has hit the problem when it would be affected maximum.

Challenges In Implementation of This Move:

The tight timeline to completely phase out the notes and immediate stoppage of these notes for regular
transactions have created a task of unprecedented level of logistical challenge. The size of this country,
population, and infrastructural limitations make this task even more complicated.

About 150 thousand of post offices along with 137 thousand bank branches will be executing the entire
exercise of exchange and deposit of old notes over the next six weeks, until 31 December 2016. Many
banks have already announced extended working hours, additional cash counters, and working over
the weekends to facilitate the huge demand.

IMPACT ANALYSED

Impact on Election Funding:

Demonetization 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. Punjab is the other major state
which is going into election over the next few months.

This document is authorized for use only in career Launcher

Impact on Indian Economy:

Government Revenues Could Go Up: The direct positive impact will be felt on government’s tax
revenue collections, its ability to spend on infrastructure investments and the resultant impact on
growth. Inflation, could see some downward pressure in the short term because cash transactions
will reduce. In the long run though, as government spending rises pushing up employment and
incomes, demand will revive. Therefore, the impact on inflation should be neutral in the medium-to-
long term.

Higher GDP Growth On A Reported Basis—as black economy will gradually become part of the formal
economy,

Higher Tax-To-GDP Ratio from proper reporting of income in the future; sections of the unorganized
industry and professionals did not report their full income; the implementation of GST will hasten the
move. The one-time impact on tax collections could be high. However, in the longer run, better tax
compliance and some initial disincentive to hoard cash could push up direct tax collections in the
medium term. The government has already said declaration of unaccounted income because of
demonetization is liable to be taxed / penalized at a rate of 30 to 120% depending on the source.
Already, the Income Declaration Scheme of the government which ended in September is expected
to add close to Rs.300 billion to direct tax collections over fiscals 2017 and 2018. Currently direct tax
collections are just about 5.5% of GDP and about 50% of total tax collections, and this contribution is
expected to rise going further. This will also help the government stick to its fiscal restraint path.

Public Investments To Rise And Drive Jobs And Income: Over the last two years, fiscal savings on
account of lower oil subsidies gave the government room for infrastructure spending. Higher direct
tax collections will now allow the government to further increase such spending. This is critical given
that private infrastructure investments remain weak. It will also have positive spillover effects on
employment and income. As investments drive up the supply capacity of the economy, overall GDP
growth is expected to benefit in the long term. In the short-term, GDP growth may get impacted
negatively as the cash based economy feels a crunch and consumption and investment moderates.

This document is authorized for use only in career Launcher

 Tax rates could edge lower: Higher income tax collections arising from better compliance would also
offer scope to reduce income tax rates over the long term, which would increase disposable incomes.
This can have a positive impact on consumption demand in the long term.

Impact on Economic Variables:

Lower demand to exert downward pressure on inflation in the coming few months. Categories such as
housing, transport and food that tend to have a higher cash component could see downward price
pressures in the coming months as demand is negatively affected.

Also, rural areas which have a higher share of cash transactions could see a sharper dip in inflation
compared with urban for most categories. That said, in the long run, as government spending rises pushing
up employment and incomes, demand will revive.

o GDP: Immediate Impact: Negative: Consumption and investment demand to see some dent as the
cash based economy feels a crunch. Also, not all the black money may get declared and therefore the
overall money available with people for cash based consumption demand would be lower. Long Term
Impact: Overall Positive: Increased direct tax collections to create room for investment spending.
Also, disposable income may go up in the long term, if government chooses to bring down income tax
rates given that the tax base will widen. Higher disposable income to bode well for consumption. On
the other hand some sectors of the economy (mainly those in construction) can get negatively
impacted. It is also a worry because these sectors generate huge employment.

o Inflation: Immediate Impact: Downward pressure on prices due to lower demand, especially in rural
areas and for sectors such as housing, transport and food where share of cash transactions is high.
Sharper fall in rural inflation Vs urban is possible. Long Term Impact: Neutral: To have minimal impact
in the long run, as demand will bounce back up with increased government spending and positive
impact on employment and incomes.

o Liquidity: Immediate Impact: Positive: Increased liquidity in the banking system led by higher
deposits. Will help mitigate any short term liquidity concerns. Long Term Impact: Neutral: RBI’s stance
is to maintain neutral liquidity in the banking system. RBI will suck out any excess liquidity through
open market operations.

This document is authorized for use only in career Launcher

o Currency In Circulation: Immediate Impact: Negative: As on 31 March, 2016, 500 and 1000 rupee
notes constituted around 86% (Rs 14.8 trillion) of the total currency in circulation Short-term
reduction in usage of these notes, along with imposition of withdrawal limits will lead to decrease in
currency in circulation in the next few months. Long term Impact: Neutral: As new currency notes are
introduced, currency in circulation is expected to revert to normal levels. However, if people are
averse to holding cash and if there is a greater move towards accepted electronic payments in future,
that can bring down the currency in circulation.

o Fiscal Deficit: Immediate Impact: Neutral: To take time for tax officials to claim tax on the deposits
made by people. The one-time impact on tax collections could be high. However, in the longer run,
better tax compliance and some initial disincentive to hoard cash could push updirect tax collections
in the medium term. Long Term Impact: Positive: Income tax collections expected to see a kick-up as
funds earlier unaccounted for enter the banking system and eventually get taxed. About 23% of the
economy estimated to be unaccounted for. Plus this involuntary declaration of income to invite 30 to
120% rate, depending on the source of income. Additional collections to help create room for
infrastructure spending

o Current account deficit (CAD): Immediate Impact: Positive: Gold demand already dented due to
policy restrictions. This step will additionally bring down gold import because demand is mostly driven
by cash (about 80%). Long Term Impact: Negative: Pent up demand for gold may lead to higher
imports. Also people might chose to hoard gold instead of cash. This can widen CAD.

o Digital payments: Immediate Impact: Positive: Individuals substitute towards digital payments Long
Term Impact: Positive Because the unified payments interface (UPI) gains greater acceptance and a
larger proportion of the population gets incorporated into the digital financial ecosystem. Additionally
it could save Government a lot of money. According to a study by Visa, if India were to spend around
INR 60,000 crore over a period of five years in subsidising the appropriate equipment and in giving
tax-breaks to promote digital payments, it could save over INR 470,000 crore over the next 10 years
by way of lower costs of managing a cash economy.

Sectoral Impact: To be Continued In Next Update…..

Disclaimer: Nishkala Capital makes best endeavors to ensure that we use current, reliable, comprehensive information and obtain such information from sources which we believe are reliable. However, such information has not been independently verified by us and no representation or warranty, express or implied, is made as to the accuracy or completeness of any information
obtained from third parties. The information, opinions, views expressed in this Document are ours as at the date of this. Nishkala Capital may or may not subscribe to any and/ or all the views expressed herein. This Document should be read and relied upon at the sole discretion and risk of the recipient. If you are dissatisfied with the contents of this document or with the terms of this
Disclaimer, your sole and exclusive remedy is to stop using this document and Nishkala Capital shall not be responsible and/ or liable for any direct/consequential loss howsoever directly or indirectly, from any use of this Document. This document is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any
other person or published, copied in whole or in part, for any purpose. Neither this document nor any copy of it may be taken or transmitted or distributed, directly or indirectly within India or into any other country

This document is authorized for use only in career Launcher