Notebandi Wasn't All Bad - Here's one Unexpected Benefit

Tue, 28 Mar Pre-Open

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The remonetization phase has been in full swing and is almost completed according to Economic Affairs Secretary Shaktikanta Das. Most restrictions have been removed - apart from the withdrawal limit of Rs. 24,000 from a savings bank account.

But has the purpose for which Notebandi was implemented been achieved? The government had originally stated that the main reason for Notebandi was to curb black money. It envisaged a situation where black money wouldn't return to the banking system, rendering it worthless. This devalued black money, estimated at Rs. 3 Lakh Cr would be a profit to the RBI, subsequently transferred to the central government. The government could then use this to fund infrastructure growth thereby accelerating the GDP growth.

In The Vivek Kaul Letter (subscription required) dated 6^th January 2017, our big-picture expert Vivek explains how, since most of the demonetized money made it back to the banks, it seems the Government's lofty aim of accelerating GDP growth by using black money wasn't successful.

But there's one silver lining of notebandi which we're certain even the government couldn't have imagined: India's credit expansion.

India and China had similar GDP in 1980. India's GDP currently stands at 20% of China's. China's credit to GDP ratio is three times that of India.

This discrepancy was likely due to the Indian tendency to hold large amounts in cash. India's cash to GDP ratio is the highest amongst BRICS (Brazil, Russia, India, China, South Africa), at 10.9% as of March 2016. China which had a 14.6% cash to GDP ratio has considerably reduced it to 9.1%. This high cash holding has impacted the growth of the Indian economy adversely.

Due to notebandi, however, around 3% of the GDP has found its way from cash to the banking system. If used efficiently, it has the potential to increase India's GDP by 15-25%.

All three stakeholders have an important part to play in efficient allocation of this capital: Banks need to extend credit to boost growth; borrowers need to borrow these loans handed out by banks and use them diligently; and last but not least, the government needs to keep an adequate check to ensure that the credit handed out does not turn into NPAs. (As we noted in a recent 5 Minwrapup edition, banks' return ratios have deteriorated due to its profits written off on account of NPA provisions.)

The government has certainly taken steps in its recent budget for a credit push. Recent interest rate discounts for housing loans up to Rs 6 lakh, and cheaper financing for affordable housing have all aimed at incentivizing the average retail borrower looking to buy a house. Similarly, the government needs to ease corporate borrowing to further accelerate economic growth.

The Indian economy is in a great position to capitalize on this unexpected benefit from Notebandi. A proactive approach by the government followed by a change in mindset by the Indian borrower could significantly push the Indian economy forward.

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