How to Measure the Success of De-monetisation?

Wed, 16 Nov Pre-Open

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Post de-monetisation there has been a lot of volatility in the market. The trump win and de-monetization has created a lot of confusion among the market participants. Indian markets have been in pressure and both BSE Sensex and NSE NIFTY were down 1.92% and 2.26% respectively yesterday.

The markets are reacting negatively for two reasons. First is the short term pain across sectors due to currency shortages and second is the strengthening of the US bond yield and US dollar.

The de-monetisation is being considered as a black swan event which shocked the masses. This was done for three key reasons.

First, nullification of black money hoarded in cash. Second, tackling the counterfeiting Indian currency notes, and lastly curbing terror financing using the fake currency notes.

This will impact various sectors and the section of population which lives outside the banking system.

India is a cash-dependent economy. Its cash to GDP ratio at about 11% is much higher than in most economies. Close to 98% of all consumer payments are made in cash.

There will be fall in demand in the short run, especially in the retail side of the business.

However, this will be a short term phenomenon rather than a long term one. There will be a structural shift that will lead to long term advantages for the economy.

All said and done, the big question is 'How to measure success of de-monetisation'?

We believe the main yardstick to evaluate the success of demonetisation will be the fiscal gain accruing to the government.

According to the RBI, Rs 500 & Rs 1,000 notes together constitute around 86.4% of the total notes in circulation. This translates to Rs 14,180 billion.

The size of the black economy in India is estimated to be in 20-25% range. Further, it is estimated that proportion of black cash in the aggregate currency in circulation is also around 25%.

Thus, the demonetisation will be successful if the fiscal gain is at least 25% of demonetised currency in circulation. This translates into Rs 3,545 billion.

The fiscal gain will have two parts. First, the untendered demonetised currency notes either for exchange or credit in the bank account. Second, taxes and penalties that income tax department will levy on non-declared income.

It will be interesting to see how the Government deals with the rising cacophony of opposition to this move. The denouement will indicate how the rest of the term of the present government will be like.

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