Late night on 08/Nov/2016, Prime Minister Shri Narendra Modi, announced the withdrawal of large-denomination banknotes (₹ 500 and ₹ 1,000) to clamp down on ‘black money’ and curb corruption. The details are:
1) Banknotes of ₹ 500 and ₹ 1,000 will cease to be legal tender on 09/Nov/2016. Such notes in circulation will have to be deposited/ exchanged at banks by the end of December 2016. While there are limits on the withdrawal of notes (₹ 20K weekly cap), there is no limit on the value of “old” ₹ 500/₹ 1,000 notes that can be deposited into an individual’s own bank account. Those unable to deposit ₹ 1,000 and ₹ 500 notes by 30/Dec/2016 can do so until 31/Mar/2017 by providing a declaration besides a proof of identity.
2) RBI will issue new high-security banknotes in denominations of ₹ 2,000 and ₹ 500 which will be put into circulation on 10/Nov/2016. Banks will be closed on 09/Nov/2016. ATMs will not work on 09/Nov/2016, and in some places not on 10/Nov/2016 either. This is to allow the transition to the new currency notes.
3) Concessions will be allowed for the use of the old currency notes for essential needs.
4) No restriction on non-cash transactions. There is no restriction on any kind of non-cash payment via check, demand draft, debit or credit card, or electronic fund transfer. This could mean that payments move more towards electronic channels over time.
Source: Nomura Economics Research
(a) Government Finances: Fiscal Deficit is expected to improve as:
- Integration of the black economy with the regular economy to reduce tax leakages
- Increased transparency and compliance will bring in more people under the tax net
(b) Inflation: This move is expected to bring the prices down as:
- Consumption (discretionary, and possibly otherwise) is likely to be negatively affected in near term bringing down the demand
- Reduction in volume of transactions and lower currency in circulation will improve underlying inflation
(c) Growth: May slow in the next two-quarters as a luxury real estate, land prices, jewellery and consumption spending (especially on big ticket items) should correct in near term. The potential disruption to the payments system and economic activities over the coming weeks is likely to weigh on near-term sentiment & growth outlook.
Long-term Structural Change:
This move generates support for financial savings instruments – eg, bank and non-bank deposits, mutual funds, equities and bonds. A potential reduction in holdings of cash would also point to lower currency ’leakage’ from the banking system. Clubbed with GST, this move will have far-reaching impact on bringing parallel economy to mainstream economy thus giving a further boost to India’s GDP & Improve inflation outlook.
Impact on bond markets:
(a) Increased Liquidity:
- Banks are expected to receive significant deposits from individuals and corporations until 30/Dec/2016. This will lead to a sharp buildup in bank’s deposit base during this period.
- Normally, the second half of the financial year sees significant demand for a physical currency due to pick-up in business activity. This seasonal phenomenon is expected to be significantly muted due to restrictions placed on cash withdrawals.
(b) Higher demand for government bonds: This improvement in banking system liquidity will result in downward movement in bank deposit rates and lead to increased demand for SLR securities (government bonds).
(c) Lower Rates: We expect rates at the short end to be structurally lower and the newly created liquidity to spur demand for investment opportunities in the bond markets making short-term, medium-term and long-term mutual funds, an attractive investment option.
Near-term market moving events
- CPI (15/Nov): Expectations are sub 4%
- FED (15/Dec): Prospects of a Fed December rate hike have declined to 50% on the back of recent US election results
Source: DSP BlackRock Investment Managers Pvt. Ltd. AMC.
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