Deposit accretion continues at a sturdy pace limiting negative wealtheffect: As per RBI’s press release, post the demonetisation measuresannounced, banks have reported that exchange/deposits of cancelled notesamounted to Rs8.45 trillion (exchange amounted to Rs0.34 trillion anddeposits amounted to Rs8.11 trillion) during Nov 10th-27th. Considering thereis still time to deposit cancelled bank notes (till Dec 30th), if the current pace ofdeposit accretion continues (57% of Rs 14trn already deposited), this willlower the need of the RBI to write-down the unaccounted currency liabilities inits book and will also limit the negative wealth effect, in our view.
Supply of new currency notes likely to improve from Jan-17: The bankshave reported that Rs2.2 trillion has been withdrawn by the public during Nov10th-27th from their accounts either over the counter or through ATMs. Overthe last few days, we have seen the currency supply in the economysomewhat improve with new Rs500 notes becoming available, ATMs havebeen recalibrated to dispense new notes while giving priority to rural areas.
Assuming the printing of new notes started in Sept-16 and the printing presshas been operating at full capacity, we expect the circulation of notes to startimproving from Jan-17 even though it will take another few months (likely Mar-Apr 2017) to restore the amount of liquidity taken out of the system.
Short-term growth disruption from demonetisation measures likely;increased scope for counter cyclical policy support: As we beenhighlighting, we expect demonetisation to hurt consumer discretionaryspending in the near term. The supply chain disruptions and adverse impacton productivity is also likely to delay the recovery in investment cycle. Indeed,there are certain asset classes that are likely to see a long lasting impactincluding real estate/land sales, jewellery etc as organised segment shrinks.
That said, we expect the slowdown in economic activity to be largely limited,spread over the next 6-9 months and growth to start improving from thesecond half of FY18. Indeed, we now expect growth on a GVA basis toslow to 6.6% in FY17 (vs. 7.4% estimated earlier) before recovering to7.4% in FY18 (vs. 7.8% estimated earlier). Our channel checks areindicating that credit cycles have been extended in both the formal andinformal economy. Indeed, we expect policymakers to undertakecountercyclical policy measures to support growth. We estimate fiscal spaceof at least ~0.5% of GDP to be available in FY18 both from higher taxbuoyancy and fiscal windfall gains from the notes that do not return to thebanking system. We continue to expect inflationary pressures to remaincontained (~4.5% CPI inflation estimated in FY18) and see scope of further50-75bps cut in the repo rate over the next 12-months. We believe the recentCRR hike to withdraw excess banking liquidity to be largely a temporary moveand is likely to be followed by higher MSS (market stabilisation scheme)bonds which will give leeway to the banks to cut lending rates going forward.
Medium term structural reform: We believe the demonetisation move willhelp improve transparency, increase tax compliance and encourage a movetowards a digital economy in the medium-term. The increase in tax buoyancywill help provide more resources in the hands of the government to undertakedevelopment spending. This will also encourage a shift in household savingsfrom physical towards financial assets, thus providing productive resources toboost investments and hence overall growth in the medium-term.
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