Demonetisation will Benefit the Economy in the Long Run


Kochi: Transformational events are rare. And, paradigm shifts that can unleash structural shifts in the economy and change the financial culture of the people are even rarer! The demonetisation announced on November 8 is a paradigm shift of seismic proportion. The consequences of this momentous decision will be disruptive in the short run but hugely positive in the long run.

Why demonetisation?

Broadly, demonetisation has three objectives: Elimination of fake notes (used in terror financing); Attacking black money and thereby, destroying the parallel economy, and expediting transition into a cashless economy.

Of the three objectives, attacking black money is the most important. Demonetisation removes the fake notes completely. Transition to cashless transactions will certainly gather momentum, but it will take a long time in a country like India.

Beyond black money

The fact is that this epoch-making decision will go beyond attacking black money and will have far-reaching and profound consequences for business and economy. It has the potential to change the financial and business culture. It is not a secret that many segments of businesses, particularly small and medium ones, are not transparent. Compliance to laws is not widespread. The new initiative of the government will focus on encouraging compliance.

Short-term pain; long-term gain

In the short-term, liquidity crunch has caused lot of suffering to the ordinary people. Trade has been disrupted and many economic activities have been adversely impacted. These short-term pains will slowly recede. The long-term benefits from demonetisation will be huge. If demonetisation is followed up with an attack on benami property, it will go a long way in attacking the parallel economy in India.

Real estate to be hit

The most impacted segment will be the real estate sector. It is widely known that a part of real estate transactions is done in cash. This unreported cash transaction becomes black money and escapes the tax net. This practice will stop. The immediate impact of this will be a decline in land and apartment prices. New project launches will remain frozen for some time. The sector will slowly move towards transparency, accountability and maturity in the long run.

Rates will go down

Inflation is likely to trend lower due to deficiency of demand. This, along with the bumper harvest made possible by good monsoon, will lead to steady decline in prices. Down trending inflation will enable the RBI to cut rates further. Already the 10-year bond yields have declined to around 6.6 per cent. Another 0.75 per cent cut in interest rate is likely in the next one year.

The bribe takers, the corrupt and the black-monied are today a worried lot. The government should take this forward and strictly punish the peddlers of black money. A significant attack on benami property is the next logical step.

(The author is Investment Strategist, Geojit BNP Paribas)