India: Unprecedented move to eliminate shadow economy

Transcription

1 Treasury Research Group For private circulation only India: Unprecedented move to eliminate shadow economy Niharika Tripathi Kamalika Das Samir Tripathi Please see important disclaimer at the end of the report In a historic move, the Government has cancelled high denomination notes of INR 500 and INR 1000 w.e.f. November 8 th. This is in line with its continued efforts to check black money and counterfeit notes. Industries (such as trading, mining, real estate, construction etc) with heavy cash reliance are likely to see the strongest impact and weigh on growth in the short term. However, the move remains positive from a medium term perspective amid more inclusive growth, increased efficiency and improved corporate governance practices. On the inflation and liquidity front, the move will be seen positively given the expected sharp fall in currency in circulation(cic). Fiscal arithmetic will also see positive impetus amid increased tax compliance. Government takes historic steps to crackdown on shadow economy The Government in a historic move made notes of denomination INR 500 and INR 1000 void yesterday (w.e.f. midnight). Individuals and corporations will have up to December 30 th to comply with the change by exchanging their money at banks/ post offices. Select areas such as hospitals, airports and petrol pumps will continue to accept the notes for some time. The move comes in Government s continued attempts to curb financing of terrorism through the proceeds of Fake Indian Currency Notes (FICN) and use of such funds for subversive activities such as espionage, smuggling of arms, drugs and other contrabands into India, and for eliminating black money. The World Bank in July, 2010 estimated the size of the shadow economy for India at 20.7% of the GDP in 1999 and rising to 23.2% in 2007 (averaging 22.4% for the period ). Impact analysis: A. Growth to take a hit in short term; see positive impetus in medium term Shadow Economy accounts for ~22% of India s GDP Country Size of shadow economy (% of GDP) China 12.8 India 22.4 South Africa 28.1 Brazil 39.8 Philippines 41.9 Thailand 51.9 Peru 59 Figures represent average over Source: World Bank, ICICI Bank Research In the short term, the move to declare void notes of denomination INR 500 and INR 1000 will hit those industries which are majorly dependent on cash transactions. Industries such as construction, real estate, hotel businesses, self-owned businesses, bullion and jewellery, mining etc. are likely to see the impact of this move. Medium and small businesses that are cash transaction heavy will be hit as well. Industries such as mining, trade, real estate etc that are expected to be strongly hit account for ~55% of the GVA basket. Given their significant share in GVA, growth is likely to see a sharp plunge in the near term. (For a detailed impact heat map see appendix). However, in the long term, the move will be growth supportive. More inclusive growth, increased crackdown on black money and corruption, increased efficiency (by increased tax compliance and checking counterfeit money) and boost to formal economy will be a positive. Additionally, increased transparency in business transactions is supportive of better corporate governance practices and will help to instill confidence in India Inc. According to the World Bank s ease of doing business report, India currently stands at 130 (of 190 countries). However, sub components such as Dealing with construction permits (rank: 185), Registering property (138) and Paying taxes (172) have very low ranking. These categories may see marked improvement over the medium term.

2 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 In Focus B. Move to further cool inflation significantly The demonetization of the higher denomination currency is expected to lead to lower inflation. The vast magnitude of currency in circulation (especially that deployed via means of corrupt means) has been closely linked to inflation and can in part explain the sharp rise in prices. Sharp plunge in prices in industries such as real estate is likely to be seen. Given the high usage of cash in the rural economy, especially with relation to agriculture, food prices are also likely to come off sharply. This is over and above the low inflation trend witnessed in some of the component of the CPI basket. Overall we believe that the move is likely to moderate inflation significantly in the medium term. C. Systemic liquidity to witness a boost as currency in circulation likely to see a sharp fall Currency in circulation (CIC) has seen a marked rise over the last fiscal year, rising by over INR 2 tn. This has further risen by INR 1 tn this fiscal to INR 17.7 tn currently. CIC remains a key leakage from the system. Given the move to demonetize, CIC is expected to fall sharply and systemic liquidity is likely to improve significantly. Consequently, lower OMO intervention by RBI (to support liquidity) will be seen. Currency in circulation to see a sharp fall going ahead (INR tn) Currency in Circulation (CIC) Growth (RHS) (%YoY) D. Fiscal arithmetic to be supported Stricter measures against black money will lead to increased tax compliance and support fiscal arithmetic in the medium term. Further, complemented by the implementation of the Goods and Services Tax the move will be fiscal supportive. Monetary policy: The disruption in domestic economic activity along with sharp disinflationary trend in inflation will open the scope for aggressive monetary easing going forward. Source: CEIC, ICICI Bank Research Conclusion In conclusion, short term challenges are likely to be seen on the growth from. However, in the medium term the benefits of this move will be seen amid more inclusive growth, increased crackdown on black money and corruption, increased efficiency and improved corporate governance practices. Inflation and liquidity will see positive impact amid expected fall in currency in circulation (CIC). Fiscal arithmetic will also see positive impetus.

3 APPENDIX Heat map of impact on growth sub-components: Share in GVA (%) Share Impact GVA Agriculture, Forestry and Fishing Crops 10.2 Livestock 4.0 Forestry and Logging 1.3 Finishing and Aquaculture 0.8 Industry Industry: Mining and Quarrying 3.0 Industry: Manufacturing 17.1 Food Products, Beverages and Tobacco 1.7 Textiles, Apparel and Leather Products 2.4 Metal Products 3.3 Machinery and Equipment 3.4 Other Manufactured Goods 6.3 Electricity, Gas, Water Supply and Other Utility Services 2.2 Construction 8.8 S ervices Trade, Hotels, Transport, Communication and Services Related to Broadcasting 18.9 Trade, Repair, Hotel and Restaurant 12.0 Trade and Repair Services 10.9 Hotels and Restaurants 1.1 Transport, Storage, Communication and Services Related to Broadcasting 6.9 Railways 0.8 Road Transport 3.3 Water Transport 0.1 Air Transport 0.1 Services Incidental to Transport 0.8 Storage 0.1 Communication and Services Related to Broadcasting 1.8 Services: Financial Services, Real Estate and Profesional Services 21.0 Financial Services 6.1 Real Estate, Ownership of Dwelling and Profesional Services 14.9 Services: Public Administration, Defence and Other Services 12.7 Public Administration and Defence 5.8 Other Services 6.9 Key: Strongly impact Low-medium impact Least impact

4 Move to a digital payment system: According to a study by Visa, if India were to spend around INR 60,000 crore over a period of five years in subsidising the appropriate equipment and in giving tax-breaks to promote digital payments, it could save over INR 470,000 crore over the next 10 years by way of lower costs of managing a cash economy. The move undertaken by the Government last night will aid in moving towards a more digital economy. Given below are the annual turnover by payment system type as detailed in RBI s annual report. Payment System Indicators Annual Turnover V olume (million) Value (INR bn) Systemically Important Financial Market infrastructures (S IFMIs) 1. RTGS , , ,57 Total Financial Markets Clearing (2+3+4) , , , CBLO , , , Government Securities Clearing , , , Forex Clearing , , ,257 Total SIFMIs (1 to 4) ,355,822 1,426,488 1,545,672 Retail Payments Total Paper Clearing (5+6+7) 1, , , , , , CTS ,691 66,770 69, MICR Clearing ,943 1, Non-MICR Clearing ,682 16,819 11,972 Total Retail Electronic Clearing ( ) 1, , , , , , ECS DR ,268 1,740 1, ECS CR ,492 2,019 1, NEFT , ,786 59,804 83, Immediate Payment Service (IMPS) , National Automated Clearing House (NACH) , ,221 3,802 Total Card Payments ( ) 1, , , , 575 3, 325 4, Credit Cards ,540 1,899 2, Debit Cards , ,213 1, Prepaid Payment Instruments (PPIs) Total Retail Payments (5 to 15) 3, , , , , , 752 Grand Total (1 to 15) 3, , , ,499,570 1,580,617 1,723,425 Source: RBI, ICICI Bank Research

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