India's War on Black Money: Did Demonetization Succeed?

Posted On Wednesday, Nov 08, 2017


What has one year of notebandi aka demonetization done to the world’s biggest democracy? The government wanted to eradicate illicit cash out of the economy by aiming at combating corruption or black money. Did that work? One year down experts from Quantum AMC pen down their views to determine if what looked like a huge success turned out to be a total failure…

Impact of Demonetisation on Equity
By Nilesh Shetty- Associate Fund Manager, Equity  

The Demonetisation exercise launched by the NDA government on Nov 8, 2016, has now become a text book case of how not to execute a currency recall. Corporate India sitting on freshly expanded capacities and having faced two years of weak demand in FY15 & FY16, due to failure of monsoons and stagnating policy making under UPA 2, was finally staring at a pick-up in consumer sentiment. The feedback from consumer companies on demand in the festive season just prior to the Demonetisation exercise suggested we were on the cusp of an economic recovery driven by better monsoons and stimulus in the form of pay commission hikes and one rank one pension payouts. Demonetisation essentially was a kick in the gut to the Indian consumption cycle which deferred economic recovery by up to 18 months. Inventory cycles which were disrupted after Demonetisation have again been disrupted due to GST and have still not normalized. After one year of the exercise it looks like Raghuran Rajans original hypothesis to the government of the costs far outweighing the benefits may have been proved correct.

Take on Demonetisation and Gold
By Chirag Mehta - Sr. Fund Manager-Alternative Investments

At the stroke of demonetization a year ago, significant amount of gold was sold to purchasers scrambling to convert their currencies at hand (which were about to turn invalid) into gold. The gold rush was so strong that many jewelers sold whatever they had on showcase and were left almost empty. A couple of months later as the remonetisation gathered pace, gold buying caught momentum largely as a inventory build-up at the wholesalers and Jewellers end. Post this was the GST scare; this led to preponement of gold buying from jewelers to build in the inventory and consumers as well. This was done to take advantage of the low tax rates before the feared high rates under GST kicks in. The GST rates were not prohibitive as feared has led to demand staying relatively buoyant. India imported nearly 132 tonnes post the introduction of GST. Surprisingly, demand has not faltered despite higher buying earlier in the year. There was a view that demonestisation would significantly reduce gold purchases but that hasn’t happened. Rather we are seeing significantly higher demand this year as compared to the year before demonetization. India imported about 640 tonnes in the first three quarters of this calendar year as compared to 510 tonnes in whole of 2016. Clearly, demonetization has clearly failed in many of its agendas including its impact on gold.

Source: GFMS, Thomson Reuters

One year of being De'Modi'tized
By Pankaj Pathak - Fund Manager-Fixed Income

November 8th, 2016 was a momentous day which India will never forget.  PM Modi’s Demonetization move was a huge shock to the system. Never before has 86% of a country’s currency in circulation being withdrawn at one go.
It was thus an extremely bold move with major economic and political implications.

The immediate reaction was from its expected impact on black money. PM Modi’s initial speech focused on the aspect of Black money, Fake currency, Terror financing which needed to be tackled through demonetization.
Government’s own estimate (which they filed with the Supreme Court) was that close to 30% of the currency withdrawn will be deemed worthless as the holders won’t be able to prove its source and hence won’t be able to deposit the currency back into the banks.

But Indian entrepreneurial ingenuity ‘Jugaad’, which helped create the Black Money in the first place, went on an overdrive in those 50 days to help deposit 99% of the currency withdrawn back into the banking system.

The supposed outcome of lower currency in the system, the fiscal benefit of extinguished currency and higher taxes from the money deposited has not played out. The two income disclosure schemes thus far haven’t borne much fruit. It also indicated the reality that ‘All Cash is not Black and all Black is not held in Cash’.

The government sensing the ‘Jugaad’ espoused the narrative of a move to a Cashless Economy.
Demonetization has indeed hastened the adoption of cashless means of transactions and has likely also spawned newer business and technologies that will further increase cashless transactions.
Currency/GDP though is inching up indicating use of cash increasing. The spurt in electronic/ wallet/mobile transactions is also tapering off... though it will settle at much higher levels than earlier.

Demonetization impacted economic growth which the recorded numbers will never capture appropriately as the informal sector and the daily/casual labourer bore the brunt and the economy is still recovering from that impact.
The government though has data on the deposits made during the period and the activities in those accounts since then, which they can mine to target and claim more taxes. The overdrive against corruption and black money is also seen by the de-registering of more than 200,000 shell companies many of which could have been used to launder money during demonetization.

The Banks and the Bond markets were indeed the key initial beneficiaries but the impact of demonetization is wearing off as we complete one year.
Especially so in the bond markets, with the 10 year bond yield at around the same level as it was prior to demonetization. Bond yields did fall towards 6% but the sentiment reversed on the falling prospects of fiscal benefits and excess tax collection. The RBI too had to suck out liquidity through issuance of MSS bonds and OMO Sales which further impacted bond yields. The Slower economic growth post demonetization has impacted normal tax collection thus leaving the government to stare at a breach of the fiscal deficit target further worsening sentiment in the bond markets.

Banks another beneficiary got cheap funds with currency held with public turning into bank deposits which helped them cut lending rates faster than may have been the case. The excess liquidity in the system though has reduced and we anticipate that excess liquidity will come back to neutral by December 2017 and that currency in circulation will also inch towards the pre-demonetization mark sometime in the first half of next year.

Indian stock markets have been on an upswing post the initial down move with demonetization maybe triggering an increase in the inflows into domestic mutual funds who have out invested the foreign investor and ensured that the stock market makes new highs despite not so encouraging economic data.

Overall data points though do point to the fact that the immediate benefits of demonetization has not played out as expected and the short term economic impact cost more than outweighs the benefits. We have to wait and see if the longer term expected benefits from lower black money generation and higher cashless transaction do materialize.

Black Money; Fake Currency; Cashless Economy; CorruptionPre-DemonetizationHighest and/or Lowest Level in the last 1 year depending on the data usedCurrent level
Currency in CirculationOct 2016 - 17,282 billion8,980 (Lowest)Oct 2017- 16,346 billion
Banking System LiquidityOct 2016 (-) INR 265 billion(+) INR 5,461 billion (Highest)Oct 2017 (+) INR 966 billion
Point of Sale Terminals for Credit/Debit cardsOct 2016 - 1.51 million2.88 millionAug 2017 - 2.88 million
Cards and Digital transaction*Oct 2016 - 407 million855 million (Highest)Aug 2017 - 705 million
GDP GrowthJune - Sept 2016 - 7.5%5.7%April - June 2017 - 5.7%
CPI InflationSept 2016 - 4.391.54 (Lowest)Sept 2017 - 3.21
10 year Bond YieldOct 2016 - 6.806.19 (Lowest)Oct 2017 - 6.86
BSE SensexOct 2016 - 27,93033,266 /25,765Oct 2017 - 33,213

*Number of credit card and debit transaction at POS, Mobile banking and M-wallet Transaction
(Source: Bloomberg, Reuters, RBI)

Impact of Demonetisation on Mutual Fund Industry
By Harshad Chetanwala - Head - Customer Delight

A year ago every household in India was blindsided by an unfamiliar concept: Demonetisation. The controversial event has been debated globally over the last year, and that debate will continue for years to come. Instead of getting into the debate of whether it worked for or against the economy, which only time will tell, let us delve into whether the Mutual Fund Industry benefited from Demonetisation.

Until the time Demonetisation was announced, the Mutual Fund Industry was hitting new Asset under Management (AuM) records seemingly every month, and industry observers anticipated positive growth as far as the eye could see. One could say that, along with that optimism of investors, Demonetisation actually helped the industry to attract more investments. While overall AuM has grown by 25% since November 2016, which was almost same for prior eleven months (1 Dec 2015 – 31 Oct 2016), Equity AuM grew by 36% during the same period versus growth of 19% from Dec 2015 to Oct 2016. This AuM growth is because of two things: an increase in general market levels (which propels the value of invested assets), and new inflows from investors. The table below on Mutual Fund Industry data for Pre- and Post-Demonetisation helps us understand the impact of Demonetisation on the Mutual Fund Industry.

 31-Oct-1630-Sep-17% Change
Industry Total AuM (In ₹ Crore)1,628,9762,040,30125%
Equity AuM (In ₹ Crore)432,411588,47836%
Inflows (₹ Crore)1 Dec 2015 - 31 Oct 20161 Nov 2016 - 30 Sep 2017% Change
Equity Funds148,071258,18074%
Balanced Funds34,05785,965152%
Income Funds658,354896,82836%
Source: AMFI(Association of Mutual Funds in India)

From the above data it appears that during and after Demonetisation, a lot of people who had their money parked in their Bank accounts have moved to . This is natural because with lower interest rates these days, keeping money sitting in a bank account would not earn very high returns. As they say ‘With great power comes great responsibility’! The same can be said for those of us in the Mutual Fund Industry, ‘With great inflow comes great responsibility’ - the responsibility to generate sensible returns for investors who have entrusted their money with us.

While mutual fund houses work towards that, investors have to keep in mind that their investments have come in a market which is regularly hitting new highs. It is important that investors do not have a kneejerk reaction if the market hits a correction in the near future. So while the debate on the pros and cons of Demonetisation will continue in multiple forums for years to come, investors have their strategy cut out: stay invested with the right funds and enjoy the benefits down the line. From our perspective, Mutual Fund houses should continue to focus on what works best for investors and follow the investment mandate which made investors invest their money with us.

Disclaimer, Statutory Details & Risk Factors:

The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. Please visit – to read scheme specific risk factors.

Above article is authored by Quantum.

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