Decoding demonetization; a nifty move or an impetuous pronouncement?

Admin August 10, 2016, 15:09 PM Simplifying the complex concept of Demonetization
Influnce of demonetization on real estate What is Demonetization?

Demonetization is the act of stripping a currency unit of its status as a legal tender. Demonetization is essential whenever there is a change in the national currency. It involves retirement of the old units of currency which are replaced with a new currency unit.

The D-Day, 8th Nov 2016

Prime Minister Narendra Modi may have shocked the nation with his announcement, but his declaration was hardly unprecedented. India had pulled select denominations of its currency twice before the Prime Minister’s announcement of 8th November.

Press release of Demonetization

Government of India officially announced the demonetization of ₹ 500 and ₹ 1,000 on 8th November 2016 as Notification No. 2652. The Indian Government withdrew the Legal Tender status of ₹ 500 and ₹ 1,000 denominations of banknotes of the Mahatma Gandhi Series issued by the Reserve Bank in effect from November 8, 2016. They stated that it was a necessary move to tackle counterfeiting Indian banknotes; to effectively nullify black money hoarded in cash and to curb funding of terrorism with counterfeit notes.

A flash back on demonetization in India

The first event of demonetization in India was when Rs1,000, Rs5,000, and Rs10,000 notes were taken out of circulation in January 1946, a year and a half before the country won independence from the British. In fact, Rs 10,000 notes were the largest currency denomination ever printed by the Reserve Bank of India, which were introduced for the first time in 1938. All the three denominations were reintroduced in 1954.

In the early ’70s, the Wanchoo Committee, a direct Tax Inquiry Committee set up by the government, suggested demonetization as a measure to uncover and neutralize the reach of black money. Nevertheless, the public’s reaction to the recommendation kindled the accumulators of black money to enact quickly and to get rid of high denominations before the government was able to close down on them, Mint recounted.

Then, in 1977, the Janata Party coalition government came into power. And after his first year the then Prime Minister Morarji Desai was more assertive about bringing down fake notes and black money. The High Denomination Bank Notes (Demonetization) Act, instigated by the Janata Party on 16th Jan, 1978, regarded the Rs 1,000, Rs 5,000 and Rs 10,000 notes as illegal for the second time.

At the time, the then-RBI governor I.G. Patel had a varied opinion about the implementation of demonetization and blamed the Janata coalition government of trying to cripple the reputation of the predecessor governments instead of simply eliminating black money.

Impact of Demonetization on the Indian economy

Some economists fear that the government’s move to draw out 86% worth of money in flow by demonetizing Rs 500 and Rs 1,000 currency notes would negatively affect India’s economic growth, at least for a short term. A few others have an opinion that the demonetization move taken to eradicate black money and counterfeit notes, would have minute impact on the economy.

Statistics suggest that with 86% of value of money in circulation, the economy would have to make do with only 14% of money in circulation at least for two weeks, until then there would be a limit set on the amount that can be withdrawn from the ATMs. This move is likely to impact a large number of cash transactions which would have a multiplier effect on the economy.

It is the informal sector accounting for around 40% of the economy which would bear the maximum impact and especially in rural India. This would thus reduce GDP growth in the coming period.

Experts Opinion

N.R. Bhanumurthy, Professor at the National Institute of Public Finance and Policy, said that a decrease in money supply would directly affect growth in the short term based on the quantity theory of money. “If all the money sucked out of the economy does not come back which is likely due to the existence of black money, then it would directly impact growth in the short run. The extent of its impact on growth would depend on the size of unaccounted money in the economy,” he added.

Current chief statistician of India T.C.A. Ananth, however, said that the disruption due to demonetization in the economy is unlikely to be significant. “The rural economy has changed a lot compared to what it is used to be 30-40 years ago. It is only a transitory phenomenon of shifting from one currency to the other and is unlikely to have any significant impact on the economy,” he concluded.

Finance minister Arun Jaitley, responding to a question at a press conference on Wednesday, ruled out any short-term impact of demonetization on growth, holding that it would rather benefit growth in the long run. He further stated, “All this would impact the size of the GDP itself because more transaction that was happening outside the (formal) economy would get into the economy itself.”

Influence to the real estate

The real estate sector would definitely be touched by the implementation of demonetization protocol, as it has conventionally seen a very high association of black money and cash transactions. However, almost all such occurrences have been only in the secondary sales market, where cash elements have typically been a veritable 'must'. In other words, the major impact would be faced by resale properties segment.

The luxury and high-end segments of residential real estate would also see a major impact from this exercise, since it is another area which has seen a lot of payments done in cash. The legal banking/financing channels have accounted for only a small part of all transactions in this space. According to industry expert’s opinion, the demonetization move is likely to result in luxury property prices dipping by as much as 25-30% as sellers struggle to offload properties to generate liquidity. This means that luxury home buyers would suddenly have a much wider bandwidth of options to choose from.

The principal market - or, more precisely, the market formed by projects undertaken by renowned and credible developers in the top 8 Indian cities - would remain more or less unaffected or untouched. This is because buyers interested in such projects take the home loans/finance route to buy their homes, and transactions are done through legal channels. Therefore, there would not be any major impact on sales in this segment. However, there might be an influence on quite a few projects in tier 2 or 3 cities where cash has played a pivotal role even in the primary residential sales. However, the turmoil in this segment might settle down in a short period of time.

Benefits to Real estate stake holders
  1. For Indian real estate, RERA and GST were directed at bringing in transparency and to rationalize taxation. But Demonetization of 500 and 1000 rupee notes - is clearly one that would fight black money, corruption and terrorism. It would not just warrant more credibility for the industry, but also in effect, make Indian real estate more appealing to global investors.
  2. Home and land prices could perceive downward pressure, which would in turn help revive demand in the slow-moving housing segment.
  3. This act would also augment confidence of global investors looking at large investments in the real estate sector.
  4. Over the next 12 months, an influx of money into financial instruments and hard assets like real estate could be expected, as people would be encouraged to unveil their earnings. This probably will improve liquidity and lowering of interest rates.
  5. The professional, well organized companies in the real estate sector would significantly benefit from this demonetization and the plague of black money would finally disappear from the sector and the overall economy.

Having said all the above mentioned, industry would have to confront the following as well

  1. In the immediate future, the sector would be under grave pressure with volume, number of transactions and prices in the professional, well organized companies in the real estate sector would considerably benefit from this move and the epidemic of black money would finally vanish from the sector and also from the overall economy. Residential and land markets seeing a substantial downward drift. The impact would be experienced across the board with tier-II and tier-III markets receiving a larger hit.
  2. The influence is likely to be seen in secondary markets, therefore making real estate more "illiquid" for a particular interval of time until the market adjusts to a new normal.

Recent Post