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Trump win & Notes scrappage -Near term jitters provide opportunities

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Mr.Dhananjay Sinha

Head of Research and strategist.

09 Nov 2016

Unfolding of two major events-one domestic and other global, have led to market jitters which in our view presents an opportunity for value buying.While scrappage of Rs 500-Rs 1000 note is an attempt to eradicate fake notes, we anticipate imminent gains for the banking sector. Trumps win could sustain deglobalisation 

The combination of US election results and the launch of the demonitisation of Rs 500 and Rs 1000 bills in India has triggered a substantial tribulation for the markets. The European markets corrected 1-2% at the advent of the US election result as market participants considered Donald Trump’s victory as an adverse outcome. Indian markets corrected over 5% earlier today as fears of the implication of the demonetisation move griped sentiment along with global cues.

In our view sharp reactions to such events typically present good value opportunities to buy into targeted stocks and other investments.

With regards to the demonetisation event, we believe that this move will extend the long term trend of declining currency holding by the public and is eventually beneficial for the economy over time.

• Importantly, over the past two years the declining trend was reversed somewhat with a peculiar surge in currency holding growth; it surged to a high of 18% from a low of 8-9% in 2014.

The key concerns people have is that demonitisation of the Rs 50 & Rs 1000 currency notes will compress transactions and hurt business in a significant way. This emanates from the understanding that the attack on black money because of this move will diminish business for lot of sectors ranging from real estate, consumer durables, building material, etc


Below we carry out a simple calculation to quantify the potential damage (Exhibit 1). Our conclusions are that:

a)The impairment of the currency holding will effectively be around 32% from last three month average of Rs 16.8tn or around Rs 5.4tn

b)Overall, money supply is unlikely to decline as significant portion of currency will convert into bank deposits and supply of currency will be partly compensated by the new currency bills of Rs 500 and Rs 2000.

c)Effectively the money multiplier will rise due a change in mix of money supply in favour of bank deposits, specially demand deposits.

d)We estimate that currency holding/total deposit will decline from 15.7% to 10.1% and time deposit/total deposit will also decline from 89.8% to 87%. This will result in a massive rise in money multiplier from current 5.8x to over 7.5x assuming a constant effective cash holding at 4.2% (vs mandatory CRR at 4%)

e)Clearly, increased proportion of currency holding will enhance the banking system to generate monetary transmission as it contains the leakage.

f) Aside from the short term disturbances, the decline in currency holding will enhance the monetary mechanism, by extending the rising proportion of transaction thorough banking and formal financial channels.

g)Having said this, it is important to note that substantial portion of decline in in currency holding with public as percentage of money supply (55% to 18%) which happened between mid-1960s to early 1990s is due to nationalisation of banks, increase penetration of banks, ingress of banking technology and subsequently also due to greater financial inclusions. Currently, at 13-14% is it probably at a level consistent with the level of transaction demand for money and possibly further substantial decline can happen with greater push to payment technology platforms like Paytm, valet etc.

h)Potential spike in money and deposit multiplier could stimulate counterbalancing response from RBI: 1) reduce OMO purchases of Gsec, or 2) increase CRR

Trumps electoral win could sustain deglobalisation

• Notwithstanding the characteristic fiscal hawkishness that goes with a complete Republican sweep, the intent of Donald Trumps victory speech indicate a move away from fiscal rectitude. The prominent focus of Trump’s economic policy framework is to spend aggressively on domestic capital formation, including infrastructure projects and active containment of US current account deficit. Clearly, the slant is towards protecting US jobs and re-establishing US economic hegemony. This would imply furtherance of US protectionism. The broader implication would emerge in the form of restricted access to US market for global trade of goods and services, higher supply of treasuries (higher yields), higher inflation and a more strident trade policy approach towards China.

• A chain of adverse reciprocal trade policies could diminish growth impetus attributable to external trade for countries like India. From Indian stand point, challenges for IT industry will likely continue in the form of tighter immigration laws and higher salary levels for onsite staffs. Likewise, Indian manufactured products can face challenges, specially if they have to compete with Chinese goods originally meant for US exports.

Themes to play

a) Banks will end up gaining: Expect CASA of banks to improve both in the immediate term as well as over longer period due to rise in money multiplier in the economy and deposit multiplier for banks. We see positive impact for banks with strong retail franchise that can channelize enhanced deposit mobilisation for retail lending. SME may face near term payment issue due to sudden scrappage of high currency notes. This would increase demand for working capital loan. If we look beyond our old time favorite HDFCBC, INDUSIND, banks which filters through are Federal Bank, DCB Bank and ICICI Bank. In case of tractor, farm income is exempt from taxation. Dealers do initial funding for tractor which is repaid when harvesting is done. We don’t expect any major disruption in tractor demand and fall in MMFS should be buying opportunity. 

b) Staples to remain largely unscathed– No impact here since the items are low ticket. GST rates are likely to be favourable to them. Our conviction stays with HUVR & GCPL. Potential adverse impact could be from the spill over effects of further retardation of construction activities in the Urban areas in the form of lower transfers by construction workers. Higher government spending and Jan Dhan accounts in rural area to boost demand

c) Consumer discretionary- erosion of wealth effect could prolong – Rural and most urban areas have already seen erosion of wealth effect due to decline in real estate prices (land and property). Expunging of Rs 500 & Rs 1000 currency notes can possibly prolong it. We believe the impact on small ticket discretionary spending will likely be minimal, while high value item can experience longer impact. 

i. Auto – 2wh could be impacted more than cars due to high dependence on cash sales and high % of rural sales. Nonetheless, car demand may also drop by a couple of % points. Safest bet would be TTMT which has strong demand growth as well as possible margin tailwind in JLR due to weak GBP.

ii. Consumer Durable – We favour smaller ticket discretionary like Crompton Consumers. Avoid high value consumer discretionaries as demand could soften in near term viz Kaya and Titan.

iii. Paints – Repainting was a major growth driver for this category which has been growing by double digit. APNT could see a couple of quarters of disappointment

d) Real Estate and allied sector – This is major negative for real estate sector which has huge unsold inventory and prices has been under pressure. Rub off effect would be felt in tiles and ply as well. We have seen demand softening for cement as well.

Exhibit 1: Broad calculation of the impact of de-monetisation of Rs 500 and Rs 1000 notes:

Rs bnCurrency holdingTotal depositBroad money
 a) Outstanding (3 mth average) 16758 106946 123704
 86% is 1000, 500 notes 14412  
  White (@50%) 7206  
  Black (@50%) 7206 
 b) Potential amounts converted into deposits 10809 
   - 100% of white and 50% of black    
 c) = a)-b) Potential outstanding currency 5949  
 d) Conversion from new 500, 2000 notes into currency 5405  
 e)=(c+d) Net effect (withdrawal of old and intro of new notes) 11354 112350 123704
 % change from current -32 5 0.0
 Absolute change (Rs bn) -5405 5405 0
 New ratios (% of M3) 9.2 90.8 100.0
 Current ratios (% of M3) 13.5 86.5 100.0
 Money multiplier impact Current After impacts of demonetisation
 Currency/Deposits 15.7% 10.1% 
 Term depo/total deposit 89.8% 86.9% 
 Actual CRR 4.2% 4.2% 
 Money multiplier (estimated M3/RBI reserve money) 5.8 7.7  
 Total deposit multiplier (bank deposit/M3, esti) 3.2  4.0 
 Assumption (70% of increase in deposits of Rs 5404bn is in form of demand depsot and rest in time deposits) 

 Exhibit 1: Broad calculation of the impact of de-monetisation of Rs 500 and Rs 1000 notes: