By: Punam Sharma
The scale of black money and unaccounted wealth in India has been much talked about although putting an exact quantum remains difficult. What is certain is that currency in circulation at ~12% (much higher than other economies) of GDP has been growing at a faster pace than nominal GDP growth over the last few years. The government has been committed to a path of implementing key reforms so as to reduce the quantum of parallel economy as well as cash based transacting. The latest announcement of the Prime Minister to withdraw the legal tender for Rs.500 and Rs.1000 notes from the midnight of November 8th is just another step towards achieving this goal. It has certainly shifted the economy into an uncertain phase. While the medium and long term impacts of this move have been generally welcomed by most, the immediate and short term impact could be negative.
On the macro economic front, the impact is expected to be positive with contraction in money supply due to demonetization expected to be neutralized by a more liberal monetary policy with interest rate cuts being a key agenda item. For a more detailed impact on the macro, refer our note ‘Move to Extinguish Currency Notes- Bond and Macro Implications Nov’16’.
On the micro front, the clarity, unlike the macro is far lesser. While at an overall level, the impact will be most felt in distribution channels with myriad levels of cash transactions; to assess the impact of demonetization at a sector level, we propose an analysis derived by focusing on the supply chain from the producer to the consumer.
Broadly, three types of distribution channel emerge as illustrated below:
Type I: Companies selling directly to dealer eg. Automobile/oil marketing companies
Type II: Companies using a multi layered distribution channel where they supply either to own stores / exclusive distributors, wholesalers or retailers eg. Consumer durables, home improvement, ready-made garments
Type III: Companies where wholesalers sell directly to retailers. Additionally, a multi layered distribution channel is used (excluding own stores) eg. Consumer staples, domestic pharmaceuticals
Our belief is that the distribution channel directly controlled by the company i.e Type I will have least problems of bad debts / receivables in the short term. The other two segments will be impacted twofold (1) recovery of outstanding dues within the channel and (2) medium term impact on inventory management and sales, which may take a longer time to recover given the liquidity crunch. We believe that organized retail might benefit over the medium term and gain market share from unorganized retailers as incremental sales are likely to be driven through electronic modes of payment.
Two sectors, financial and real estate need special mention. With regard to the financial sector, strength of branch network is clearly evident. The collection at PSU Banks is several folds the collection of fresh deposits at big private sector banks like HDFC Bank and ICICI bank. In the Non-banking finance segment (NBFC), the race to grow loan book across various product segments such as Loan against property, loans to SMEs and micro SMEs, housing loans to self-employed will come under severe test in the coming quarters. We expect higher build-up of gross NPAs and modest credit off take in these segments over the next few quarters.
On real estate, the impact of this move is likely to be even more severe given the high element of cash transactions required; from buying land to sourcing regulatory approvals. Given that real estate has been the preferred investment destination for unaccounted wealth, the impact on the sector maybe long drawn. Self-occupied and self-constructed housing however may not be impacted. In order to counter the impact of demonetization, we expect an announcement from the Government on affordable housing.
Lastly, on consumer confidence, an erroneous thought has been built up over the last few days that consumption is dependent heavily if not entirely on black money. Just from a flow perspective black money in hand, was not necessarily being used for consumption, though it may have had a “wealth” effect. The emergence of middle class has been the most critical factor to spur consumption over the last decade; this move will continue going forward as well. We believe that consumer confidence is driven by certainty of income and confidence in the near to mid-term. In several international surveys Indian consumers have regularly been rated as amongst the most secure and bullish; it will be interesting to see whether that confidence sustains in the coming quarters. For a significant section of the consumers who are salaried and have mainly accounted wealth, it would be business as usual; for those with a significant share of unaccounted wealth, the coming quarters will be a period of adjustment. Sentiments to a large extent are driven by our surrounding environment, our media, unfortunately treats its independence as a license to stir hysteria. Hysterical media coverage may dampen the sentiment in the near term to some extent.
Among our key fund strategies, IDFC Premier Equity Fund continues to focus on the consumption theme, which may impact the performance in the near term however we are using the current volatility to realign our portfolios to add names which in our opinion are not only best in class in their categories across market cap segments but should also benefit from the revival as it unfolds. IDFC Sterling Equity Fund continues to focus on a rebound in investment cycle by participating in the mid and small cap segments. IDFC Classic Equity Fund continues to identify opportunities which combine quality with relative value focusing on the large cap segment. IDFC Imperial Equity Fund will utilize the current market opportunities to build a focused portfolio of companies. IDFC Infrastructure Fund retains its focus as a pure infrastructure fund with modest leverage as a key variable. IDFC Equity Fund focuses on large caps, a segment which offers more attractive valuations at current market levels.
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