Demonetization And Savings

Sanjiv Mehta  |  2017-10-16


It was very interesting to see how Trump victory got overshadowed in India- as quite a few people pointed out that local notes are more important than alien votes. There have been raging debates everywhere, homes, offices, newspapers, TV and social media. Opinions have shown a tremendous range- pessimists have argued that previous similar moves in 1946 and 1978 were inconsequential. Optimists have declared that black money has been rooted out.


However, a broader consensus has emerged at least on certain issues:

1 Short term inconvenience and pain to the common man- long queues continue and nobody seems to be disputing this one.

2 Short term gains- It is reported that already Rs 3 lakh crores has been deposited in the banks. To put it in perspective, India’s current fiscal deficit stands a little above Rs 5 lakh crores. With infusion of funds in the banking system, liquidity is improving and interest rates are likely to come down. Real estate prices are already showing a significant decline, overall inflation is likely to fall with consequent effect on interest rates with some economists expecting these to fall by as much as 1 % in the next 6 months. With more money in the legal economy, tax revenues are likely to be enhanced thus reducing fiscal deficit and giving government more room to spend on physical and social infrastructure. Economic growth after initial setback because of less consumer spending should show a healthy acceleration. Also with fake currency taking a hit, financing of terrorism and criminal activities is also going down.


For long term gains, opinions are very divergent. Here a few experts have argued that the benefits will evaporate soon since black money generation will resume. Black money is considered to be 1/4th of Indian economy of almost Rs 140 lakh crores-that amounts to Rs 35 lakh crores. Very little is held in cash while a major part is in gold, property and foreign deposits. A big hoarder might be considering this move just as a temporary setback before he starts his normal black money generation activities. Therefore the crux of the debate is when gains are temporary, why inflict so much pain in the short term? However, there are equally strong opinions that the government will take other measures which will make it difficult for hoarders to maintain status quo.


To gauge further policy initiatives, a good indicator is past behaviour. Modi government ever since assuming power in 2014 has taken steps against black money including Supreme court monitored SIT on black money, Jan Dhan Yojana, Renegotiation of tax treaties and automatic information exchange agreement with tax havens, Tax act 2015 for foreign black money, Income declaration scheme 2016, Penalty on real estate transactions undertaken in cash exceeding Rs 20000, Tax collection at source on cash sales exceeding Rs 2 lakhs and Benami tax amendment bill.

Also looking at Mr Modi’s mindset, there are elections in 2019, he is exactly at midpoint of his term, he knows that common man has gone through tremendous inconvenience and therefore will not take the risk of frittering away his goodwill by causing so much pain without any lasting benefits.

Some of the actions being contemplated or talked about include not allowing cash transactions above Rs 10000, all salaries and business expenses to be in cheque to be recognized as expenses for income tax calculation, cash limitation order, demonetization of Rs 2000 note with limited notice, ban on gold coin manufacturing and imports, declaration of jewellery, property and asset declaration order and even a drastic action of stopping of income tax by replacing it with banking transaction tax.

At least the segment of people who have legitimate businesses but do not pay tax and therefore hold large amounts of cash, might step into the legal system-a constant threat of demonetization of new Rs 2000 note will also tilt them in the right direction. Moreover, unlike similar moves in 1946 and 1978, technology could be a major catalyst, an important booster and an enabler to a largely successfully transition in making India much less dependent on cash

Taking all these factors into consideration, I belong to the camp which believes that Mr Modi will implement more measures to slow down and decelerate the accumulation of black money and eventually reduce its proportion in Indian economy.


Based on above belief, my recommended asset allocation for maximizing the benefit of our savings is following:

1 For money with a time horizon of more than 3 years, equity will be very good. After a possible initial slow down; falling interest rates and improving corporate profitability will push the market higher. This correction consequently is a very good opportunity. Equity is safe since its prospects were good even without this move. So even if a lower probability scenario plays out in which there is no significant dent in black money, Indian equity is still likely to be higher.

Some sectors like real estate might go down, however overall opportunity will be very good. Selection of schemes should be in multicap schemes with a good track record of alpha generation with small sectoral allocation to banking and pharmaceutical sectors. I am recommending pharmaceutical sector not because of demonetization but because of its current attractive valuation.

2 For money with a time horizon of 1-3 years, balanced funds with a mix of equity, equity derivatives and debt will be good, since tax treatment being similar to equity funds is better than that of debt funds. Additionally, even in a down market, they hold their value well on a comparative basis. Since interest rates are likely to come down, duration debt funds can also be utilized.

3 For 0-1 year time horizon, short term and liquid debt funds are a good alternative. For people requiring monthly income stream, a SWP (systematic withdrawal process) could be structured in a tax efficient manner.

4 Real Estate is expected to fall and might stabilize in about a year’s time providing a good buying opportunity later. Therefore, my recommendation will be to wait and watch. In the interim, grow your savings in financial instruments which are expected to outperform.

5 Gold- As I have always written, historical returns of Gold are very low , although periodically it does go through fairly long period s of appreciation and then can decline for quite some time-long term overall trajectory is almost flat. Therefore, invest only that proportion of savings which fulfills your real gold requirement and not as a return enhancer.