India Fund

PM Modi’s War on Corruption

MODI’S ANNOUNCEMENT

India’s Prime Minister Mr. Narendra Modi in an unprecedented, surprise and historic move to curb black money announced the scrapping of currency notes of Rs.500 and Rs.1000 denominations effective midnight of 8th November 2016. These denominations account for over 80% of all currency in circulation by value and potentially constitute 40 to 50% of black money in India.  Some of the key announcements made by PM Modi were;

  • Currency notes of Rs.500 and Rs.1000 denominations will not be legal tenders beginning November 9, 2016
  • New notes of Rs.500 and Rs.2000 would be released and circulated from November 10 which will have enhanced security features and will not be easily replicable.
  • Banks and ATMs in India will remain closed on November 9 to transition to the new currency
  • People can deposit/exchange old notes of Rs.500 and Rs.1000 in their banks from November 10 till December 30, 2016.
  • Those unable to deposit notes by December 30, 2016 can change them till March 31, 2017 by furnishing ID proof
  • Cashless fund transfers won’t be affected by the move

PM Modi while addressing the nation termed this announcement as an action taken that will have a defining impact on India’s destiny.

THE MOVE A GAME CHANGER IN THE FIGHT AGAINST CORRUPTION AND COUNTERFEIT CURRENCY NOTES

The Narendra Modi government has taken a series of steps since it came to power in its fight against corruption. Some of the steps taken by the Modi government are shown below.

Exhibit 1: Steps taken by Modi to curb Unaccounted Money

Enacted the stringent Black Money (undisclosed foreign income and assets) and imposition of Tax Act, 2015  to curb illicit wealth abroad

Enacted the Benami Transaction (Prohibition) Amendment Act 2016 to curb black money within the country

Permanent Account Number (PAN) made mandatory for all transaction above Rs.2 lakh irrespective of the mode of payment

Unique Identification Number of everyone were mapped to the PAN numbers of individuals to weed out duplicate PAN numbers.

Tightened income tax return forms seeking more details from tax payers earning more than Rs.5 million a year and now

Announced one time window for domestic tax evaders to come forward, declare their unaccounted wealth and pay a tax and penalty

Scrapped Rs.500 and Rs.1000 notes.

All the above steps were progressive in nature, from the initial steps to strengthen the regulatory framework for curbing black money. Next was to seek details of transactions and link it with the unique identification numbers of individual tax payers. Afterwards the government provided a window of opportunity for tax evaders to come clean, declare and pay their tax liability without any question being asked. This window saw declarations of Rs.700 bn (AU$14 bn). And now, the large amount of unaccounted money in India that have commonly been stashed as currency notes have been discontinued.

As per the Reserve Bank of India (RBI), there were 15.7 billion Rs.500 currency notes and 6.326 billion Rs.1000 currency notes in circulation. These would amount to Rs.7,850 bn (AU$157 bn) of Rs.500 notes and Rs.6,326 bn (AU$127 bn) of Rs.1000 notes in circulation. Market estimates suggest that 40 to 50 % of these, is unaccounted for, pegging the unaccounted amount of money at Rs.5,670 bn (AU$115 bn) to Rs.7,000 bn (AU$140) bn. The declaration of all the unaccounted money could mean a tax windfall to the government of between Rs. 3,400 bn (AU$68 billion) and Rs.4,250 bn (AU$85 bn). Non-declaration of the unaccounted money could mean a transfer of these funds to the government’s coffers by the RBI which could well be in excess of Rs.5000 bn (AU$ 100 bn). An amount required to fund India’s planned infrastructure investments over the next couple of years.

This move will also eliminate the fake currency in circulation and hit a fundamental reset in the economy. As per a study conducted by the Indian Statistical Institute, 250 out of every 1 million notes in circulation are fake. Fake currency is a major source of funding for terror outfits and drug cartels.

SECTORAL IMPACT

Two sectors real estate and financials will be majorly impacted by this move.

Real Estate

Real estate companies operating in northern India which accept certain proportion of cash in a transaction will be adversely impacted and may face liquidity constraints in the near term.

Financial Services

Financial services companies which have funded these real estate companies will be exposed to stress in their assets exposed to the sector. This pain though would be short term for financial services companies and the long-term benefit of availability of higher amount of money will outweigh the short-term negative in the sector.

Consumer Discretionary

The consumption of higher end consumer discretionary (luxury goods) items could get impacted over the next few quarters due to the plugging of the parallel (unaccounted for) economy.

OUR VIEW

While the move will create some initial adjustment chaos for households and small businesses, it will be very positive in the long term. This “out of the box” solution implicitly signals that this government is serious about tackling the issue of corruption and unaccounted money in the system. In our view this move by the government will:
  • Lower corruption will increase the ease of doing business in India significantly and enhance India’s perception globally
  • Steer the country towards a cashless economy, which strikes at the root of unaccounted money transactions. According to some estimates, almost 80% of the economy still runs on cash
  • Higher government receipts will boost government expenditure on infrastructure build, providing a capex led boost to the economy. Estimates of 3% of GDP over time windfall[1].
  • The extra liquidity in the banking system will help further reduce interest rates and boost consumption and the capex cycle further. An increase of around 4% of GDP over the next 3 years1.
  • The move will also have an impact on the political economy in India which is mostly funded by black money. PM Modi’s party may stand to gain in the upcoming state elections in Uttar Pradesh, Punjab and Goa as the local parties may not have ready access to unaccounted funds to buy votes.
[1] “Government deals a lethal blow to India’s black economy” Ambit Capital Pvt Ltd, 10th Nov 16
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