The latest data suggests that a very large proportion of the denotified currency will be deposited back into the banking system. In effect, the government has ended up by running a sort of Voluntary Disclosure of Income Scheme.
Initially, there were some hopes that a large proportion of black cash would be extinguished, allowing the Reserve Bank of India (RBI) to transfer surplus assets to the government in some sort of special dividend. The legality and advisability of such a move may have been debatable but now this discussion is academic.
It is likely that the direct costs of demonetisation will exceed whatever revenue does accrue via punitive taxes. If we count the loss of productivity incurred and ongoing losses due to the cash crunch, the costs will definitely exceed the returns.
The banking system is struggling with a peculiar problem of plenty. Credit was growing at a very low rate before the demonetisation. The cash crunch has further hit demand in many sectors, which means that credit growth will slow even more. At the same time, loan servicing has become difficult and banks have been forced to give easier terms of credit and allow debtors more time.
Banks are flush with funds but RBI had reset the CRR norms with retrospective effect to ensure that 100 per cent of deposits since September 16-November 11 were covered. The 100 per cent CRR is being pulled with effect from December 10, so RBI sees the situation is closer to normalcy.
Banks have barely touched lending rates since the last RBI Policy in early October. But, borrowing costs have reduced. The spread between borrowing rates and lending rates for commercial banks is now four per cent or more. Since inflation is falling and expected to fall further, this makes real borrowing costs very high and loans are therefore, unattractive for
businesses.
The RBI has decided to pause and leave policy rate unchanged, probably because it is worried about higher oil prices and about the prospects of a dollar raise. Over time, assuming RBI stance is geared to cutting rates again once the US Fed's stance is known, commercial lending rates must fall. Until banks are prepared to cut rates, demand for credit will not rise. On the other hand, banks will be reluctant to lend at lower rates until their balance sheets are less messed up and there is more clarity on how the post-demonetisation scenario will pan out. This cycle of low business activity can be broken by a combination of banks being brave enough to cut rates and by consumption picking up.
In the meantime, bank valuation remains very difficult. The prior results don't have much in the way of predictive value since the demonetisation represents a watershed. It changes how the banking system functions and it also affects consumer behaviour in many ways.
It remains to be seen how long the negative impact lasts. It also remains to be seen how much the positive impact will be. If there are large-scale cash withdrawals over the next six-nine months and consumers stay cautious, banks will struggle. On the other hand, if banks make deep cuts and consumer behaviour recovers quickly, banks could bounce back quickly.
The last surveys came in before the man in the queue had realised how long this process would take and how much pain the aam aadmi would have to absorb. But for what it was worth, PMI and business confidence was upbeat. So, there's certainly some hope.
The author is a technical and equity analyst
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
