Modi Took A Massive Political Risk With Demonetisation, Says Chris Wood

Wood called the decision laudable but a massive political risk by Modi in his first term.

Out of service ATM machines in Jammu on Thursday. (Source: PTI)
Out of service ATM machines in Jammu on Thursday. (Source: PTI)

Prime Minister Narendra Modi's decision to withdraw Rs 500 and Rs 1,000 notes has left people scrambling for cash. It’s inconvenient but the benefits of the move will outlast those inconveniences, said brokerage firm CLSA's chief equity strategist Christopher Wood.

In his weekly newsletter ‘Greed & Fear’, Wood called the decision laudable but a massive political risk by Modi. While building in a short-term economic hit, Wood said that India will see a V-shaped recovery and detailed how demonetisation may play out across different sectors.

While these are laudable objectives, the political risks are considerable given the practical issues raised for ordinary people with average queues of three hours and more at ATM machines as people waited to take out the daily permitted maximum of Rs 2,000, though this was raised to Rs 2,500 on Monday.  
Christopher Wood, Managing Director and Chief Strategist, CLSA

Real Estate: Delayed Recovery

The residential property market will see a longer downturn as this is the sector where black money cash is most widely deployed, Wood wrote in the report.

The sector is also dealing with long overdue regulatory reform. The Real Estate (Regulation and Development) Act, which was passed in March 2016, is due to be implemented throughout the nation by May 2017. The act makes it mandatory for real estate developers to put 70 percent of the cash proceeds from advance bookings into escrow accounts. The act also looks to curb unaccounted money from being pumped into the sector.

Demonetisation, combined with the change to the business model triggered by RERA, is now going to lead to dramatic consolidation since only well capitalised developers are going to be able to function in a business where pre-sales can no longer fund developments.
Christopher Wood, Managing Director and Chief Strategist, CLSA

Private Investment And Consumption Cycles To Be Hit

Demonetisation will also have broader macroeconomic implications like a further delay in the recovery of the investment cycle. Consumption will take a short term hit as well, said Wood.

The housing market had offered hope for a revival in the private sector investment as India's capital spending is still weak on account of a low capacity utilisation rate and the stressed asset hangover in the country's banking sector. Wood explains that government-driven infrastructure spending will show strong growth as private sector investment activity will take longer to kick in due to demonetisation.

If the private sector investment story remains constrained, areas where the cycle has already picked up in terms of consumption now face some short term setbacks because of the knock-on contractionary effects of Modi’s attack on cash. Examples are autos and cement...Hopes of a revival in rural demand driven by India’s best monsoon season in three years will also be deferred.
Christopher Wood, Managing Director and Chief Strategist, CLSA

Bond Rally; Growth In Deposits

In contrast to the negative bond action seen globally, India's government bond market has remained unhurt by Donald Trump's victory.

The Indian 10-year government bond yield has declined 36 basis points to 6.43 percent since November 8. Wood attributes this bond rally to the demonetisation move.

Wood also anticipates that this would lead to a significant increase in deposit growth into the banking system, which had slowed to 9.8 percent year-on-year in October compared to 16 percent in 2013.

Rising deposit growth should also give the banks more room to pass on interest rate cuts to borrowers going forward, whereas since the start of 2015 only about half of the 175 bp of rate cuts have been passed on to borrowers.
Christopher Wood, Managing Director and Chief Strategist, CLSA

Trigger For Rate Cuts And Shrinking Fiscal Deficit?

In a separate research report issued on November 10, CLSA's India economist Rajeev Malik had forecast rate cuts of 75 basis points through the next financial year till March 2018.

Wood said that the prediction makes sense as demonetisation will have near term deflationary implications.

As a result of demonetisation, India's tax revenue inflow will also grow, creating more room for structural improvement in the fiscal deficit which is projected to decline to 3.5 percent of the gross domestic product in this fiscal year and 3.0 percent in FY18, according to Wood.

Indian Equities Still The Best Bet In Asia

All things considered, Wood said that India still remains the best long term equity story in Asia by far.

It is remarkable how well the growth orientated stock market has held up given the continuing lack of an investment cycle, given that credit growth has only been rising in line with nominal GDP growth for the past five years and given that earnings growth has still not really bottomed out.
Christopher Wood, Managing Director and Chief Strategist, CLSA