There isnt enough data out to proclaim if the demonetisation exercise is a success or a failure (though that hasnt prevented even illustrious commentators like Kaushik Basu and Jagdish Bhagwati from weighing in with their views, on either side, on putative outcomes!). Whether this will result in diminution of black money, increase digital penetration, wreck the economy, result in a tax windfall, destroy livelihoods - there's little by way of empirical data, as yet. Some of the high frequency data points (auto sales, rabi sowing area etc) have been mixed, and hence its perhaps too early to conclude one way or another.
However, on one count, ie, that of rescuing the banking sector - as captured in an earlier post, demonetisation is well on its way to achieving its (un)stated objectives. How? Consider the numbers.
Total cash back into the banking system is already ~8 lac crores (12.5 lac crores of old banknotes have been returned, ~4.5 lac crores has been exchanged for new notes). Taking the "worst case scenario" (of the naysayers of the exercise), lets say the entire 15.5 lac crores of old banknotes come back. It would mean banks will be, after accounting for exchange to new notes, left with ~10-11 lac crores of deposits. Given the physical restrictions on withdrawals being likely to be in place for 3-4 months more, it would mean a straight drop of 15-18k crores to bank profits (assuming a conservative NIM of 3% on 11 lac crores for ~5-6 months). Assuming 75% of the deposits flow out once the physical restrictions are waived off, that still means incremental 4 lac crores in deposits, generating 8k crores p.a (@ a modest NIM of 2%) as annuity revenues.
Next, treasury gains to banks as a result of yields dropping and banks booking profits on their G-Sec trading portfolios. As per KV Kamath, the potential treasury gains are as high as 2.5 lac crores this year. Downscaling that number by half would still give 1.25 lac crores. Given the gains displayed by fixed income (and gilt) funds in the market, it provides a reasonable basis for bank treasury portfolio performance.
Last, the general softening of interest rates will result in expansion of margins across the board as legacy deposits are repriced over the next 6-12 months.
Take all the three above together, and the net impact on banks could be expected to be anywhere between 1.3 -1.5 lac crores of additional profits (or capital) for the banking system. The total recapitalisation requirement of Public Sector Banks has been variously estimated to be between 1.8 and 2.5 lac crores by 2019. Whichever number is taken, demonetisation helps plug at least 50% of the requirement. Add in modest government support (current year's budget is 25k crores for recapitalisation), and suddenly banks look to be in a much better shape to raise fresh capital from the market.
Ergo, from data available today, demonetisation as India's TARP is a conclusion that can be reached with reasonable amount of confidence. Certainly much tighter confidence intervals than the broader macro gains (and gloom) being predicted by the commentariat.
Flip side? Unlikely that the government can market this undeniably worthy objective as a measure of its success. In the long run, whatever else demonetisation might end up doing, it would be a Schrodinger's Cat - alive (successful) on the banking side, even if dead (failed) in everything else!
However, on one count, ie, that of rescuing the banking sector - as captured in an earlier post, demonetisation is well on its way to achieving its (un)stated objectives. How? Consider the numbers.
Total cash back into the banking system is already ~8 lac crores (12.5 lac crores of old banknotes have been returned, ~4.5 lac crores has been exchanged for new notes). Taking the "worst case scenario" (of the naysayers of the exercise), lets say the entire 15.5 lac crores of old banknotes come back. It would mean banks will be, after accounting for exchange to new notes, left with ~10-11 lac crores of deposits. Given the physical restrictions on withdrawals being likely to be in place for 3-4 months more, it would mean a straight drop of 15-18k crores to bank profits (assuming a conservative NIM of 3% on 11 lac crores for ~5-6 months). Assuming 75% of the deposits flow out once the physical restrictions are waived off, that still means incremental 4 lac crores in deposits, generating 8k crores p.a (@ a modest NIM of 2%) as annuity revenues.
Next, treasury gains to banks as a result of yields dropping and banks booking profits on their G-Sec trading portfolios. As per KV Kamath, the potential treasury gains are as high as 2.5 lac crores this year. Downscaling that number by half would still give 1.25 lac crores. Given the gains displayed by fixed income (and gilt) funds in the market, it provides a reasonable basis for bank treasury portfolio performance.
Last, the general softening of interest rates will result in expansion of margins across the board as legacy deposits are repriced over the next 6-12 months.
Take all the three above together, and the net impact on banks could be expected to be anywhere between 1.3 -1.5 lac crores of additional profits (or capital) for the banking system. The total recapitalisation requirement of Public Sector Banks has been variously estimated to be between 1.8 and 2.5 lac crores by 2019. Whichever number is taken, demonetisation helps plug at least 50% of the requirement. Add in modest government support (current year's budget is 25k crores for recapitalisation), and suddenly banks look to be in a much better shape to raise fresh capital from the market.
Ergo, from data available today, demonetisation as India's TARP is a conclusion that can be reached with reasonable amount of confidence. Certainly much tighter confidence intervals than the broader macro gains (and gloom) being predicted by the commentariat.
Flip side? Unlikely that the government can market this undeniably worthy objective as a measure of its success. In the long run, whatever else demonetisation might end up doing, it would be a Schrodinger's Cat - alive (successful) on the banking side, even if dead (failed) in everything else!
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