'Money pullback good for markets in the long run'

NIRMAL JAIN, chairman of IIFL Group, explains the impact of demonistisation in an interview with Rajesh Bhayani. He says the process is like de-printing money and that it will help the economy. Edited excerpts:

The markets have been very volatile in the wake of demonetisation and Donald Trump victory. How is the outlook?
Obviously, these two events have been completely unexpected and have tremendous impact on market sentiment. The markets will remain volatile, driven by news and events. In the short term and particularly this quarter, companies, particularly those dependent on domestic consumption, may see a contraction in sales. Given the operating leverage, earnings may get hit even more. At index level, we see earnings downgrade of 6-8 per cent for this quarter. But, demonetisation has immense long-term positives for the economy. If demonetisation is good for economy, it has to be good for the markets, too. Trump’s policies will have a mixed impact and one need not be pessimistic too early.

How exactly will demonetisation help the economy?
India has massive physical cash in circulation, ~17 lakh crore or almost 12 per cent of the GDP. If a larger part of this money gets into the formal banking system as deposits, it has a multiplier impact on credit and funds available for productive investment. In classic economic theory, if you take credit-to-deposit ratio at 90 per cent, broad money created is 10 times. To illustrate, if you deposit, say, ~10 lakh in a bank, it has the ability to lend ~9 lakh. It becomes deposit for some other bank, which in turn can lend ~8.1 lakh and so on.

The other long-term positive impact is lower inflation and lower interest rates. As we all know, when the central bank prints money (deficit financing), it is inflationary as more money chases the same quantum of goods and services. Demonetisation is a reverse process – it is sort of ‘un-printing’ the money and, therefore, there will less money chasing the same quantum goods and services. Lower inflation and more money with the banking system would lead to lower interest rates. Also, we’ll see a significant increase in the government’s direct and indirect tax revenue.
But, won’t be there some short-term pains as well?

Black money has been like cancer and this treatment is like chemotherapy. With bad cells, many good cells also get killed.

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The government has to make available new currency notes of ~500 in adequate quantity, very quickly. After this shock, most people will start using electronic and cheque modes of payment. Encourage the same with subsidies on POS (point of sale) machines, lower charges to merchant for discounting card payments, no charges for funds movement from wallets to banks, etc.

Besides, before the Goods and Services Tax kicks in April 2017, the government can have a ‘consumption festival’ with across the board temporary reduction in indirect taxes on consumption products including food items, durables, cement, vehicles and make them cheaper by 10-20 per cent. It will be a huge incentive for people to buy as this will be available only till March. This will mitigate serious concerns that economists and analysts have that economy slow down would have a significant impact on people’s sentiment, employment generation, new investment and income levels of lower middle-class people, etc.

Q. Sectors such as banking have done well of late, but pharma and IT are trailing. What do you say?
The banking sector will struggle with excess liquidity in the short-term, but will have strong low-cost Casa (current and savings account) deposits and falling interest rate would be a windfall for their bonds portfolio. Over the long term, the banking sector benefits immensely. Pharma and IT sectors are not impacted by demonetisation but there are worries about Trump’s policies. I think some of the worries are exaggerated and one should buy at declines.

Q. What’s your advice to retail investors?

Have patience and bear with this turmoil. Do not panic. Buy at declines for the long term. The government is working over-time and cash shortage issues will soon be sorted out.