Economists are scrambling to calculate potential gains from Modi’s late Tuesday decision to ban Rs500 and Rs1,000 notes as legal tender. Photo: Pradeep Gaur/Mint
Economists are scrambling to calculate potential gains from Modi’s late Tuesday decision to ban Rs500 and Rs1,000 notes as legal tender. Photo: Pradeep Gaur/Mint

Modi’s ban on Rs500, Rs1000 notes to boost India budget by 3 times of Iceland’s GDP

Mumbai-based brokerage Edelweiss Securities Ltd predicts the government's surprise crack down on high-value currency notes will uncover `3 trillion in black money

Mumbai: Prime Minister Narendra Modi’s biggest move to fight tax evasion and graft can add $45 billion to India’s budget, or about three times the size of Iceland’s economy.

Mumbai-based brokerage Edelweiss Securities Ltd predicts the government’s surprise crack down on high-value currency notes will uncover 3 trillion ($45 billion) in black money, which is cash that’s stashed away to avoid tax. ICICI Securities Primary Dealership Ltd is even more optimistic, pegging the figure at as much as 4.6 trillion.

Economists are scrambling to calculate potential gains from Modi’s late Tuesday decision to ban 500 and 1,000 notes as legal tender. The move will suck out about 86 % of the 17.8 trillion of currency in circulation. The analysts say as much as a third of this will prove to be illegal and be unclaimed. Those funds can then be used by the government to narrow Asia’s widest fiscal deficit.

“This money can now get utilized for various economic reforms’ funding," said Edelweiss analyst Manoj Bahety. The central bank can reduce its liabilities by an equivalent amount or share the cash with the government, he said.

Here’s what the funds could offer Modi:

“As investments drive up the supply capacity of the economy, overall gross domestic product growth is expected to benefit in the long term," economists including Dharmakirti Joshi at Crisil Ltd., the Indian unit of S&P Global Inc., wrote in a report on Wednesday. “In the short-term, GDP growth may get impacted negatively as the cash based economy feels a crunch and consumption and investment moderates."

Among sectors that will be squeezed are real estate, jewelry and cement, they predict. Shares of DLF Ltd, India’s biggest listed developer, plunged the most in two years on Wednesday; jeweller Tribhovandas Bhimji Zaveri Ltd tumbled the most on record; and Ambuja Cements Ltd fell the most in a year.

However, less cash in the hands of consumers could also drive down prices of key goods, helping control one of Asia’s fastest inflation rates. Citizens will have until the end of 2016 to exchange their now useless currency for newly printed 500 and 2,000 notes. Each person can exchange as much as 4,000 for cash while higher amounts will have to be deposited in their bank accounts.

“The good news here is that there could be a considerable drop in interest rates over the course of the next three to six months," S. Naren, executive director and chief investment officer at ICICI Prudential Asset Management Co. Ltd, India’s biggest money manager with $29 billion in assets, said in an email response. “This would mean that many of the projects which were unviable could become viable as the interest rate subsides. Therefore, over the next three years, we expect a boom in the Indian economy backed by capital expenditure cycle, starting 2018."

The risk is that this “war on cash" may make households and businesses averse to spending, rendering lower interest rates ineffective, said Prasanna A. and Abhishek Upadhyay, economists at ICICI Securities.

“The move will be seen as a war on the parallel economy, corruption and money laundering," they wrote in a report on Wednesday. “Along with the introduction of the goods and services tax, this constitutes a far reaching reset of the Indian economy." Bloomberg

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