Economy: Demonetization and GST: Keeping track of new normals - Kotak

Demonetization and GST: Keeping track of new normals. We believe the process of re-monetization is almost complete. The currency in circulation (CIC) is stabilizing at a much lower level than before demonetization. But, lower CIC is unlikely to disrupt economic activity. Digital payments are picking up steadily though it remains at a nascent stage. With an eye on the expected formalization of the economy, we outline a few metrics to gauge the structural impact of demonetization and GST in the next few years.

Remonetization broadly complete with CIC likely to stabilize at 10-10.5% of FY2018E GDP

CIC on July 28 was Rs15.4 tn and is showing signs of stabilizing at this level. From here, we believe incremental CIC will be a function of seasonal demand. We note that CIC/GDP has fallen to 9.2% from 11.9% before demonetization and expect it to hover around 10 to 10.5% by March 2018. We do not expect much disruption in economic activity from lower CIC given that a part of it would have been "idle" cash before the note ban. However, challenges of demonetization and GST will persist for a few more quarters for traditional cash-intensive businesses including jewelry, textiles and leather products (in the informal segment), and real estate (additional pressure from RERA).

Non-cash transactions have picked up though it has a long way to go

Average volumes for Nov 2016 to Jul 2017 is around 2X the average for the same period a year ago. This compares well with the average total value of transactions which is around 1.2X that of a year ago. Part of the CIC was anyway unproductive before demonetization (idle, unaccounted cash), but a part of the dip in CIC was offset by the pick-up in digital payments. We note some positive signs: (1) higher installation of POS machines leading to a sharp reduction in the number of people per POS terminals, and (2) steady increase in volumes for UPI transactions from November 2016 levels.

GST and demonetization: steady formalization of the Indian economy

One of the most important fallouts of the GST and demonetization will be the formalization of the economy. The larger impact we need to focus on are (1) changes to business models with firms increasingly becoming tax compliant and their focus on greater efficiency, and (2) unorganized sectors turning organized. We also need to be mindful of any negative fallout on employment as the economy formalizes. We will gauge the impact of demonetization and GST over the next few years using the metrics outlined below.

Key metrics: tax filers and revenues, digital payments, financial savings and MSME credit

On the hard data front, the most direct impact of demonetization and GST should be seen through (1) increase in tax revenues for central and state governments and the number of tax filers (due to higher compliance and formalization), (2) greater use of digital payments (promotion of cashless transactions and financial inclusion), (3) larger share of financial savings (curb on unaccounted cash and financial inclusion), and (4) increase in bank credit, especially in the MSME sector (formalization and economies of scale). We discuss these in detail in the next section.

Key metrics: Tax filers and revenues, digital payments, financial savings, and MSME credit

- Tax revenue and tax filers. Income tax collections should increase substantially over the next two to three years from higher compliance and greater data availability to the government post-demonetization. As of March 2017, 53 mn registered users have e-filed income tax out of 62.1 mn total registered users. Around 81% of the filers were in Rs0-0.5 mn income bracket. As of June 2017, there are around 64 mn income tax registrations (individuals, HUFs, company, etc.) for e-filing of tax. We would watch for the (1) pace of increase in the number of filers, (2) shift in the number of tax payers in the income brackets to gauge the impact of demonetization.

- Through GST, consolidated government's indirect tax revenues should increase as compliance improves and unorganized segment shifts towards the organized. These should also imply that the number of tax filers (both of direct and indirect taxes) should increase from current levels. Based on anecdotal evidence, there has been an increase in transactions with invoices and levying of GST (especially in retail trade). Data on GST registrations and collections will hopefully be released over the next few months. We expect the government to disclose the datasets in such a way that the benefits of the tax reforms are visible to the public.

- Digital payments. With currency in circulation stabilizing at much lower levels than before demonetization, digital payments should gain ground over the next few years. As discussed earlier, we are still in the early stages of becoming a non-cash economy. But the pace of adoption of digital payments is encouraging. As part of the enablers in terms of infrastructure, we had highlighted in our report dated February 20, 2017 (Less-cash economy: Blip and a long haul) that mobile and internet penetration will be key requirements for it. As of March 31, 2017 there were 422.2 mn broadband users with internet penetration at 32.9%.

- Financial savings. We have been highlighting higher financial savings as one of the dominant themes for India over the next five to ten years. Post demonetization, there has been a reduction in idle cash and unaccounted incomes. A large portion of the cash has moved to formal banking channels in the form of deposits. Further, we note that since November 2016, flows (SIPs, etc.) to domestic mutual funds has been high compared to previous months. We believe that with a relatively young population, increasing financial inclusion and literacy, positive real interest rates, the stage is set for a steady uptrend in financial savings.

- MSME credit. One of the greatest impacts of formalization will be greater use of banks for MSME credit. This has typically been self-funded or dependent on informal lending channels. Based on the Sixth Economic Census (Jan 2013-Apr 2014), 78% of MSMEs were self-financed and only 4% by financial institutions / money lenders / self-help groups. Data pertaining to MSME sector financing is patchy beyond banking sector data and some sporadic reports. Given the present mode of financing, formalization of the economy can provide a vast (more than 10-15X current levels) opportunity for credit disbursements through formal financing institutions to the segment.

Source : Equity Bulls

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