Businesses that depend on cash for generating sales will naturally be affected due to the demonetisation move by the BJP led NDA Government at the Centre . The extent of impact depends on the percentage of cash based consumption of products for the respective sectors. There is cash based consumption directly or indirectly for most sectors of the economy.
It is easy to tell that sectors such as real estate, infrastructure, FMCG, Jewellery, consumer durables, automobile, cement, microfinance, NBFCs, aviation, logistics, travel and tourism and paints would have a direct negative impact while others such as Banks would directly benefit from demonetisation. Sectors such as oil and gas, information technology, pharmaceuticals, healthcare, capital goods and power would not face any major slowdown in their sales in the next few quarters.
Large part of the demand for Goods and Services would be affected in the rural areas as most of the transactions are dealt in cash. Apart from the setback in demand for products due to demonetisation there would be an issue of management of daily expenses (working capital) for companies like daily wages to labourers and buying of raw materials for sometime. The phenomena of sectors getting affected negatively or positively is only short-term and as soon as liquidity improves from the current situation consumption would be back on the growth track.
Valuations for some sectors were expensive as compared to others before demonetisation and if growth falters to some extent then the valuations may get rerated .
Let us analyse the effects of demonetisation on various sectors of the economy and what is likely to be its impact in the near future.
Fast Moving Consumer Goods (FMCG)
Fast Moving Consumer Goods are required for daily purpose and consumption of such items although essential, would be hampered to a large extent till normal levels of cash are available in the system. Demand would thus remain subdued for FMCG products such as soaps, shampoos, hair oil and other relevant products as temporary shortage of cash would lead to lesser number of products bought by customers in the rural and urban areas. Inventories of FMCG goods are piling up in the urban and rural regions and the rural segment would see a significant slowdown in demand because bulk of the buying is done by paying cash.
Future Retail in the FMCG space reportedly said that cash transactions used to account for 60% of the sales before demonetisation and it has reduced drastically to 10% -15% range after demonetisation.
As government is pushing for a cashless economy through demonetisation, it would be a long time opportunity for these companies, but in the short term they will get affected negatively as lower demand is seen in the near term. Demonetisation is expected to snatch market share from the unorganised sector to an organised one.
For FMCG companies the immediate impact would be reduction in demand for their products in the market followed by a gradual recovery. The sales and profitability would be hampered and would reflect in the quarterly performance of Q3FY17. The recovery in sales growth would get reflected in the last quarter of FY 2016-17 and the first few quarters of FY 2017-18.
S&P BSE FMCG index fell by 6% since the announcement of demonetisation.
Consumer durables are a category of consumer products that do not have to be purchased frequently because they are made to last for an extended period of time. A washing machine is an example of a durable good which takes many years and multiple uses to ultimately buy a new one. This sector is expected to take a drastic hit on demand for their products in the next few months till levels of cash reach normalcy.
Customers in the urban and more so in the rural areas are expected to postpone their purchases of durables such as a washing machine, air conditioner, kitchen appliances, electronic goods, furniture and sports equipment. Since consumer durables usually represent big-ticket items consumers typically make these purchases only when they are confident that they have cash to buy these items.
S&P BSE Consumer Durables index fell by 10% since the announcement of demonetisation.
Demonetisation Rs 500 and Rs 1000 notes would lead to surge in bank deposits, as a lot of the 14 trillion Rs which are floating in 500 and 1000 denominated notes will come back to the system in the next 50 days. A lot of it may also get withdrawn, but some may remain in the system. It will lower the cost of funds helping lower lending rates but in the near term credit growth will remain at current levels of 9% as inflation is likely to fall sharply and the banking system will be flushed with liquidity giving banks treasury gains.
For short term NBFCs and Microfinance institution could see deterioration in asset quality and repayment of loans that are in cash can get affected but there would be no problem in the long term. The move towards a cashless economy will boost savings in financial assets. With any sharp infusion of deposits and relatively limited avenues to lend, the credit deposit ratio for banks would become unfavourable, and thus impact margins.
Demonetisation will impact real estate sector negatively which is already struggling with lower demand which can impact housing finance companies in terms of loan demand and asset quality.
S&P BSE Bankex index fell by 1% since announcement of demonetisation.
Automobiles and Auto Ancillaries
The Automobile Industry is divided into segments such as Passenger Vehicles, Commercial Vehicles, Two Wheelers and Three Wheelers.
In the two-wheeler segment, around 35-45% purchases are made via financing, while the rest are by cash, or are simply unaccounted. Demand for Two Wheelers may be affected in the urban areas and mainly in the rural areas.
In the Passenger vehicle segment, around 75% to 80% purchases are made via financing while the rest are made by cash. Demand for passenger vehicles may not get impacted to a very large extent in the third quarter of FY2016-17.
In the Commercial vehicle segment majority of the buying is done by financing. In case of tractors 65% of the transactions are financed and the impact of demonetisation would be minimal.
S&P BSE Auto index fell by 9% since announcement of demonetisation.
Real Estate and Construction
Real Estate and Construction business is expected to be the most affected as cash transactions are largest for this sector. The demand for overall residential real estate in India has been subdued for the last few years and a cash crunch would pave the way for a further decline in sales and piling up of more inventory. Ideally piling up of more inventory would mean declining prices per square feet for most of the construction in cities. Metros such as Pune, Hyderabad, Mumbai, Chennai, Bangalore, Delhi, NCR and Kolkata would witness temporary slowdown but demand is expected to get back to normal levels with increase in liquidity.
S&P BSE Realty index fell by 8% since announcement of demonetisation.
The demand for cement consumption depends mainly on real estate but in the last few years infrastructure growth has been the main reason driving volume growth for these companies. Real Estate and Construction accounts for 70% of the demand for cement and the rest is due to other sectors such as infrastructure. Volumes of cement sold especially in the tier 2 and 3 cities is expected to fall in the near-term as real estate demand may get affected in the interim. Demand in tier-1 cities has been weak for the past 2-3 years but infrastructure demand, backed by government spending which has been driving growth, is unlikely to be impacted.
Cement companies would not face a major slowdown in volumes and sales as much of the demand has come from infrastructure growth given that real estate and building construction growth was already muted. The growth and demand for cement is region specific and accordingly stocks would see healthy correction in valuations depending on the impact.
Overall aviation industry sales are reportedly down by 10% on a week on week basis after demonetisation. People are postponing their travel for leisure in the favourable travel season due to the liquidity crunch.
Passengers carried by domestic airlines during January- September 2016 period were reported at 72.698 million as against 59.021million during the corresponding period of previous year thereby registering a growth of 23.17%.
Aviation companies may report a decline in sales on a year on year basis and profitability would get temporarily affected as occupancy levels would remain relatively low.
The Paint industry caters to two segments – Industrial segment and Decorative segment. The industrial segment is unlikely to witness any slowdown in demand as cash transactions would be less as a percentage of total sales. Decorative segment would witness a temporary slowdown in demand as large number of transactions are in cash. The Decorative segment is growing faster than the industrial segment but companies which cater to the decorative segment would witness temporary slack until cash levels get back to normal. Stocks in the decorative segment might see more correction as compared to the industrial segment.
Paint companies which are into big project sales, deal in cash component worth 30% to 40% of sales, while for shops which have higher retail sales, cash component is in the range of 70% to 80%.
Pharma and Information Technology
Demonetisation is not expected to have any major impact on the Indian pharma market and demand is not expected to get impacted in a big way. Information Technology sector is also expected to have relatively minimal or no impact as the percentage of cash transactions would be close to zero.
Pharma and IT sector fell by 4% and 1% respectively since announcement of demonetisation.