Fundzpark shares Demonetization Effect

banner-4Demonetization Effect

Effect of demonetization on the Stock Prices

Dr Nikhil Rastogi

Professor, IMT Hyderabad

Consultant, Fundzpark

Effect of demonetization on the Stock Prices
How does the demonetization drive of the Government effect the stock markets?
In any economy at any given moment of time a given amount of currency is in circulation as a percentage of GDP of the island. This is the minimum amount which is needed for enabling various transactions that happen in that economy/country. All of a sudden, some significant percentage of the currency is deemed unusable by the government. This leads to a situation where the country would suddenly feel short of the money that it needed to enable the transactions. The real goods in the country remain the same but the money to purchase those goods reduces. This obviously leads to a situation where the prices of goods go down (Someone wanting money will agree to sell it at a lower cost, since money is in short supply).So the country would find that the cost of goods/services would reduce till the time the purchasing power of citizens comes back to the earlier level. The purchasing power would only return when the people so affected earn that kind of wealth again, which obviously would take some time. Till that time this decrease in purchasing power would start to negatively impact the prices of various goods and services. The decrease would be felt more for assets which are used for long term investment and consumption. It could be real estate, cars, with direct effects on the core sectors of steel, cement, etc. This effect should last for a shorter term up-till when the purchasing power is restored. This is likely to negatively affect the stock prices of companies in these sectors. However the impact on stocks of defensive sectors like FMCG and Pharmaceuticals should therefore be limited. But the question is what happens over a long term?
This change in purchasing power for few years would also affect the investment ability of enterprises making largely cash investments i.e. micro, small and medium scale enterprises. While they can always borrow from banks but their cost of funds are likely to be much more than those for the organized players who apart from having a sound credit history also have access to capital markets to raise funds. On account of this advantage the organized player are likely to offer competitive pricing thereby capturing the market catered to by unorganized players. This advantage to the organized sector would improve its growth as well as profitability. This would surely translate into higher stock prices of companies who are leaders in their industry or who have good management to appreciate and exploit this opportunity. It is extremely good news for the organized sector and the markets. The shares of companies more likely to do well are the ones where the unorganized sector currently holds higher share of production. Thus transport and logistics, retail, real-estate should do very well over a period of time. All this is good business opportunity for the banks and companies in the financial services space since the investment needed would largely be sourced through them, in one way or the other. This is a big structural change in the economy, assuming that the size of black economy is of significant size. The structural change would undoubtedly be clearer in hindsight. Until then one would see bouts of volatility. As Warren Buffet said, “Volatility is the friend of long term Investor”, one can use the current volatility to make sound investment decisions and reap benefits for extended period of time. Happy Investing!


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