Likely Economic Impact of Demonetization

On November 8, the Indian government announced that the two largest denominations of notes (Rs. 500 and 1000),would be discontinued immediately. These accounted for 86% of the Rs. 17.54 Trillion currency in circulation (amounting to Rs 15.08 Trillion in value).

It has been acknowledged as a bold move by many economists and citizens. The objectives of the policy were to root out black money, to discourage future generation of black money, and to root out counterfeit currency that was being used by terrorists.

I have been thinking about what could be the likely economic impact of demonetization. 

Demonetization is likely to have the following impacts:

1) Reduction of black money: This manifests itself in two ways:

• New disclosures of unreported income and government seizures: So far Rs. 11.5 Trillion has been deposited (until December 6) in bank accounts. The Income Disclosure Scheme (IDS) which was operational before November 8 had yielded disclosures of more than Rs. 0.67 Trillion. Rs. 2000 crores of unreported income disclosures and Rs 130 crore of seizures have been reported from depositors after November 8 so far. The tax revenue to the government from this is likely to be Rs. 958 crores (as of Dec 7). This number is expected to rise as more disclosures and seizures are made. Future seizures of real estate, gold and other assets bought from unexplained sources of income is an area of great promise.

• Old currency not deposited back in the banks. This leads to a reduction in the liability of the RBI (India's central bank) and could create an extraordinary profit for the RBI. Given that the deposits in the first 30 days since November 8 account for 76.3% of the value of old notes in circulation on November 8, many analysts and economists feel that less than 5% of the old stock of currency will remain in private ownership on December 31. The RBI Governor has clarified that old currency not returned back will not decrease the liability of the RBI, and therefore will not be recognized as income.

2) Printing cost for the new stock of currency (net of scrap value of old notes): According to the RBI , there were 16.5 billion ‘500-rupee’ notes and 6.7 billion ‘1000-rupee’ notes in circulation on November 8. Each 2000 Rs note costs Rs. 3.73 to print whereas a Rs. 500 note costs Rs. 2.97 to print. Due to the movement towards digital and plastic transactions, we could assume that the currency required to run the country's business could be reduced by 25-50% (Note that 26% of the deposits made till Dec 3 have already been withdrawn by citizens. That number is likely to rise as withdrawal limits ease and currency is made more available). My estimate is that the cost of printing an adequate stock of new currency would be between Rs. 3000 crores and 5000 crores. 


3) Decrease in value of housing and land stock: According to PropEquity research, (a real estate data and analytics platform covering over 83,650 projects of 22,202 developers across over 42 cities in India), valuation in the top 42 cities in India, sold and unsold, will take a tumble and fall up to 30 per cent ( approximately  Rs 8,02,874 crores. If we were to include older urban housing, rural housing and land, the impact will be several times more.

4) Impact on GDP: Demonetization is likely to effect national output in several ways:

• Liquidity Reduction: As the availability of legal tender to conduct transactions is constrained for few weeks after the policy announcement, it impacts the ability of citizens and corporations in conducting transactions. This impact will get reduced only when adequate supply is made available and/or when citizens and corporations move to account-based transactions. As of October 2015, 233 Million citizens were still 'unbanked'. Even at full-capacity, the RBI printing presses will not be able to replace 50% of the stock of old currency in the next 4 months. This will impact cash-sensitive industries such as retail trade, hotels and restaurants and transportation, and in the unorganized (including agriculture) sector. These constitute collectively more than 50% of the economy, by my estimates.
• Confidence Reduction: As liquidity got sucked out of the system in one fell swoop, consumers and purchasing managers become more frugal. Their confidence in spending their savings/income/profits gets impacted. This is visible in the latest Nikkei/Markit PMI Survey released in early December. The Nikkei/Markit Services Purchasing Managers’ Index sank to 46.7 in November from October’s 54.5, the first time since June 2015 that the index has gone below the 50 mark that separates growth from contraction.It was also the biggest one-month drop since November 2008, just after the collapse of Lehman Brothers triggered the global financial crisis.“The latest set of gloomy PMI figures for the Indian service sector shows that companies were heavily impacted by the Rs500 and Rs1,000 banknotes ban,” said Pollyana De Lima, economist at survey compiler IHS Markit. The reduction in confidence will manifest itself across all sectors of the economy but particularly in luxury goods, automotive, jewelry, home appliances, and capital goods. These sectors have seen a 20-30% dip in business since November 8.
• Activity Reduction in Construction: As real estate prices are expected to fall by 20-30%, construction of new homes will slow down. This will impact activity in the housing/ construction sector. As secondary transactions dry up in the remainder of the fiscal year, the registration taxes collected by state governments will also take a significant hit.
• Productivity Loss: As people line up in queues for many minutes/hours per week (particularly in rural areas), there will be a significant loss in labour productivity. This impacts the unorganized and self-employed sectors more than other sectors.
• Economic stimulation by increased government spending: The government can negate the impacts of the above effects by increasing spending. The Finance Minister, Mr. Jaitley has already proposed an increase in budget spending of Rs 35,170 crores to fund rural jobs development, the RBI Monetary Stabilization Scheme, farm subsidies and higher pensions. However this number is less than 1% of the quarterly GDP of India, and is unlikely to fully negate the other effects.
• Vicious cycle effects: Even when liquidity is restored to 'acceptable levels' in 4 months, the ripple effects of the GDP de-growth will continue for a few months as people adjust to the 'new normal' (lost jobs/income in the unorganized sector, lost wealth for asset holders, etc). Of course, every government official and banker will try to convince the public that the future will be more rosy as the past, so that these vicious cycle effects are negated.

Various economists have indicated a 50 to 200 basis points reduction in GDP growth due to demonetization in FY'16-17. Due to the magnitude of the effects stated above, I personally believe that the impact will be much more. Even if the GDP for the 140 day period in FY'16-17 after the announcement reaches the same level as the GDP during the same period last year, the GDP growth for the year will have been impacted by more than 290 basis points. In my mind, it is likely that GDP impact is more than the gloomiest analyst's estimate (Ambit Capital's estimate of 330 bps impact in FY'16-17). Even if we assume that GDP growth is impacted by 330 bps in FY'16-17, that impact would total Rs. 4,95,000 crores!! Considering that taxes in India amount to 17.7% of GDP on average, the government's revenues for the last 2 quarters of the year will take a significant incremental loss.

Other Impacts: While I considered the impact of demonetization on future corruption and counterfeit currency, I believe these impacts will be short-term and insignificant. Counterfeit currency in circulation is estimated to be less than Rs. 400 crores. Counterfeiting will continue to be a challenge as counterfeiters find ways to duplicate the new currency.

What should the government do now?

1. Increase government spending in the rural and unorganized sectors. The 37,000 crore relief being planned may not be enough!
2. Increase social and welfare scheme funding to protect the weaker sections of society
3. Aggressively mine data from bank depositors to identify tax cheats. Raid premises to seize gold/jewelry/property documents that have not been disclosed in tax statements
4. Ensure that there is a taxable entity (PAN number) associated with each piece of real estate. Follow up with step 3.
5. State governments should reduce property registration fees and property tax to prop up the secondary market, and to disincentivize creation of future black money.

(Disclaimer: Please note that I am a business analyst and not an economist. So please do take my analysis with the requisite amount of caution. It is definitely not an advice to buy or sell any assets.)

Sign-up discounts: Bad strategy for eCommerce firms

A lot of eCommerce players in the Indian eCommerce industry offer  up to 25% discount coupons on sign-up which give discounts up to Rs. 2000 (~$35). These include Jabong, Myntra, and fashionara, among others.

The logic that these players might be using for this strategy may be:
1) The discount coupons allow them to acquire new customers, that may remain loyal after the initial discounts are over.
2) They operate mainly in the apparel category where regular gross margins are 30-40% to begin with. So a 25% discount would not lead to a negative gross margin on each sale.

I think this is not a good long-term strategy because:
1) Based on chatting with a few young friends, I feel that most have figured out that they can use multiple email addresses to get multiple coupons. They don't use the same email address to purchase after the discount coupons are exhausted. This also leads to a problem of customer duplicates in the database of the eCommerce retailer.

2) A 25% discount on an item which had an initial gross margin of 35% may not sound like unprofitable business. However that calculation ignores the free shipping given to the customer and the cost-per-action commissions (up to 10% of the sale!) given by the website. This implies that the items purchased by these 'acquired customers' are often being sold at a negative margin. The terms of the discount coupons (e.g., 'Cannot be combined with other offers') mean that most signups occur for fully-priced merchandise during the regular season. This is clearly a double whammy.

3) Most of these online apparel retailers are getting into accessory businesses. The discount coupons are often valid on accessories. This converts what should be a regular, high-margin, attachment business into a money loser.

4) I imagine there would be a significant sales backlash when the sign-up discounts are eventually withdrawn.

My advice: The industry needs to move from rewarding customer sign-up to rewarding long-term customer loyalty.

Customized database marketing for Indian e-commerce

Most of the players in the Indian e-commerce market are losing money.

My friend, Sanjay Dattatri has blogged about the challenges facing Indian e-commerce (click here). As he points out, Indian consumers are price-sensitive, dis-loyal and ill-behaved. I tend to agree with him.

As Sanjay points in another blog post, pricing sanity needs to prevail (click here). I agree with him on this one as well.

I do think that e-commerce vendors in India need to adopt a more customized approach to marketing and pricing. After all, aren't online marketers supposed to know all about their customers' buying behavior, browsing, email response (and customer care calls).

Why give the discount to all your customers when the reality is that some customers value your brand and superior delivery performance (and couldn't care less about the few rupees extra for that). The vendor can give a golden treatment to these price-insensitive customers by giving differential free shipping terms, and loyalty points. Some players like indiaplaza and healthkart do have a loyalty program.

On the other hand, one cannot lose out on selling to the price-sensitive customers, who will switch on a better deal available somewhere else.

The only way out is customized database marketing.

In my opinion, e-commerce vendors need to stick to the following rules of customized database marketing:

1) Target your discounts at customers who are likely to shift their purchases from your competition to your website, when given a discount. Examples of these customers include:

• Customers who bought a regular purchase like clothes, or diapers, or books, or groceries or nutritional products many months back and have not purchased since. I was delighted to see that healthkart sent me a  customized coupon code for whey protein 6 months after my first purchase. They avoided giving the discount to everyone as they know they have targeted a potential buyer. The key is to send out a customized coupon code which works only with the specific customer's login.

• Customers who have browsed a particular product or a category for a long time and not bought that product/ category. This can be done only when the customer is browsing with his cookie activated, and the e-commerce vendor is smart about tracking browsing behavior. A classic example would be a books-buyer browsing a mobile phone product page, getting a customized offer. My recommended approach would be to price the product at slightly higher than competition for the masses, and to give a discount coupon to customers who browsed and did not buy. (Quick programming note to vendors: Please don't send discount coupons for lingerie to men who are just browsing. But for that you've got to read the next point.)

2) Get to know more about the customer (even though you may know nothing to begin with). I get shocked when online retailers say that they deliberately have no information about their customer other than their user ID, name and shipping address. As a trusted seller you should try to get more information about the customer. Incentivize customers to update their profile online (such as gender, date of birth, marital status, interests, etc). The Payback program (called imint earlier) did that when they transitioned. When you know that you are dealing with a single guy who has never bought women wear before, you can stop sending him lingerie ads and coupons. Also some interesting things you can do with demographic data:

• Promote Gudi Padva to Maharastrians, and Onam to the Keralites and Eid to Muslims (irrespective of where they live)! -- if you can classify names by mother tongue and religion
• Promote kids items to families with kids

3) Send personalized recommendations/ suggestions, by putting yourself in the customer's shoes. Most e-commerce vendors are using formulaic recommendation engines which give recommendations based on the customer's last purchase. Ideally the recommendation engine should be based on the basket of goods purchased by the customer in the last 6 months.

Also, the recommendation logic needs to be altered for capital goods purchases (mobiles, electronics) vs. regular purchases (books). A mobile phone buyer does not need recommendations on what other similar mobile phones to buy! However a book buyer may appreciate recommendations on which other similar books to buy. For the mobile phone buyer, a list of accessories which go with his/her phone may be useful, but a formulaic recommendation engine may not capture that.

More later...let me know what you think!

Amazon launches as Junglee.com in India! Is it a big deal?

Amazon launched as Junglee in India earlier this week. It is a price comparison site for various merchants to list their products and provide prices. Already quite a few significant Indian vendors (homeshop18, indiaplaza, healthkart, uRead, bookadda, etc) have listed their products on the website.

So, with the brand name of Amazon, one would think this will be a major development in the Indian online market. Right?

Well I don't think so.

Amazon has launched this price comparison site (and not an ecommerce website) only because Indian law prohibits 100% foreign direct investment (FDI) in multi-brand retail. Foreign investors who want to own Indian retail operations (e.g., international private equity firms, foreign internet retailers) have typically invested in the 'supply chain back-end' operations of retailers or in 'wholesale cash-and-carry' operations. Amazon apparently is not interested in playing such games.However let's be clear that Amazon will launch its own store-front in India the very day that Indian government allows FDI in multi-brand retail.

Given that scenario, it is likely that Junglee is only an attempt by Amazon to learn about the Indian ecommerce market and understand the price sensitivities of the Indian consumer. They are also getting pricing information freely from their competitors !! I assume many of the sellers listed would only be too happy to be acquired by Amazon when the time is right.

However some of the bigger players in the Indian market (flipkart, snapdeal, dealsandyou, fashionandyou, yebhi, myntra, etc) seem to be staying away from Junglee. They seem to understand the threat of giving structured pricing data to their future competitor.That is why, Junglee is unlikely to be a great force in the Indian e-commerce landscape.

Current Alexa rankings for India:
snapdeal 26
flipkart 30
homeshop18 124
Myntra 153
koovs 186

infibeam 208
indiaplaza 284
Junglee 533

While these rankings are based on 3 month averages and Junglee is likely to rise in rankings over the next 3 months, there is also a honeymoon effect which is likely to wane (also as buyers see lot of items with only 1-2 sellers).

My bet is that Junglee will make it to top 200 within the next 3 months, but will not generate as much traffic as the leading Indian e-commerce sites.