Will Indian black market crackdown boost economy?

India could be set to bounce back after the government’s recent decision to launch a major strike against the country’s black market economy - a move which could bring opportunities for equity investors said Kames Capital’s international equities manager, Euan Weir.

Will Indian black market crackdown boost economy?

On 8 November, the government in India effectively withdrew 86% of all bank notes in circulation when it made the old 500 and 1,000 rupee notes (worth about £6 and £12) illegal tender overnight. This bold move was aimed at formalising and taxing the underground economy, which makes up perhaps as much as 40% of the wider Indian economy.

Although banks were inundated, queues in urban areas were orderly and the majority of Indians seemed willing to accept the government’s action as a necessary long term measure.

The move triggered weakness in the markets, sending Indian stocks and the rupee sharply lower, as investors speculated how long and deep the economic air pocket might be. Overseas investors pulled a net $2.6bn out of Indian shares in November, according to data from the Indian regulator.

But investors’ fears may not be justified. Although the country will experience short-term pain, the long-term gains from this anti-corruption drive could be significant.

In a recent visit to India, I met more than 30 companies who said they feel positive on demonetisation, despite the big impact on sales already felt in the consumer staples and automotive sectors, and the obvious administrative burden on the banks.

There is an unspoken fear of unrest if things grind to a halt. However, the consensus seems to be for a one-to-two month liquidity crunch and then a further three to six months for the economy to recover.

After this, I believe the January budget will bring a raft of measures to stimulate the economy, including infrastructure spending and possibly income tax cuts. Some sectors will begin to look more attractive as these changes take effect.

We had previously trimmed our Indian positions on valuation grounds, with the assumption that most of the good news, such as rate cuts and the new sales tax, were already priced in.

In the short term, we expect the change to be a drag for India, but we believe there will be buying opportunities as the dust settles, particularly in the consumer, infrastructure and banking sectors.

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