Background of Financial Markets in India

Introduction

India has a diversified financial sector undergoing rapid expansion, both in terms of strong
growth of existing financial services firms and new entities entering the market. The sector
comprises commercial banks, insurance companies, non-banking financial companies, co-
operatives, pension funds, mutual funds and other smaller financial entities. The banking
regulator has allowed new entities such as payments banks to be created recently thereby adding
to the types of entities operating in the sector. However, the financial sector in India is
predominantly a banking sector with commercial banks accounting for more than 64 per cent of
the total assets held by the financial system.

The Government of India has introduced several reforms to liberalize, regulate and enhance this
industry. The Government and Reserve Bank of India (RBI) have taken various measures to
facilitate easy access to finance for Micro, Small and Medium Enterprises (MSMEs). These
measures include launching Credit Guarantee Fund Scheme for Micro and Small Enterprises,
issuing guideline to banks regarding collateral requirements and setting up a Micro Units
Development and Refinance Agency (MUDRA). With a combined push by both government and
private sector, India is undoubtedly one of the world's most vibrant capital markets.

Market Size

Mergers and acquisition (M&A) activity in India rose 125 per cent year-on-year to US$ 32.5
billion across 445 deals during January-September 2016.** Domestic M&A deal value stood at
US$ 7.3 billion across 137 deals during July-September 2016, which is around 65 per cent of the
total M&A deal value of US$ 11.3 billion during the quarter. ^

Private equity (PE) investments in real estate sector in India have increased 22 per cent in the
first nine months of 2016 to reach Rs 283 billion (US$ 4.24 billion), as compared to the same
period in 20151

Funds mobilized by Indian companies through non-convertible debentures (NCDs) increased

sixteen-fold to Rs 23,901.4 crore (US$ 3.58 billion) during April-September 2016 led by
growing investor appetite.@

The assets under management (AUM) of the mutual fund (MF) industry grew 45 per cent to Rs
17.89 lakh crore (US$ 268.35 billion) during March 2016 to February 2017.@@ Mutual fund
asset base in India increased by Rs 3.71 trillion (US$ 55.65 billion) to reach a total corpus of
around Rs 17 trillion (US$ 255 billion) in 2016, which is the highest growth recorded in the last
seven years.

The Indian life insurance industry has begun to recover and is likely to report 12-15 per cent
growth in FY 2016-17Indias life insurance sector is the biggest in the world with about 360
million policies, which are expected to increase at a Compounded Annual Growth Rate (CAGR)

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of 12-15 per cent over the next five years. The insurance industry is planning to hike penetration
levels to five per cent by 2020, and could top the US$ 1 trillion mark in the next seven years. The
total market size of India's insurance sector is projected to touch US$ 350-400 billion by 2020.

Investment corpus in Indias pension sector is expected to cross US$ 1 trillion by 2025,
following the passage of the Pension Fund Regulatory and Development Authority (PFRDA) Act
2013.

In 2016, 2.4 million new demat accounts were opened by Indians, the highest number of account
openings since 2008, led by higher number of initial public offerings (IPOs) and greater interest
in mutual fund investments. SBI, the second largest issuer of credit cards in India, has reported
issuance of 115,000 new cards in December 2016, post demonetization, taking its total card
issuance to 4.75 million.

Prime Minister of India, Mr Narendra Modi has stated that the BHIM (Bharat Interface for
Money) mobile application reached the mark of 10 million downloads indicating the widespread
acceptance of the app. India's digital payments industry is expected to grow by 10 times to reach
US$ 500 billion by 2020 and contribute 15 per cent of Gross Domestic Product (GDP).$

Investments/Developments

The Taiwan Futures Exchange (TAIFEX) has launched the TAIFEX Nifty 50, a new
Taiwan dollar denominated futures contract that will track the National Stock Exchange's
(NSE) Nifty 50 index, thereby providing international investors with more efficient
access to the Indian capital market.

Warburg Pincus LLC, the US-based private equity firm, plans to invest around US$ 75
million in series C round of funding to buy a significant stake in Capital Float, an online
credit platform.

Asset management company Rising Straits Capital plans to raise US$ 100 million to
capitalise its real estate-focused non-banking financial company (NBFC) named Rising
Straits Finance Co. Pvt. Ltd, which is expected to start lending from 2017 to regular
residential and office projects, and also to logistics, hospitality and healthcare sectors.

IFMR Capital, an NBFC that works in the area of financial inclusion, has raised US$ 25
million from London-based venture capital fund Eight Roads Ventures, which will be
used to grow its existing business and explore other opportunities across new products
and sectors.

The first ever rupee-denominated bond in the world by an Indian company, termed as
masala bond, has been listed on the London stock exchange by the Housing Development
Finance Corporation Limited (HDFC Ltd). The issue raised US$ 450 million, with a
maturity of three years and an annual yield of 8.33 per cent.

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 IFMR Capital, a debt finance provider, has raised US$ 17 million from British banking
and financial services firm Standard Chartered Private Equity (SCPE), which will be used
for product innovation and to increase its client base and sectors that it caters to.

US-based private equity (PE) firm Advent International has acquired a minority stake of
40 per cent in ASK Group, a leading investment and wealth management company, in a
deal worth US$ 130 million.

Avendus Capital plans to start its structured finance business with a dedicated fund of
size Rs 500 crore (US$ 73 million), which will be primarily raised from domestic
investors, and will aim for investments in growth companies, mid-market companies and
opportunities to provide structured debt or private financing.

Baring Private Equity Asia (BPEA) is raising a new India-dedicated credit fund of Rs 500
crore (US$ 75 million) with an option of retaining extra money collected than initially
planned up to Rs 250 crore (US$ 37.5 million). BPEA also plans to raise a US$ 500
million new offshore credit fund.

Fino Paytech, a technology solution provider, plans to launch its payment bank
operations soon to provide basic banking services through 400 branches across 30 cities
located in Maharashtra, Madhya Pradesh, Uttar Pradesh and Bihar.

Payism Technologies India Pvt. Ltd, a cash and cashless transactions facilitator, plans to
raise approximately US$ 25 million in growth equity capital for expansion purpose.

Paytm, an online payments firm, plans to invest Rs 600 crore (US$ 90 million) over the
next 10 months to expand its QR code-based payment network, aiming to add 10 million
merchants across 650 districts by December 2017.

True North, a private equity firm, plans to acquire a majority stake in Home First Finance
Co. India Pvt. Ltd (HFFC), a private housing finance company, for US$ 100 million,
which will be utilised for geographic expansion and customer acquisition in affordable
housing segment.

Institute for Financial Management and Research (IFMR) Investment Managers Pvt. Ltd
has launched two credit funds named IFMR FImpact Long Term Credit Fund and IFMR
FImpact Medium Term Opportunities Fund, which focuses on investing in the financial
inclusion space by aiming to raise Rs 850 crore (US$ 127.50 million) through these
funds.

Paytms e-commerce unit raised US$ 200 million in a funding round led by Chinese e-
commerce giant, Alibaba and existing investor, SAIF Partners, to become the latest
Indian unlisted company to be valued at over a billion dollars.

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 Indiabulls Housing Finance has raised over Rs 1,300 crore (US$ 195 million) by selling
masala bonds to foreign investors, which would be used partly for its affordable housing
segment.

Kotak Mahindra Bank Limited has bought 19.9 per cent stake in Airtel M Commerce
Services Limited (AMSL) for Rs 98.38 crore (US$ 14.75 million) to set up a payments
bank. AMSL provides semi-closed prepaid instrument and offers services under the
Airtel Money brand name.

Tata Capital, the financial services arm of Tata Group, plans to raise Rs 2,000 crore (US$
300 million) for its real estate fund, from State General Reserve Fund (SGRF), the
sovereign wealth fund of Oman.

Nippon Life Insurance, Japans second largest life insurance company, has signed
definitive agreements to invest Rs 2,265 crore (US$ 339.75 million) in order to increase
its stake in Reliance Life Insurance from 26 per cent to 49 per cent.

Government Initiatives

In the Union Budget 2017-18, the Government of India has announced a few key reforms
like abolishment of Foreign Investment Promotion Board in 2017-18, Introduce bill for
curbing illicit deposit schemes, Establish a Computer Emergency Response Team for
financial sector (CERT-Fin) and set aside Rs 10,000 crore (US$ 1.5 billion) towards
recapitalization of banks.

SEBI plans to tighten the norms governing various market participants in order to
strengthen scrutiny, improve transparency and mitigate liquidity risks from algorithmic
trading.

SEBI has relaxed norms for registered foreign portfolio investors (FPIs) in India,
allowing them to operate through the International Financial Services Centre (IFSC)
without undergoing any additional documentation or prior approval process.

The RBI has introduced trading in interest rate options (IRO), effective from January 31,
2017, which will provide another avenue to market participants to hedge and speculate on
interest rate risk.

SEBI plans to allow investors to make mutual funds transactions worth up to Rs 50,000
(US$ 750) a month through digital wallets, as part of its efforts to digitise the distribution
processes for all financial products. It also plans to allow immediate credit to customers
bank accounts on liquid mutual funds redemption to attract retail customers as well as
boost inflows.

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 Mr Ravi Shankar Prasad, Union Minister of Law & Justice and Information Technology,
has launched a free Doordarshan DTH channel called DigiShala, which will help people
understand the use of unified payments interface (UPI), USSD, aadhaar-enabled
payments system, electronic wallets, debit and credit cards, thereby promoting various
modes of digital payments.

The Government of India has relaxed norms for small merchants with a turnover of up to
Rs 2 crore (US$ 300,000), allowing them to pay 6 per cent of deemed profit in tax instead
of 8 per cent of total turnover or gross receipts received through banking channels or
digital means for FY 2016-17, in a bid to encourage cashless transactions in the country.

The Prime Minister of India has launched the Micro Unit Development and Refinance
Agency (MUDRA) to fund and promote Microfinance Institutions (MFIs), which would
in turn provide loans to small and vulnerable sections of the business community. The
lending target has been fixed at Rs 244,000 crore (US$ 36.46 billion) for 2017-18.

Government of Indias Jan Dhan initiative for financial inclusion is gaining momentum.
Under Pradhan Mantri Jan Dhan Yojna (PMJDY), 217 million accounts# have been
opened and 174.6 million RuPay debit cards have been issued. Government of India aims
to extend insurance, pension and credit facilities to those excluded from these benefits
under the Pradhan Mantri Jan Dhan Yojana (PMJDY). The Union Cabinet Minister has
also approved the Pradhan Mantri Suraksha Bima Yojana which will provide affordable
personal accident and life cover to a vast population.

The Department of Industrial Policy and Promotion (DIPP) has allowed 100 per cent
Foreign Direct Investment (FDI) in asset reconstruction companies (ARC) under
automatic route, which will help to tackle the issue of declining asset quality of banks.

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 Impact of globalization on Financial Markets

Globalization has been a historical process with ebbs and flows. During the Pre-World War I
period of 1870 to 1914, there was rapid integration of the economies in terms of trade flows,
movement of capital and migration of people.

The growth of globalization was mainly led by the technological forces in the fields of transport
and communication. There were less barriers to flow of trade and people across the geographical
boundaries. There has been a greater emphasis on the development of equity markets as a part of
financial reforms. India has also followedthis path. With the globalisation, financial markets are
becoming more and more important every day.

A developed stock market is considered crucial to national economic growth as it provides an

additional channel along with banks and other financial institutions, for encouraging and thus
mobilising domestic savings. It also ensures improvements in the productivity of investment
through market allocation of capital and increases managerial discipline through the market for
corporate control.

Advantages of Globalization

Cost reduction

Global learning

Rapid industrialization

Better allocation of resources

Reduction in poverty

Employment generation

Balanced development

Better quality of life

Human development

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 Disadvantages of Globalization

THREAT TO DOMESTIC INDUSTRIES

UNEMPLOYEMENT

EXPLOIATATION OF LABOUR

WIDENING GAP BETWEEN RICH AND POOR

OVERUSE OF NATURAL RESOURCES

THREAT TO NATIONS SOVEREIGNTY

India before LPG (prior to 1991)

Most banks were state-owned

Banks, pension funds and insurance companies were forced to buy State Issued bonds -
primary investment.

Bombay Stock Exchange was closed market. Run by Brokers for the benefit of its
members. There was no right governance and regulation.

There was no single derivative market.

All financial transactions were controlled by the RBI and Ministry of Finance

Other problems prior to Globalization

Strict entry barriers in every sub-industry.

Difficult to start a bank, a mutual fund, a brokerage firm, an insurance company, a

pension fund, a securities exchange or sub-broking firm.

Foreign firms were restricted to touch any one of these parts

Comprehensive capital control and restrictive legislations

Hindrances which needed improvement

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 MRTP act, 1969

The Capital Issues (control) act, 1947

Indian Companies Act, 1956

Industries Act, 1956

Foreign Exchange Regulation Act, 1973

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Globalization and India

Globalize its economy in 1991

Mounting problems- huge fiscal deficits, BoP crisis and foreign exchange crisis

Foreign investors and NRIs had lost confidence in Indian economy

Major measures as a part of the Globalization strategy

Devaluation of Currency

Disinvestment

Dismantling of The Industrial Licensing Regime

Abolition of the MRTP Act

Allowing Foreign Direct Investment

Wide-ranging financial sector reforms

Impact of Globalization

Indias growth rate in the 1970s was very low at 3% and GDP growth in countries
like Brazil, Indonesia, Korea, and Mexico was more than twice that of India.

Though Indias average annual growth rate almost doubled in the eighties to 5.9%, it
was still lower than the growth rate in China, Korea and Indonesia. The pick up in
GDP growth has helped improve Indias global position.

Indias position in the global economy has improved from the 8th position in 1991 to
4th place in 2001; when GDP is calculated on a purchasing power parity basis.

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GDP growth rate before and after 1991

GDP growth rate %

12
10
8
6 GDP growth rate %
4
2
0

Large Number of Multinationals Have Moved to India Post Globalization (Strategy

100% Equity, Collaboration, Franchise, Importing, Manufacturing)

Beverages (Coke, Pepsi)

Fast Foods (McDonalds, Pizza Hut, KFC)
Coffee (Barista, Caf Coffee Day)
Sports Wear & Goods (Nike, Adidas)
Apparels & Garments (Levis, Reid & Taylor)
Cosmetics (Revlon, Oriflamme, Maybellene)
Two/Four Wheelers (Honda, Toyota, Suzuki, Hyundai, General Motors, Ford,
Mercedes)
Computers (Dell, HP, IBM, Samsung, Sony)
Construction
Engineering Companies
Pharmaceuticals (US, Europe, Britain)
Music (Sony, BMG, Warner)
Entertainment Channels (Star, National Geographic, Discovery, Sony)

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 Reforms relating to the banking system

Equity issues and subordinated debt.

Prudential norms were introduced and progressively tightened for income recognition,
classification of assets, provisioning of bad debts, marking to market of investments.

Pre-emption of bank resources by the government was reduced sharply.

New private sector banks were licensed and branch licensing restrictions were relaxed.

At the same time, several operational reforms were introduced in the realm of credit
policy:

Detailed regulations relating to Maximum Permissible Bank Finance were abolished

Consortium regulations were relaxed substantially

Credit delivery was shifted away from cash credit to loan method

Exchange Control and Convertibility

Exchange controls on current account transactions were progressively relaxed

culminating in current account convertibility.

Foreign Institutional Investors were allowed to invest in Indian equities subject to

restrictions on maximum holdings in individual companies.

Restrictions remain on investment in debt, but these too have been progressively relaxed.

Indian companies were allowed to raise equity in international markets subject to various
restrictions.

Indian companies were allowed to borrow in international markets subject to a minimum

maturity, a ceiling on the maximum interest rate, and annual caps on aggregate external
commercial borrowings by all entities put together.

Indian mutual funds were allowed to invest a small portion of their assets abroad.

Indian companies were given access to long dated forward contracts and to cross
currency options.(Derivatives)

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 Reforms in the capital market

SEBI- the apex regulator of the Indian capital markets

Regulations were framed for insider trading

Abolition of capital issues control

Introduction of free pricing of equity issues

On-line trading was introduced at all stock exchanges

Evolution of Indian financial markets with reference to legal framework of

corporate governance.

What is corporate governance?

It is a process set up for the firms based on certain systems and principles by which a company is
governed. The guidelines provided ensure that the company is directed and controlled in a way
so as to achieve the goals and objectives to add value to the company and also benefit the
stakeholders in the long term.

The high profile corporate governance failure scams like the stock market scam, the UTI scam,
Ketan Parikh scam, Satyam scam, which was severely criticized by the shareholders, called for a
need to make corporate governance in India transparent as it greatly affects the development of
the country.

To understand the scope of the legal framework and study the amendments, proxy advisory firms
analyze the role of directors and how they are impacted by changes in the amendments. Proxy
firms offer analytical data for the shareholders and corporate advisory services to companies.

The Objectives Of Corporate Governance

Transparency in corporate governance is essential for the growth, profitability and stability of
any business. The need for good corporate governance has intensified due to growing
competition amongst businesses in all economic sectors at the national, as well as international
level.

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The Indian Companies Act of 2013 introduced some progressive and transparent processes
which benefit stakeholders, directors as well as the management of companies. Investment
advisory services and proxy firms provide concise information to the shareholders about these
newly introduced processes and regulations, which aim to improve the corporate governance in
India.

Corporate advisory services are offered by advisory firms to efficiently manage the activities of
companies to ensure stability and growth of the business, maintain the reputation and reliability
for customers and clients. The top management that consists of the board of directors is
responsible for governance. They must have effective control over affairs of the company in the
interest of the company and minority shareholders. Corporate governance ensures strict and
efficient application of management practices along with legal compliance in the continually
changing business scenario in India.

Corporate governance was guided by Clause 49 of the Listing Agreement before introduction of
the Companies Act of 2013. As per the new provision, SEBI has also approved certain
amendments in the Listing Agreement so as to improve the transparency in transactions of listed
companies and giving a bigger say to minority stakeholders in influencing the decisions of
management. These amendments have become effective from 1st October 2014.

Why is Corporate Governance in India Important?

A company that has good corporate governance has a much higher level of confidence amongst
the shareholders associated with that company. Active and independent directors contribute
towards a positive outlook of the company in the financial market, positively influencing share
prices. Corporate Governance is one of the important criteria for foreign institutional investors to
decide on which company to invest in.

The corporate practices in India emphasize the functions of audit and finances that have legal,
moral and ethical implications for the business and its impact on the shareholders. The Indian
Companies Act of 2013 introduced innovative measures to appropriately balance legislative and
regulatory reforms for the growth of the enterprise and to increase foreign investment, keeping in
mind international practices. The rules and regulations are measures that increase the
involvement of the shareholders in decision making and introduce transparency in corporate
governance, which ultimately safeguards the interest of the society and shareholders.

Corporate governance safeguards not only the management but the interests of the stakeholders
as well and fosters the economic progress of India in the roaring economies of the world.

Evolution of Financial Markets

The Indian economy has undergone significant change in the last two decades. From the
closed economy of the 1980s, the 1990s was a decade of liberalization of the economy and in

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the 2000s, the economy witnessed unprecedented growth. The growth in the economy was
duly supplemented by a significant increase in the capital markets activity. There were
significant changes to the legal framework, with Securities Exchange Board of India (SEBI)
being entrusted with the regulatory power to govern the capital markets to ensure compliance.
There was also technological advancement in the capital markets with the introduction of
terminal based trading replacing the open outcry system and launch of the integrated market
surveillance system, to monitor market malpractices, by the regulator.
The Corporate Governance framework was also strengthened through a series of
amendments to the existing governance structure, by introduction of Clause 49 to the
Listings Agreement and setting up of committees like the Naresh Chandra Committee Report
on Corporate Audit and Governance. So far India has risen up to the challenge of a growing
economy by ensuring that the requisite infrastructure is put in place to ensure market best
practices and restore investor confidence.
The story of growth is incomplete without the presence of governance. The strong
fundamentals of an economy are based on the virtues of good governance and ethical practices.
This thought leadership study makes an attempt to chart the course of the Indian capital
markets through the last two decades of growth with governance.

Much has happened in the Indian capital market in the last 17 years. With its foundations laid
in socialist based economy of four decades, with strict government control over private
sector participation, foreign trade and foreign direct investment, India opened its gates to the
outside world in the early 1990s. Since then its economy and financial markets underwent
radical changes, largely in response to the economic crisis of the late 1980s. The government
control on foreign trade and investment were loosened and the barriers to entry in the days of
the license raj were relaxed.
The emergence of Securities and Exchange Board of India (SEBI) as the supreme capital
market regulator showed Indias commitment to come across as a strong economic force,
through establishing market best practices of enhanced corporate disclosure and increased
investor protection.
The establishment of National Stock Exchange (NSE), a state-of-the art exchange, with
sophisticated technology to improve trading practices and reduce unethical dealings,
supported by a strong legal framework and technological base to strengthen the governance
structure, has been the highlight of the Indian capital market in the last decade. The opening
up of the economy has increased the flow of Foreign Direct Investment (FDI) and has put
India on the global map, as a new-age economic force to reckon with.
The increased level of sophistication in the market has been duly supported by increasingly
complex instruments like derivatives and other structured products. While, the recent global
meltdown has made us aware of the perils of sophisticated markets, the learning has been to

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follow a path of caution while maintaining a steady pace.
Several steps have been taken by the regulator to enhance the level of corporate governance
and reporting requirements of the Indian stock market. Significant legislation has taken place
in this area to curb market malpractices. The large scams and frauds have taught us that
growth without a robust governance structure falls short of global expectations. The
regulators have been active in responding to such events and in certain cases have undertaken
proactive measures to stop such events from recurring.

The depleting foreign currency reserves in 1991 forced India to start the process of
economic liberalization. The reforms were accomplished by allowing increasing
competition and greater foreign participation to provide fillip to the troubled
economy.
The capital markets reforms in 1991 were preceded by a regime which ensured almost
complete control of the state over the financial markets. Initial Public Offerings (IPO)
were controlled through the Capital Issues Control Act. The Controller of Capital Issues
(CCI) controlled the price and quantity of IPO and trading practices were short of
transparency. The banking sector too was significantly controlled. There were few private
banks and those faced challenges on their expansion plans. The banking sector suffered
from lack of competition, low capital base, low productivity and high intermediation cost.
After the nationalisation of large banks in 1969 and 1980, the government-owned banks
dominated the banking sector. The Reserve Bank of India

(RBI) controlled the interest rates and the financial sector was replete with entry barriers,
significantly restricting opportunities for the establishment of new banks, insurance
companies, mutual funds and pension funds.
The Unit Trust of India (UTI) created in 1964 was the only mutual fund and it enjoyed
complete monopoly of the mutual fund business up until 1988. The resource
mobilization by mutual funds demonstrates UTIs dominance in the early 1990s.

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The early 1990s therefore, was a time when the primary role of the financial system in
India was to channel resources from the excess to the deficit. The role of technology was
limited and customer relationship and service was not a priority. Risk management
procedures and prudential norms were weak, affecting asset portfolio and profitability.

Stock Exchange

The Bombay Stock Exchange (BSE), the oldest and the largest stock exchange in India,
traded for two hours in a day with an open outcry system. The exchange was managed in the
interests of individual members, a majority of whom had inherited their seats. A large
proportion of stocks listed on the exchange were not actively traded. There was minimum
supervision from the exchanges and speculation was rampant. There were regional
exchanges which were unconnected and engaged in open outcry sysem of trading. Each
exchange had a board representative nominated from the Capital Markets division of the
Minstry of Finance, the then regulator of the capital markets.

The capital market reforms were based on improving two fundamental aspects. First, the
improvement in the legal reporting framework and second the improvement in the
technology framework.
Legal framework
There have been significant reforms in the regulation of the securities market since 1992 in
conjunction with the overall economic and financial reforms. A key element of the reform
strategy was building a strong independent market regulator. The SEBI Act, which came into
force in early 1992, established SEBI as an autonomous body. The apex capital market
regulator was empowered to regulate the stock exchanges, brokers, merchant bankers and
market intermediaries. The Act provided SEBI the necessary powers to ensure investor
protection and orderly development of the capital markets.
The introduction of free pricing in the primary capital market has significantly de- regulated
the pricing control instituted by the erstwhile CCI regime. While, the issuers of securities can
now raise capital without seeking consent from any authority relating to the pricing, however
the issuers are required to meet the SEBI guidelines for Disclosure and Investor Protection,
which, in general, cover the eligibility norms for making issues of capital (both public and
rights) at par and at a premium by various types of companies.
The freeing of the pricing of issues led to an unprecedented upsurge of activity in the primary
capital market as the corporate mobilized huge resources. However, it did expose the
inadequacies of the regulations. In order to address these inadequacies, SEBI strengthened
the norms for public issues in April 1996

The disclosure standards were enhanced to improve transparency and uphold the objective
of investor protection. The issuers are now required to disclose information on various

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aspects, such as, the track record of profitability, risk factors, etc. Issuers now also have
the option of raising resources through fixed price floatations or the book building
process.
Clearing houses have been established by the stock exchanges and all transactions are
mandatorily settled through these clearing houses and not directly between the members,
as was practiced earlier.
The practice of holding securities in physical form has been replaced with dematerialized
securities and now the transfer is done through electronic book keeping, thereby eliminating
the disadvantages of holding securities in physical form. There are two depositories
operating in the country. The margin system, limits on intra-day, trade and settlement
guarantee fund are some of the measures that have been undertaken to ensure the safety of
the market. The trading and settlement cycles have been significantly reduced. The cycles
were initially shortened from 14 days to 7 days. The settlement cycles were further
shortened to T+3 for all securities in 2002. The settlement cycle is now T+2.
Listed companies are required to furnish unaudited financial results to the stock
exchanges and also publish the same on a quarterly basis. To enhance the level of
disclosure by the listed companies, SEBI decided to amend the Listing Agreement to
incorporate the segment reporting, accounting for taxes on income, consolidated
financial results, consolidated financial statements, related party disclosures and
compliance with accounting standards.
The last few years have seen significant interaction with the international capital markets. A
major step towards that was the inclusion of Foreign Institutional Investors (FIIs) such as
mutual funds, pension funds and country funds to operate in the Indian markets. As a quid
pro quo, Indian firms have also raised capital in international markets through issuance of
Global Depository Receipts (GDRs), American Depository Receipts (ADRs), Euro
Convertible Bonds (ECBs), etc.

The cause & effect of demonetization with reference to Indian financial markets

Indian equity markets have been on a near secular falling trend since the government
demonetized the 500 rupee and 1,000 rupee currency notes after midnight on November 8, 2016.
The two benchmark equity indicesthe Nifty 50 and the S&P BSE Sensexfell on each trading
day since the demonetization except for November 10 and November 22. While the Nifty 50 fell
6.3% from November 8 until November 22, the S&P BSE Sensex fell 5.9% during the same
period. Due to the rise in the US dollar, the dollar equivalents of the Sensex and the Nifty fell
more than 8% each.

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The S&P BSE 100 Index, which is comprised of 100 stocks compared to the Sensexs 30, fell
6.6% during this period. Mid and small-cap indices have been hit much harder than broader
market indices. Even after a rise on November 22, the S&P BSE MidCap and the S&P BSE
SmallCap indices fell 8.2% and 10.9%, respectively, in the previously mentioned period.

Apart from concerns about demonetization, Donald Trumps victory and concerns about his
restrictive trade philosophy led to foreign investors pulling out of Indian equities. According to
Bloomberg, foreign investors have net sold Indian equities worth $1.4 billion from November 9
17.

However, once the short-term impact of demonetization is over, Indian equities will likely
bounce back sharply. A rate cut from the Reserve Bank of India would be helpful and easy
monetary conditions are generally beneficial for equities. Consumption-driven sectors and stocks
will continue to be hit in the short term.

Indian rupee fell

The Indian rupee fell against the US dollar. It mainly fell due to Donald Trumps victory in the
US presidential election. Given the pressure on the local unit and its relative stability, it seems
like the Reserve Bank of India has been working hard to keep the currency stable.

Indias tech companies saw a sharp correction since the demonetization was announced.
However, the rupees weakness can benefit these stocks. For now, Donald Trumps trade
philosophy will be the main driver of the Indian unit.

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 One ripple effect of demonetization that worked against the cause & has a negative
impact on the GDP

Cash is the preferred mode of transaction globally, accounting on average for 85% of them. In
some of the developed countries, transactions carried out through cash are less than 50% of total
transactions. In India, this ratio is at around 95%. Easy accessibility, its certainty of acceptance
and efficiency as the settlement is not dependent on any additional infrastructure, and no
additional charges make it universally the most preferred mode. The only problem of cash
transactions is the anonymity and difficulty of establishing an expenditure trail which make it an
ideal mode for unreported transactions as well.

The ratio of currency to GDP (gross domestic product) in India, which averaged 8.4% during
1975-2000, crossed 10% for the first time in 2002-03 and has remained above this level since
then. This ratio has averaged 10.8% in the last decade. There has not only been a relatively sharp
increase in the ratio of currency to GDP during 2015-16 (table 1) but a reversal of the negative
trend witnessed in the previous three years. The increase in this ratio could have persisted
through the current year as well before the demonetization of higher denomination notes
announced on 8 November.

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21 | P a g e
The existence of a large informal sector has been one of the most important factors in this
dominance of a cash-based economy. Nearly 45% of gross value added (GVA) in the economy
(average of 2011-15) was generated in the informal sector. The informal sectors growth has been
mostly cash-centric and its sustenance has been dependent on prevalence of cash transactions so
far. Notwithstanding an overall lower (negative) rate of growth of savings and capital formation,
this sector nonetheless contributed to around 40% of capital formation and two-thirds of
investible funds (see table 2).

Demonetization of high denomination notes (of Rs1,000 and Rs500) has put over 85% of
currency out of circulation. This has resulted in short-term disruptions in transactions in
agriculture and related sectors, small establishments, households and among professionals. Since
injection of liquidity is slow, incomes in both formal and informal sectors have been affected
with the intensity of adverse impact being greater for the informal sector. Since self-employed
and casual workers dominate in the overall economy, their incomes may suffer a setback. While
some may view it as deferring expenditure and income, a part of it may actually be revenue and
income forgone forever.

Some rating agencies have estimated a decline of around 40 basis points in GDP growth for
2016-17 and of a smaller magnitude in 2017-18. These estimates are based on quicker liquidity
injection and a sharp shift to cashless transactions. However, there is a section of the population
which will still like to deal in cash because of religious beliefs. The estimation of a 40 basis point
decline in GDP, given the casual nature of employment for nearly 80% of workforce, may not
materialize, at least in the time frame envisaged. In our view, the dent in GDP growth may be
larger than anticipated and recovery to the normal growth trajectory may take three to four
quarters.

It is indeed difficult to predict the likely growth trajectory post demonetization. But assuming
that the formal sectors maintain the observed growth (average of last 10 quarters) and the
informal sectors have a flat growth in the third quarter (Q3) of 2016-17 (with an estimated
contraction in informal economic activity in trade, road transport and construction sectors by
5%), Q3 growth may decline to 4.1% in a best case scenario. In case the contraction extends to
industrial and professional services sector and is a little sharper in construction and trade, Q3
growth may dip as low as 1.5%.

Growth is expected to recover gradually in the fourth quarter (Q4) of 2016-17 and in the first
quarter (Q1) of 2017-18 before returning to its normal trajectory thereafter. It is indeed true that
increase in liquidity in the formal banking sector will increase GDP growth originating in this
sector, but with its share of around 6% in GDP and with an increase in growth of 0.5 and 1.0
percentage points factored in, this sectors growth in Q3 and Q4, respectively, its overall impact
on GDP growth assessed may not be significant. The impact of easy availability of credit to the
formal sector on account of this additional liquidity may take some time to materialize, and in
Q3 and Q4 it may not be significant. Further, a decline in demand in general may also keep the
demand for investible funds at moderate levels.

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How these informal sector issues will get incorporated into the quarterly GDP numbers of the
ministry of statistics and programme implementation is important as the quarterly estimates of
GVA are compiled by the benchmark-indicator method. The previous years annual estimates are
extrapolated with the growth rates observed in indicators such as quarterly estimates of forecast
crops and livestock, index of industrial production, steel and cement dispatches, sales tax returns,
sale of commercial vehicles, deposit and credit growth of banks, service tax, revenue expenditure
of government, all of which are for the formal sectors. The inherent assumption in this tracking
approach is the assumption of uniformity of growth for the formal and informal sector. This
assumption has little relevance under the current circumstances, and we may still be surprised
with a better official rate of GDP growth for Q3 and Q4. If so, we have to take it with a pinch of
salt.

Other negative effects

The International Monetary Fund (IMF) on Monday downgraded Indias growth forecast for the
year by a full percentage point to 6.6 per cent on the back of the disruption caused by
governments move to demonetise high-value currencies. In its update to the World Economic
Outlook (WEO) released in October, the IMF said India is likely to grow at 6.6 per cent in 2016-
17 against its earlier estimate of 7.6 per cent on account of the temporary negative consumption
shock caused by the currency withdrawal.

Chinas growth rate during the same period has been revised upwards to 6.7 per cent from the 6.5
per cent projected in October due to expected policy stimulus.The downward revision is in line
with the pruning of growth estimates done by Indias department of statistics earlier this month
to 7.1 per cent in 2016-17 from 7.6 per cent the previous year.

The IMF, in its update outlook, has also projected Indias growth rate in 2017-18 to slow to 7.2
per cent against its earlier estimate of 7.6 per cent. For most economies, the IMF makes forecasts
based on the calendar year while for India it follows the fiscal year.

In India, the growth forecast for the current (2016-17) and next fiscal year were trimmed by one
percentage point and 0.4 percentage point, respectively, primarily due to the temporary negative
consumption shock induced by cash shortages and payment disruptions associated with the
recent currency note withdrawal and exchange initiative, IMF said in its WEO Update.

Andreas Bauer, senior resident representative of IMF in India said the downgrade for 2016-17 is
because growth in the first half of the fiscal year was slower than the Funds expectation as well
as demonetisation. We expect the impact of demonetization will gradually dissipate in 2017-18
and there will be a recovery in economic growth, he added.

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Global rating agency Moodys had on Monday said after a temporary dampening effect on
consumption and investment in the medium term, demonetization will likely strengthen Indias
institutional framework-by reducing tax avoidance and corruption-and should support efficiency
gains.

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 Some pointers of negative impacts of demonetization

Adverse impact on informal sector

Players of informal sector as they mainly deals in cash only are facing tough time due to this
Demonetization scheme already. Sudden removal of cash from market put their business on a
dormant phase. It is important to understand that their income is not black as they dont come
under income tax slab because of less income which has become even lesser now.

Plight of Primary Producers

Lack of liquidity would result in distress to primary producers who dont have much money, so
that they could hold their produce for long and on the other side due to lack of currency in flow
they are offered very less by the buyers in the market.

Non-acceptance of Old currency regardless Government Orders

Many prescribed business houses and establishments are not accepting old currency notes from
common people, thus leaving them helpless. The fact that such people have no remedy against
such people/ business houses make the situation worst.
Milk Booths, Chemists, Petrol Pumps and Safal Stores etc. are among others. These are dealing
with basic necessities of common people.

Possibility of breaking Riots

There are many anti-state elements present in the society who are trying to spread unrest in the
society. They can exploit the situation and incite those disheartened people to make a platform to
break riots.

Excessive burden on bank employees

This is a clear fact that there is an excessive burden on bank employees to cope up with the
situation and even after working so hard they are not able to satisfy the need of people.

Decrease in demand

This is a fact that black economy do support the real economy from demand side, that is to say
black money used by the consumers to buy goods or services increases demand for those.
Although you may say this is unethical or wrong but it is beneficial from economys point of
view.

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 Violation of rule by general public

Many people are entering ATMs and using 3-4 different ATM cards and withdrawing 4X cash
than the prescribed limit for one person, thus violating the limit prescribed by the government.

Chances of incarnation of De facto currency

De facto currency is a currency that is not recognized by the government as legal tender, but is
accepted by a majority of the population. The US Dollar, for example, is accepted in Cambodia
as a de facto currency. Similarly if required money is not injected into the circulation there are
chances that people belonging to different regions would start using old currency as de facto
currency.

I would like to conclude by saying Black money is like Asura Raktabija which cannot be
abolished with just one blow. We have to strike on its weak point again and again and have to
ensure that it should not born again to completely destroy it.

In spite of the initial hiccups and disruptions in the system, eventually this change will prove
beneficial for the nation in long run.

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 Positive effects of demonetization with regards to rupee appreciation in the forex
market is it a reality or expectation

EFFECT OF FAKE CURRENCY ON INDIAN CURRENCY:-

Circulation of fake currency can have so many adverse effects on the economy of a country. I
will try to describe them in a easy and abbreviate way.

Currency inflation: If large amount of fake currency notes are circulated then high demand of
goods and commodities takes place. Then,since supply can not meet demand so scarcity of
commodities occurs and it leads to hike in the price.Now people have to pay more amount of
money for the same products.This is called currency devaluation.

Non-reimbursement by Banks: Big businesses and industries of a nation are likely to incur
huge amounts of losses. When the banks are informed about fake currency being involved in
some significant business transactions, it is confiscated with immediate effect, but most of the
time, the businesses do not get reimbursement for their money. This leads to heavy losses that
may affect them, either immediately or in the long run.

Dumping of cheaper products: Since people are not able to buy hiked products then they
purchase which they can afford.Other countries start dumping their cheaper products,obviously
at a low price.This further weakens country's economy.

There are so many other negative effects like Black marketing of products, Loss of public
confidence in their country's economy etc.

EFFECT OF BLACK MONEY ON INDIAN CURRENCY :-

The effects of black money in a country are discussed under the following heads:

(i) False Information about the Economy:

1. The presence of a sizable black money casts doubts on the validity of the data on national
income estimates, per capita income, and distribution of income, consumption, savings
and investment.

2. The economic planning losses its worth, because they are based on macro-economic
parameters which completely ignore the black money.

(ii) Impact on Fiscal System:

1. Government is fully based on tax revenue.

2. Evasion of taxes has serious consequences for the economys fiscal system.

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 3. In long-run consequence of such revenue loss is to reduce the built-in elasticity of the tax
system.

4. To raise a given target of revenue the Government is obliged to depend increasingly on

discretionary hikes in tax rates or to expand the array of taxes.

Direct Taxes Enquiry Committee in this connection mentioned Black money and tax evasion,
which go hand in hand, have also the effect of seriously undermining the equity concept of
taxation and warping its progressiveness. Together, they throw a greater burden to the economy.

(iii) Create Inequalities:

1. The black money creates inequalities among people.

2. The excess of money leads to purchase non- essential articles, which gives demonstration
effect. The overall consumption pattern is titled in favour of rich and elite classes.

(iv) Misguiding on Resource Allocation:

1. Black money distorts resource allocation in the economy and often leads to wasteful and
often leads to wasteful use of money.

2. It leads to conspicuous consumption and in turn results in the diversion of large funds to
unproductive channels which ultimately put the economy out of order.

(v) Implications for Monetary Policy:

1. The black money related to the stock of black liquidity.

2. The stock of black liquidity is defined as the cumulation of black savings (from black
incomes) in the form of cash and other readily convertible assets such as gold and silver.

It is the black liquidity which creates a lot of problems for monetary authorities to regulate the
economy. The existence of sizable black liquidity in our country misguide the Government to
diverting credit from more urgent to the less urgent.

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Poor Class

This class is affected adversely immediately. This class hardly use debit or credit card. They also
keep hardly any money in banks. They keep most of their money in cash in their home in the
higher denominations. They have to, therefore, rush to the ATM and stand in the queue to
withdraw their money to run their day-to-day affair. However, this problem is temporary and
within a month, things are likely to return to normal.

This class is likely to make better use of banking channel and the cards in future. That will make
their life more secure and help them earn more money through interest on their deposit.

They will also gain from the increases taxes and lower corruption in the government schemes
that would follow this move.

2: Middle Class

The middle class of India is used to use credit/debit cards and other online methods to transact
their business. They too have to stand on the big queue for short time because they still need the
100 rupee note for making petty payments. Yet they can buy most of things using their credit
cards. This class would become more cashless now so that they can eliminate the need of
currency notes as much as they can.

3: Upper Class

The honest upper class of the society is already making most of the transaction cashless even
now using cards and electronic transactions. They too may face a few days of trouble but their
life would become normal very soon.

The dishonest upper class is the worst hit due to this move of government because most of
their black money is stored in 500/1000 notes which would go waste. They have to either burn
their notes or give them to a large number of poor people (on commission) for converting that to
white. The currency would become valid once replaced by new notes, but the black money
would remain black. If they face the raid, they would end up becoming bankrupt once they have
to pay 200% penalty on such money.

4: Politicians

Politicians are the worst affected class due to this move. They keep almost 90% of their money
in black. Once that money is gone, they would no longer be able to buy the votes. It is for this
reason that the move of Shri Narendra Modi is most significant. He has angered not only the
corrupt and big businessmen but also his own class i.e. politicians. Every class that used to fund
the elections must be angry with him.

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Long Term Effects

In the long run, Indians would reap several benefits due to this move.

Once the black money is reduced, taxes would leapfrog

Developmental activities would pick up significantly as the tax revenue increases

Government can reduce rates of taxes since they can raise significantly more revenue
with lower rates

Corruption would reduce since there would be little black money to pay bribe to
government officials

Dowry and other social practices like extravagant marriages would reduce due to white
economy

Illegal activities like murder, kidnapping, drug-paddling, prostitution, terrorism etc.

would reduce since all these activities need black money

The honest people would live life of much more respect as dishonest would no longer be
displaying their wealth for long time to come.

Will exchange rates be affected?

We could see some appreciation of the domestic currency in the forex markets as notes in
circulation will decrease. Though the RBI will be monitoring and taking remedial action,
negative impact on international trade cannot be ruled out at this point. Counter moves by the
government are expected to ease this impact.

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 In my opinion which sectors has been drastically affected due to demonetization

Jobs

Hiring experts say jobs at senior levels are not and wont be impacted. But overall hiring is down
right now, as managers seek to protect revenue/profit targets. No job cut plans as of now.
Variable pay/increment amounts may be impacted. Job numbers are difficult to estimate, experts
say, but sectors where hiring is most hit are retail, consumer goods, real estate, infrastructure,
logistics (for ecommerce especially), auto consumables, and building products. Hiring by mobile
wallet and fintech co are up though

Consumer spending

Consumption, a big GDP contributor, will take a hit for at least two quarters, say companies and
analysts. Two main problems: Low circulation of lower denomination notes, which may be
temporary, and wealth erosion, that is impacting big ticket purchases. FMCG sales dropped 20-
30% in November. At store levels, impulse buys like snacks, biscuits were hard hit, as were
personal care items, Nielsen data shows. December can be worse than November, since last
month consumer spend in the beginning of the month was unaffected. Nine million retailers who
buy from wholesalers are worst hit, and will feel the pain for a while. Big, organised retail is
doing well. Annual growth rate is around 4.4%. Some big FMCG companies have cut
production. Supply chains are hit as cash fuels many transactions. Full impact will show up in a
months time, and can be severe.

Real estate

Insiders say theres a 40%-plus drop in enquiries and sales across key markets of Mumbai, Delhi,
Bengaluru and Pune. Deals in secondary market have come to a standstill. In Bengaluru, drop in
deal closings is as much as 60%. Most homebuyers are waiting for big price reductions. With
fear of black money transactions and cash crunch added to an already slumping real estate sector,
near future is bleak.

E-Commerce

Mostly bad, some good. For the online retail market, gross merchandise value (GMV) of players
fell by 40-50% in first few weeks after demonetisation, in the middle of their biggest quarter for
sales. Things may remain bleak till March. Even high-value items like expensive smartphones
are selling less. Products returned are up by 50%. And experts feel consumer sentiment wont
improve quickly. But the boost to digital payments (100% jump in transactions) has led industry
to hope for a bright medium term. Also, grocery and food delivery set-ups are doing better since
they sell essential items. Some saw new customer orders jump to 25%, from the usual 15-16%.

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Tourism

Peak tourism period of November-December badly hit. For tourist destinations beyond metros,
business may be down by as much as 40%. Tourism business in metros may go down by 10%.
Cash shortage at airports and hotels are a big problem. And many national monuments entry
points dont have card payments facilities. Western countries have issued advisories on cash
crunch in India.

Auto mobile

Post-demonetization, there was some cushion at wholesale level for Maruti Suzuki, Toyota
Kirloskar Motor and Tata Motors from dealer demand for new models or new variants like
Baleno, Brezza, Fortuner, Innova and Tiago. Hyundai India, Honda Cars India and Mahindra &
Mahindra have seen some short-term impact on sales. At the retail level, sales for cars without
waiting period is down 30-50%. Two-wheeler and commercial vehicles have been hit harder.
60% to 65% of entry level motorcycle sales happen in rural markets where cash is king. Two-
wheeler sales may have gone down by 5% last month. Tata Motors posted a 17% decline in
commercial vehicle sales in November.

Aviation

In worlds fastest growing aviation market, passenger traffic growth will fall below 20% from an
average 23-24% growth recorded in previous years. Flight bookings dropped drastically in days
after demonetization. Recovered somewhat later. Offline travel agents, who took cash, badly hit.
Flights to small towns, where cash payments are the norm, are also badly hit, may post negative
growth.

Telecom

Mobile phone shipments fell by 26% in November, compared to the previous month.
Smartphone shipments are down by 23%. Inventory pile up with retailers. Big sellers who do
card and online transactions less badly hit. IDC analysts expect sales for feature phones to drop
by 25% in the quarter, and smartphones to fall by 17.5%.

Gold

Scared by government warnings, sale of gold against old currency notes fell drastically. NRI
customers have fled. Sales are down sharply, and it was already a bad year for gold.

Agriculture

Interestingly, villages have adapted in some ways better than cities. GoI allowing tax free
deposits of any amounts for farmers have led to many of them getting 20% premium from traders
when transacting. Informal credit for daily purchases and use of old notes for key inputs and

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selling produce have kept rural economy going. Crop planting increased 20-35% every week
after demonetization and remained higher than last year in all weeks after November 8.

Metals

Real estate slowdown has hit steel, and may hit further. Aluminum, copper, zinc also hit since
they are raw materials in building industry products. If auto sales are hit badly, metals business
will do worse.

Industry performance failure & how it has affected stock market due to
demonetization

Many industries have been badly impacted due to demonetization & as studied by several
economists the after effects will bring these industries performance down. Some of the major
sectors been impacted due to demonetization are Real estate, banking industry, infrastructure,
gold industry, aviation industry, most importantly agriculture industry, telecom industry, auto
mobile industry etc.

The failures of these industries have had a major impact on the Stock market & the projections
dont seem to be brighter in the future. Does the stock market think that demonetization will
have a temporary impact and investors need to look beyond it? This is what the Reserve Bank of
India (RBI) believes and it is no doubt what the government would have us believe.

So how has the Indian stock market reacted since 8 November? Sure, the BSE Sensex is a bit
lower now since that date, but then there are many other factors besides demonetisation that have
affected the markets, not the least of which has been Donald Trumps election as president of the
US and the subsequent rise in US bond yields and the strengthening of the dollar. That has led to
funds flowing out from emerging markets and India too has been affected.

The question is: how has the Indian market done compared with its peers?

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Chart 1 has the answer, comparing the MSCI India Index with MSCI Asia ex-Japan. As the chart
shows, both indices have fallen since 8 November, but MSCI India has done a teeny bit better
than MSCI Asia ex-Japan. By this yardstick, demonetization has had little impact on the overall
Indian market.

Now consider chart 2. This chart gives Bloomberg estimates of earnings of the Sensex companies
for fiscal years 2017 and 2018. As the chart shows, FY17 earnings have shown a 3.7% drop from
where they were on 10 November 2016. Much of the drop happened soon after the
demonetization announcement, as analysts adjusted their estimates for the shock.

But take a look at the FY18 earnings estimatesthe chart shows that earnings estimates for
FY18 for Sensex companies have hardly changed from the level they were at on 8 November.
Rather strangely, the estimates show an initial jump, perhaps because some analysts believed that
demonetization would be good for some companies in the long run. But in the final analysis, they
seem to believe that except in the short run, demonetization will have little impact on earnings
growth.

Another way of looking at the effect of demonetization on the markets is to see whether the
premium valuations that Indian stocks have enjoyed over their peers in the Asian region have
been eroded. Chart 3 compares the one-year forward price-earnings (P-E) multiple of the MSCI
India Index with that of MSCI Asia ex-Japan. The chart shows that the difference between the

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MSCI India P-E multiple and the MSCI Asia ex-Japan P-E multiple has come down from 4.9 on
8 November to 4.6 now. That could be the impact of demonetization, but its not much.

Taking these three yardsticks, it does look as if demonetization hasnt really affected the overall
market much and investors believe the impact is temporary, with lower interest rates and more
government spending offsetting any adverse effects. Of course, this also indicates that if the
negative impact persists, such as if there is a raid raj that affects business sentiment, or if there is
greater and more persistent demand destruction in the informal sector, then the market correction
is still ahead of us

Other reasons for stock market to be impacted due to demonetization

What will be the Demonetization Impact on Stock Market? asked one of the readers of this blog.
Though i am not a SEBI registered Investment Adviser, therefore, cannot suggest stocks but i can
always share my views. At the macro level from a sector perspective, the stock market is zero
sum game until unless there is dire need to exit the stock market. For example, suddenly the FII
buying stopped and they become a net seller. In such a scenario, the retail investors should exit
the market. At the end of the day, retail investors will lose money in the stock market if FIIs exit.

Under normal conditions, the investors are bullish or bearish on certain sectors. The overall
bullish trend in the stock market does not mean that all the sectors are expected to perform well.
For example, PSU and metal stocks are underperforming despite bullish trend. I will pull out
money from IT/Pharma and put it in Banking/Auto. Therefore, i mentioned it is a zero-sum
game. It all depends on the sentiments and the judgment of the fund manager and investors how
the sector is expected to perform in future. Every news/change in macroeconomics/change in
govt policies impacts the investors sentiments specific to the particular sector. For example,
post-GST implementation, experts were bullish on logistics stocks. Similarly, after
implementation of 7th pay commission, the experts were bullish on Auto and White goods.

Lets look at the industrial sectors performance with respect to demonetization

Equities

The day after the demonetization move was announced and Trump won the US presidency, the
BSE Sensex opened with a massive loss of 1,300 points, but recovered later. It rallied on 10
November and reported net gains for these two days of trading, only to tank 700 points the next
day. Should you be worried? The global unfolding of these two events and the market jitters
created by them presents a value buying opportunity, says Dhananjay Sinha, Head, Institutional
Research, Emkay Global. However the impact of these events is not over and investors shouldnt
ignore them. The ripple effects of demonetization cannot be understated. There are major

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industries in India that thrive on a parallel economy funded by black money, says Ritesh Jain,
CIO, Tata Mutual Fund. Though the government is exchanging old notes with the new ones, it
will still squeeze the currency circulation in the short-term. There may be a negative impact on
the GDP in the Oct Dec quarter, as consumption shock gets transmitted into the system. Some
rupee appreciation in the forex markets is also expected as notes in circulation will decrease,
says Anis Chakravarty, Lead Economist, Deloitte India. If the RBI and the government dont step
in to ease the liquidity situation, our export-oriented sectors may suffer.

On US presidential elections, Dinesh Thakkar, CMD, Angel Broking, says: Global markets have
been volatile over the past few weeks. That uncertainty is over now with Donald Trumps
victory. As the markets track news on the policy front from president-elect Trump, the focus
will now turn towards the US Fed policy meet due next month. The 10-year bond yield in the US
has gone above 2%, after a gap of eight months, and the market has started factoring an 80%
chance of a rate hike in December. This means volatility will return soon

Lets take a closer look at specific sectors, starting with real estate. It is best to avoid realty
stocks as the sector will be among the worst affected by the demonetisation move. The housing
finance sector, consequentially, will also be under pressure. Housing finance companies are
likely to witness some stress on loans given to real estate developers who are likely to face a
liquidity crunch in the short term, says Kalmesh Rao, CEO, Kotak Securities.

Even if 20% of the existing Rs 500 and Rs 1,000 notes are not exchanged, it will amount to a
permanent wealth destruction of Rs 3 lakh crore. This could impact sectors such as real estate,
jewellery and banks, says Jain. Sunil Sharma, CIO, Sanctum Wealth Management, concurs:
Business domains with exposure to unaccounted wealth should be avoided. Investors should
stay clear of sectors such as real estate and jewellery.

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Short-term disruption and wealth erosion will also impact the high-end consumer segment. The
luxury goods market is likely to get affected as this move represents an erosion of real wealth to
a large number of people. This will be felt more in luxury cars, SUVs, gems and jewellery and
high-end branded products, says Chakravarty. The consumer non-durables sector is also likely
face some heat. The effect will vary for high- and low-value items. While the impact on small-
ticket discretionary spending will likely be minimal and short term, high-value items can
experience long-term impact, says Sinha. That means stocks like Kaya and Titan will be under
pressure.

Since Trump has repeatedly said that his government will stop jobs from leaving the US, the
BPO and the IT industry may suffer. Trump has talked about restricting entry of skilled labour
from overseas countries to protect jobs in the US. So, the IT sector could remain under pressure,
at least in the near term, says Rao.

Gold

Gold has been among the most seriously impacted asset classes by the twin events.

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Safe haven assets like gold and Japanese yen have rallied on Trumps victory, but gave up most
gains later. So, one can assume that the knee-jerk reaction is over now, says Kishore Narne,
Associate Director, Motilal Oswal Commodities Broker. The demonetisation move also boosted
Indian investment sentiments vis-a-vis gold. This move has reinforced Indians belief in gold as
a safe haven asset, says Sharma of Sanctum Wealth Management. Several households, who
were stuck with old currency notes, converted them into gold, after the demonetization move was
made public. Several jewellers kept their shops open till midnight on 8 November to facilitate it

Debt

With the rupee remaining relatively stable, the debt market has reacted positively to both
Trumps victory and the demonetization move.

Bond prices may remain elevated as the flight to safety would continue, says Sharma. This is
because of the deflationary impact of demonetization. We are likely to see some decline in

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inflationary pressures as demand comes down in the short term, says Anis Chakravarty, Lead
Economist, Deloitte India. This will also keep prices in check as the ability to hoard commodities
and other assets will be greatly reduced, says Murthy Nagarajan, Head, Fixed Income, Quantum
Mutual Fund. Improvement in government finances due to shift of the black economy to white
increased tax compliance and better revenues for government is another positive aspect. The
debt market has also started expecting further rate cuts, which, again, is good news for debt
investors. With the household inflation expectations coming down, the possibility of rate cuts is
increasing, says Chakravarty. Experts expect a 50-75 basis points rate cut in the next 6-9
months

There were three key macro developments in the year 2016, which will have a long-term positive
impact on the Indian equity markets - a) the introduction of Goods and Services Tax (GST); b)
the unexpected victory of Donald Trump; c) and the currency demonetization in India.

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Discounting the initial hiccups and implementation challenges, over the long term, GST is set to
change the course of the Indian economy. Corporate India benefits in multiple ways - right from
efficient inventory management, unified taxation, easy compliance, to creating a common market
place.

All these factors will eventually help India Inc's bottom line. As margins improve, so would the
underlying performance in the stock prices. The victory of Donald Trump could be a game
changer. There is a gradual change in opinion, and many are turning optimistic. The expectation
is that Mr. Trump, considering his corporate background, would take a pragmatic leadership
approach.

He could leverage the current low-interest rate regime in the US to make stimulus spends in
infrastructure. If this pans out, and the stimulus spends are meaningful, then this is good not just
for the US economy, but for economies of the rest of world as such. Demonetization and the
clamp down on black money came in as a pleasant surprise. Yes, it has caused inconvenience to
many and has caused quite a dent in the economy on an immediate basis.

It is an expensive affair, considering the cost of printing and the revenue loss in terms of direct
and indirect taxes. By any stretch of the imagination, India will need at least, a minimum of 12
months, if not more, to recuperate from this move. However, the benefits in the long term are far
too many, especially for the stock markets. Thanks to demonetization, cash flushed banks have
already slashed fixed deposit rates, bringing in the post-tax returns to under 6.5 per cent. Do
note, the biggest financial market in India is the fixed deposit market.

However, with declining rates, we can expect a segment of fixed income market participants to
venture into the stock markets. Investors are most likely to take the mutual fund route to access
the stock markets.

This may not happen immediately, but give it another year or so and we will see this pan out.
Whenever this happens, the markets will be flushed with domestic funds, and hopefully, this will
help us reduce the market's dependence on foreign funds.

Clearly this will be a huge positive for stock market participants, especially for the investing
community. All these factors point to a similar outcome - the markets are likely to perform well
over the next few years. However, for one to significantly benefit from this expected rally in the
market, now is the time to build the portfolio.

Investors should also have a multiyear approach to their portfolios and add stock of companies
whose balance sheets are not stretched and ones which have healthy operating cash flow.

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Suggestions

However, the recent demonetization has only hit the stock of unaccounted wealth kept
exclusively in form of currency. To curb regular accumulation of more unaccounted money,
Government could institute a mechanism of incentivizing tax compliance and punitive and
demonstrative deterrents for those caught while generating black money. Extensive financial
literacy on the harmful impact of unaccounted money ranging from personal health to national
loss will help. This should become part of school and college curriculum. Finally, and most
importantly, Government could consider transparency in political funding/election funding as in
the USA and some other advanced countries.

It is a unique experiment in the world with no precedence. To understand the dimension of the
problem consider an illustration where 86 per cent of blood in the body has to be changed while
the patient is working normally and is not in ICU. Thus, in tirelessly undertaking this herculean
task commercial bankers need to be applauded. The work is still incomplete and expected to last
a few more weeks, given that ATM machines have yet to be calibrated. Therefore, with hindsight,
to ease the pressure on branch and considering convenience to customer, commercial bankers can
consider organising kiosks at secure places like schools/colleges/hospitals for exchange of
limited quality of notes. Only customers with large requirements, need to go to the branch.

So the whole operation was kept secret as necessitated. But the last mile turned out to be rather
difficult as serpentine queues outside every branch and every ATM of the country were proof of
the fact that bank branches were not battle-ready.

India is the fastest growing economy of the world with a small Current Account Deficit,
sufficient fiscal space, low inflation, and rising foreign exchange reserves. In fact, India with
nearly 60 per cent of population below 35 years will be unchallenged for next half a century.
Hence, despite pain, the country is unified in this rare opportunity, to cleanse the economy from
cancer of corruption, while on its way to becoming a superpower.

Conclusion

It can be concluded that demonetization has had positive as well as negative impacts on various
sectors, however industries/sectors where cash transaction/liquidity constitutes the flow of
business have been severely affected whereas some sectors who have been hit due to cash crunch
are expected to improve with time. Some stocks of financial markets have been badly impacted
whereas sectors such as medicines have been hardly hit. Financial market in India will take time
to recover from the short term impact but is expected to improve to a huge impact as
demonetization has had a significant impact on corruption. Corporate governance has had & will
play a vital part in taking the country ahead globally as its legal framework provides a strong
base for the financial markets to grow.

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It will be quite early to comment the effects of demonetization but with the passing of 2nd quarter,
3rd quarter of year 2017 we would have a much clearer picture as to which industrial sectors have
gained & which sectors have been badly impacted.

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