Update about the “demonetization” in India and the related impact on our operations

This document is aimed at presenting how we see evolving the “demonetization” declared on Nov 9th by Mr. Modi, PM of India; the related impact on our Indian operations (Grameen Koota – CAA-GK), on our clients and how we are managing this exceptional event.

The Background

On Nov. 8th , in a surprise move that caught most people off-guard, Mr Modi announced that all 500 and 1,000 rupee banknotes (with values equivalent to about US$7.50 and $15.00) would be immediately declared void, withdrawn from circulation and replaced by new 500 and 2,000 rupee denomination notes, with the objective of curbing black money, counterfeit notes and to some extent also corruption and the financing of terrorism – all of which has heavily leveraged on cash currency.

From a technical point of view, from Nov 9th till Dec 31st any person holding such void notes is allowed to deposit it or change a limited amount per day into new notes, at any bank branch or ATM. But in case of large amounts, the holder is required to provide adequate documentation regarding the source of such cash making almost impossible to the large holder of black money to convert it into new notes.

This exceptional move triggering the substitution of 86% of the total value of currency in circulation, equivalent to around $ 220 bln, is causing a short-term pain in Indian life and businesses and indeed will generate multiple long term effects, partly positive and, possibly, partly negative.

Short term effects

The demonetization has triggered an immediate 86% drop in the cash currency in circulation. A dramatic gap that will last till full replacement of 500 and 1,000 old Rs notes.

This substantial lack of valid currency in circulation is expected to ease by end of November and eventually disappear by year end when the replacement of void notes by new 500 and 2,000 Rs is expected to be well advanced; nonetheless causing a tangible economic impact on the cash economy of India.

To understand the impact of such massive substitution of currency in a country like India, we should consider the following key factors:

  • In India 95% of all C2B and B2C transactions are managed in cash (against 50-60% in Europe/US);
  • About 70% of employment in urban India – and as much as 75% in rural areas – is informal and one-fifth of total economic output is said to be informal;
  • Around half of the 1,25 bln Indian population is unbanked and 65% of Indians lives in rural or semi-rural areas with limited access to banks branches and ATMs;
  • Indian population enjoy one of the highest savings rate in the world, well above 20%; broadly invested one third in real estates, one third in gold and luxury products and one third in bank deposits and (still few) financial products. But if you look at the half unbanked segment of the population, the savings go into gold/silver and cash (held “under the mattress”);
  • India is also one of the countries with the highest portion of black economy (estimated between 25-35% of the GDP) and highest amount of fake circulating currency.

Considering the above, it is evident that the cash economy in India is absolutely dominant and, as a consequence of a demonetization, the turn-around time required to substitute the old notes into new notes is the key factor which will determine the level of (short term) negative impact of such demonetization.

As of today, two weeks after the demonetization start, about 50% of the old notes has been already deposited into bank branches and it is estimated that this trend will get almost completed within December. Then, it will be possible a more accurate esteem of the portion of such $ 220 bln which are actually “black money” likely NOT to re-enter anymore into the system (current estimation 20-30% of the total amount).

But more than the amount deposited, it is important to look at the amount changed and withdraw, giving the measure of what really goes back into the “cash economy” to ease the current  constrain on all cash transactions.

Here the numbers are lower, basically limited by the maximum withdrawal per day that each person can perform.

Today, looking at different estimations, we understand that around 20% of the total $ 220 bln has been effectively re-injected into the “cash economy” and the time required to complete this turn-around may expand till end December or may be a little further.

A relevant part of withdrawals are executed via automated teller machines (ATMs). Almost 50% of India’s 202,000 ATMs have been recalibrated to dispense new Rs 500 and Rs 2,000 currency notes, which is expected to ease the pressure on banks struggling to meet demand.

The ATMs are being recalibrated at the rate of around 10,200 a day, which means that the entire process should be over before November end; just in time to absorb the usual ATM monthly withdrawal pick happening when salary of employees are credited to accounts.

Despite the unavoidable pain suffered in the short term, it is relevant to note that the demonetization is being seen positively by a large part of the population, a nationwide survey conducted by C-Voter has suggested. A whopping 80-86 percent of those surveyed said the inconvenience caused by the demonetization is worth the effort of combating black money and the wide-ranging support for the demonetization cut across the barriers of categorization. The numbers remained consistently high when broken down on the basis of area of residence, income levels or by age groups.

Looking at CAA-GK clients profile, even if the majority of the transactions managed by them are executed via smaller notes, still a part of their cash assets is composed of Rs 500 and 1,000 notes; cash that they fully leverage in their daily businesses. So, the main challenge they face in the short term is to change such void notes into the new ones.

Given the majority of CAA-GK clients are unbanked and given the lower penetration of bank branches and ATMs in rural areas, we expect the process to substitute their old notes with new notes taking more time than in urban area / in the case of banked people.

Despite the above, as of today our clients are showing the well-known and tested resilience to adverse events and the repayment rate of our 2.88 mln outstanding loans is still very healthy.

More relevant is the percentage of unpaid loans suffered in the first week and the second week after the demonetization event, equivalent to 20% of the instalments planned during such first week (as a consequence of our offer to clients to grant them time to cope with the sudden cash constrain) and 4% respectively, showing the immediate impact of demonetization and the rapid adjustment in the following week; anyway translating into a total Portfolio at Risk (PAR 7 day) still below 2%.

Currently our disbursements of new loans in cash are limited by the scarce availability of new currency notes. For this reason we are working hard to activate cash-less disbursements (via prepaid cards / bank accounts) which are expected to be up and running within the next 3-4 weeks. This immediate innovation not only will limit the impact on the growth plan of the company (we expect demonetization to affect our portfolio growth trajectory in November and December) but will also turn this event into an opportunity to educate our clients toward cashless transactions.

Extraordinary actions undertaken by CAA-GK to support to its clients

  • The “Group Meetings” are being conducted as usual to ensure continuous connect with our clients. CAA-GK collects repayments in very small value on weekly payments; hence it has been easy for clients to repay in cash;
  • Clients are being advised about the non-acceptance of banknotes in the denomination of Rs.500 and Rs.1000 as per regulations;
  • CAA-GK employees are sensitised to support clients in this adverse situation;
  • Awareness is being created among clients about various options and the process of getting notes exchanged. Assistance is being provided by the branch staff for currency exchange wherever necessary;
  • Wherever a client is not able to make payments due to non-availability of currency, sufficient time is being provided to him/her to arrange for repayment;
  • Clients are allowed to execute instalment payment in tranches;
  • Currently, banks are not providing us with the cash required to execute fresh loan disbursement to clients, due to shortage of new currency in the system and absence of clear guidelines. However, CAA-GK is providing liquidity to our customers disbursing small loans and emergency loans arranged by leveraging the instalments collection received, until bank operations get normalised. This is helping the clients to large extent to ease their cash liquidity. Further, as mentioned earlier in this document, we are working hard to activate cash-less disbursements (via prepaid cards / bank accounts) which are expected to be up and running within the next 3-4 weeks.
  • Micro Finance Institution Network (MFIN), the Industry Association for NBFC-MFIs, has been actively working with members to support and coordinate the activities at industry level;
  • During the first week after demonetization, all MFIs have given one-week time to clients to cope up with the situation;
  • MFIN created a Focussed Action Group composed by senior industry leaders, which is engaged in a continuous dialogue with the Ministry of Finance and RBI to get the exemption list extended to NBFC-MFI’s, enabling MFIs to act as banks channeling the collection and deposit of old notes into banks.

Estimated long term impact on the Indian economy and on our business

While short term impact is basically correlated with the turn-around time of the substitution of old (void) notes into new notes, long term impact is much more related to the drastic reduction of cash black money into the economic system.

At macro level we understand that demonetization may impact the Indian economy as follows:

  • Among the positive dynamics: higher tax revenues (especially from operators in the sectors traditionally affected by a relevant black money component); a reduction in the public debt stock (equivalent to the cash amount eventually cancelled); lower interest rates (triggered by lower inflationary elements and an higher monetary mass deposited into the banking system);  an accelerated change in the savings habits favoring the investments in financial products; a shift toward efficient cashless transactions (via debit cards / e-wallet mobile applications); less informal money lending and possibly a slow-down in corruption practices and less criminal events/transactions triggered by a dramatically lower (black) cash stock, being required to manage such activities.
  • Among the negative effects: a contraction in the real estate sector, constructions, gold, gems/jewelry and all luxury products in general; while more uncertain is the overall impact on consumption and GDP growth where economists tent to converge seeing a 0.5 / 1.0% lower growth in the current year but no clear consensus about the longer term impact.

Regarding our microfinance business and our client base, we understand the following:

  • It is expected a reduction of the cost of funding, generating a benefit that will be transferred to our clients by reducing the interest rate applicable to our loans portfolio;
  • Despite today only 12% of Indians are familiar with e-payment systems, we see demonetization accelerating dramatically the shift to cash-less transaction.
  • With cash transactions under serious constrains, alternative forms of payment will see a surge in demand. Digital transaction systems, e-wallets apps, online transactions using e-banking, usage of plastic money (Debit, Prepaid and Credit Cards), etc. will definitely see a substantial increase in demand. This should eventually lead to strengthening the eco-system required for cashless transactions;
  • A broad acceptance and expansion of cashless transaction may eventually lead to a subsequent offer of innovative services to our clients: e-payment services, investment products, micro-insurance and micro-pension products and other non-financial services channeled via mobile applications.