Amid his display cases of gold coins and jewellery, Suresh Jain was in bullish spirits as he considered Indian households’ traditionally strong demand for the precious metal.
“There is no change,” said the 55-year-old owner of BJ Jain Jewellers, in Mumbai’s Zaveri gold bazaar. “Gold is a need of the people. It is not a luxury item; it is essential.”
Indian prime minister Narendra Modi is putting Mr Jain’s theory to the test. In a major policy move this month, Mr Modi said India’s two highest-denomination banknotes would cease to be legal tender, and bearers would need to visit banks to deposit them or convert them into new notes by December 30.
The scrapping of the existing Rs1,000 ($14.90) and Rs500 notes was an attempt to flush out the illicit cash piles held by tax evaders and bribe recipients. It is far the most aggressive move yet in Mr Modi’s popular drive to tackle corruption.
It could also help accelerate a shift in savings patterns towards formal financial products and away from physical assets — chiefly gold and real estate. These accounted for 58 per cent of household savings in the financial year ending in March, down from 68 per cent three years before, according to analysts at Kotak Institutional Equities.
The attachment to physical assets is explained in part by tradition and fears of inflation. But it also stems partly from the market in gold and real estate having long been driven largely by cash transactions, making such assets a convenient means of parking undisclosed “black money”.
Saurabh Mukherjea, head of institutional equities at Ambit Holdings, says this has cancelled out much of the beneficial impact of India’s relatively high savings rate, which stands at about a third of gross domestic product.
A big shift in savings towards financial products would significantly reduce India’s cost of capital and create “a more competitive economy, potentially more able to compete in global export markets”, Mr Mukherjea argues.
Jewellers at the Zaveri gold bazaar on Friday spoke of a surge in business since the demonetisation. The spike in activity reflects a rush by holders of undisclosed cash to exchange it for gold — despite steep premiums imposed by sellers — rather than be left with piles of worthless bills, says Mukul Kochhar, head of Indian equity sales at Investec.
But in the long term, most analysts predict that the demonetisation will reduce demand for gold, by dramatically reducing the stock of black money hitherto used in a large chunk of purchases.
“It’s not that black money can’t be created again — it can be — but the quantum will be so small and insignificant that it will need 30 or 40 years to come back to this level,” says Deepak Parekh, chairman of Housing Development Finance Corporation, one of the country’s biggest financial groups.
The shift away from gold had already begun, according to analysts at Emkay Research, who estimate an 18 per cent year-on-year fall in demand for the metal in the three months ending in June.
While that reflects higher gold prices, it also speaks to government steps to heighten monitoring of the market, such as requiring buyers to show their taxpayer’s card for purchases worth more than Rs200,000.
In property too, transaction volumes had already been brought down by anti-black money measures, says Saacketh Chawla, deputy India head for Colliers International, a real estate services company.
These have included sharply increasing the “circle rates” that set an effective floor on prices for property sales — thereby reducing the scope for sellers to demand a cash component on top of the formally declared sale price.
Shares in Indian-listed real estate developers fell sharply the day after Mr Modi’s announcement — several by nearly 20 per cent — as investors took fright at the prospect of a dramatic fall in transactions funded by cash.
This will have a knock-on effect even for developers who have scrupulously avoided cash payments, says Mr Chawla, who predicts a drop in valuations and a slowdown in housing sales as market participants adjust to the new paradigm.
“Indian real estate has been massively overvalued — and the reason is that it acts as a laundering machine for black money,” Ambit Holdings’ Mr Mukherjea says. “After [the demonetisation] you’d be out of your mind to buy a flat anywhere in India at current valuations.”
In contrast with the uncertain outlook for the gold and property markets, companies offering financial savings products have reacted to the demonetisation with enthusiasm — hoping that the logic for avoiding such products will become weaker, as the tax authorities strengthen their grip on the market for physical assets.
“We are very excited,” says Nilesh Shah, managing director of Kotak Asset Management. “We were losing out to real estate and gold not because we were not performing well, but because we were not able to provide any tax amnesty or tax shelter. Now our market share will increase.”
Additional reporting by Andrea Rodrigues