The Impact of Demonetization on the Corporate Sector

On November 8, 2016, the Indian
government made a surprise announcement that certain currency notes
(representing 86% of the currency then in circulation) would no longer be legal
tender (although they could be deposited in banks over a limited period). The
stated reason for this sudden “demonetization” was to combat tax evasion and
corruption associated with “unaccounted-for” cash. We compute abnormal returns
for firms on the Indian stock market around this event, and compare patterns of
abnormal returns for different subsamples of firms defined by industry,
ownership structure, and other characteristics. There is little evidence that
sectors thought to be associated with greater tax evasion or corruption
experienced significantly different returns. However, we find substantial
positive returns for banks and for state owned enterprises (SOEs), implying
market expectations that are puzzling in some respects. The bank results appear
to indicate a market expectation of a persistent increase in financial depth.
We also find a pattern of higher returns for industries that are characterized
by a greater dependence on external finance, possibly suggesting an expectation
of an easing of financial constraints. The returns for SOEs may be due to
possible indirect effects of the announcement on perceptions of future
corruption among these firms.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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