What will be the effect in Stock market after the Indian Government's decision to demonitize 500 and 1000 rupee notes?

The Indian government's decision to demonetize the 500 and 1000 rupee notes on November 8, 2016, had both immediate and long-term effects on the Indian stock market.

Immediate Effects

• The announcement led to a sharp decline in the stock market. The Bombay Stock Exchange's benchmark index, the BSE Sensex, plummeted by roughly 1,700 points or 6.4% in just four trading days, while the National Stock Exchange's benchmark index, the NSE Nifty, fell by approximately 550 points or 6.3%14.
• This initial drop was largely due to the uncertainty and ambiguity induced by the announcement, as investors were concerned about the potential impact on corporate profits and the overall economy1.

Short-Term Consequences

• The liquidity crisis and the subsequent scramble to exchange or deposit old currency notes led to a temporary drop in mutual fund inflows. However, this was a brief phenomenon, and mutual fund inflows quickly recovered as the government and the Reserve Bank of India (RBI) introduced measures to inject liquidity into the banking system1.
• Businesses dependent on cash transactions suffered significantly, which affected their stock performance in the short term2.

Long-Term Consequences

• Despite the initial volatility, the stock market rebounded over the following weeks and months. The RBI's efforts to increase liquidity and the shift towards digital transactions helped stabilize the market1.
• Certain sectors benefited significantly from demonetization. For example, banks and financial institutions saw substantial positive returns due to the increased financial depth and the expectation of easing financial constraints. Firms in the digital payments and banking industries, such as Paytm, HDFC Bank, and ICICI Bank, experienced significant increases in their stock prices13.
• There was a shift in investor attitudes towards equity mutual funds, driven by low interest rates which made equity investments more appealing. This led to record inflows into equity funds in the years following demonetization1.
• Small and mid-cap funds, although initially affected by the liquidity crisis, rebounded as economic conditions improved and interest rates remained low, making equities more attractive1.

Overall Impact

• The demonetization led to increased financial inclusion, with more people opening bank accounts and engaging in digital transactions. This had a positive long-term impact on the financial sector and the overall economy24.
• While the immediate effects were negative, the long-term consequences included a stronger digital ecosystem, increased investments in digital infrastructure, and a shift towards a cashless economy1.

In summary, the demonetization had a mixed impact on the stock market, with short-term volatility and long-term benefits, particularly for sectors related to digital payments and banking.