Indian markets likely to welcome scrapping of larger banknotes, analysts say

MUMBAI (Reuters) - Indian markets are likely to welcome the country’s move to kill off its 500 and 1,000 rupee banknotes on Wednesday - the U.S. presidential election result notwithstanding - as banks’ coffers will fill up as people deposit the notes as part of the process.

Analysts also see the move as leading to a softening in inflation.

The surprise step is designed to bring billions of dollars’ worth of cash in unaccounted wealth into the mainstream economy, as well as dent the finances of Islamist militants who target India and are suspected of using fake 500 rupee notes to fund operations.

Prime Minister Narendra Modi said 500 and 1,000 rupee notes would be withdrawn from circulation starting from midnight, saying it was part of a crackdown on rampant corruption and counterfeit currency.

Real estate firm's shares such as DLF Ltd DLF.NS will likely be hit in the near-term given the action could curb property prices, though it will eventually boost demand for housing over the longer-term.

Black money has long been suspected of being steered into real estate, inflating prices.

Any broader market gains could be tempered should Republican candidate Donald Trump win the U.S. election on Tuesday, an outcome that market investors have warned could lead to sell-offs due to doubts about his policies. The results of the election should start filtering through as Indian markets open on Wednesday.

“If you look at India’s economy point of view it’s a very good measure,” said Saravana Kumar, Chief Investment Officer, LIC Mutual Fund.

“Inflation will moderate and it’s going to control the fiscal deficit. Black money will come down drastically.”

Traders said bank shares would likely be the main beneficiaries as Indians hand in their bigger notes, thereby improving their near-term liquidity.

Cash positions will ease, however, as India issues new 500 rupee bills as well as higher-denomination 2,000 rupee bills to replace the retired ones.

Analysts said that the move could also lead to easing inflation as the government’s push against black money is likely to push transactions into the formal economy, leading to more transparency. The exact impact would be difficult to gauge given uncertainty over the scale of illicit funds, they said.

The Reserve Bank of India unexpectedly cut the repo lending rate last month citing easing inflation, and it is seen as potentially lowering it again early next year should growth in retail prices continue to ease.

Reporting by Abhirup Roy, Suvashree Choudhury and Devidutta Tripathy; Writing by Rafael Nam; Editing by Euan Rocha and Hugh Lawson