Demonetisation was the talk in both India and Indonesia at the end of last year.
Money is the topic of the day. India has undergone one of the most dramatic demonetisation schemes in history while Indonesia has revived plans to redenominate its currency.
On the morning of 9 November last year, queues were forming outside banks and ATMs across India. Tens of thousands of people took the day off work to go to the bank and deposit cash.
At 8pm the previous night, they had seen their Prime Minister, Narendra Modi, announce the immediate demonetisation of all INR 500 ( USD 7.50) and INR 1,000 (USD 15) notes in an unscheduled, live televised address. In order to combat corruption, black market trade and tax invasion as well as fight terrorism funded by counterfeit notes, the notes would be invalid past midnight and new INR 500 and INR 2,000 notes were already being printed, the Prime Minister said.
India has demonetised its currency twice before, in 1946 and again in 1978, both times in an effort to fight shady operations that exist outside the formal economic system. In a country where the vast majority of transactions are still made in cash, demonetisation is a huge disruptor. Up to 86 percent of the value of all the banknotes in circulation in India are INR 500 and INR 1,000 notes, meaning that a staggering INR 15.4 trillion were demonetised over night.
Downgrading the economy
Indians were given a 50-day window to declare and deposit their INR 500 and INR 1,000 notes, causing long queues outside banks. However, many were left without cash for day-to-day expenses and the new notes INR 500 and INR 2,000 notes were not made widely available. According to The Guardian, only about one-third of the cash removed from the system were replenished by the end of December, and just 40 percent of the country’s 220,000 ATMs were able to regularly distribute cash.
Market responses have been swift and significant. Shortly after the demonetisation, the World Bank downgraded India’s economic growth forecast as the country’s automobile and real estate sales dropped. The bank predicted that India’s economy would grow by a “still robust” 7 percent in the fiscal year to March 2017, which represented a 0.6 percent drop from earlier forecasts. However, the Washingtonbased financial institution said that the effects of the demonetisation was likely to be short-term. “India is expected to regain its momentum, with growth rising to 7.6 percent in fiscal year 2018-19 and strengthening to 7.8 percent in fiscal year 2019-20,” the bank said.
Société Générale (SocGen), the French-based financial services company, took a similar stance, cutting India’s fiscal 2017 growth rate to 6.6 percent on-year from 7.3 percent previously. For fiscal year 2018, which ends in March 2019, SocGen expects growth to be 7.2 percent on-year, down from an earlier projection of 7.7 percent. Concerns about inflation
The move to demonetise has spread concerns about inflation. Despite calls for interest rate cuts in face of the sudden cash shortages, the Reserve Bank of India kept its key policy rate unchanged
at 6.25 percent in January and again in February, stating that the cash squeeze was likely to be short-lived and that it needed more time to fully understand how demonetisation would effect the economy.
Others argued that inflation was set to accelerate, leading the Reserve Bank of India to increase rates much sooner than expected. Speaking to CNBC, Shilan Shah, an India economist at Capital Economics said: “Demonetisation itself is likely to be inflationary over the longer term if it leads to supply disruptions even as demand recovers. For example, some farmers in rural areas have reportedly been unable to purchase seeds and/ or fertiliser. This could lead to smaller harvests later in the year, which in turn would boost prices.”
Bad for business In addition to cash shortages and slashed growth forecasts, industry suffered heavily in the months following the demonetisation. According to Reuters, a survey by IHS Markit found that the Nikkei/Markit Manufacturing Purchasing Managers’ Index, which tracks economic indicators across a variety of sectors, fell to 49.6 in December from November’s 52.3. The reading was the first below the 50 mark that separates growth from contraction since December 2015. It also represented the biggest month-on-month decline since the start of the global financial crisis in November 2008. Speaking to Reuters, Pollyanna De Lima, an economist at IHS Markit, said that shortages of money in the economy steered output and new orders in the wrong direction, thereby interrupting a continuous sequence of growth that had been seen throughout 2016. The survey found that contractions in momentum were reported across all major subindexes, such as purchasing activity and employment.
Meanwhile, The Economist reported that fast-moving consumer goods retrenched by 1 to 1.5 percent in November, according to Nielsen, and The Guardian reported that data from the Society of Indian Automobile Manufacturers showed the largest fall in sales in 16 years, with a 19 percent drop in sales in December compared to a year earlier. According to a report by property consultants Knight Frank India, property sales came to a complete standstill with sales falling by 44 percent across eight major Indian cities between October and December 2016, compared with the same period in 2015.
Silver lining While the immediate and short term effects of the demonetisation have been evident, the jury is still out on the mid and long term effects. Initially touted as a strategy to combat corruption and untaxed wealth, officials in India are now framing demonetisation as the first step towards a “cashless” country where the majority of transactions are completed online and under the watchful eyes of tax authorities. Indeed, with nearly INR 15 trillion of the 15.4 trillion taken out of circulation now accounted for, according to The Economist, many are now wondering whether the rich were really hoarding as much dirty cash as supposed, or whether they have just been very good at laundering it.
According to The Guardian, digital payments boomed in the weeks following demonetisation. However, India’s rural economy and its huge informal sector, which is estimated to employ 80 percent of the workforce and contribute to 45 percent of the country’s GDP, are still far from digitalisation. In December 2016, India’s Labour Minister Bandaru Dattatreya announced it would soon be mandatory for employers to pay their staff into bank accounts, an ambitious goal in a country where up to 90 percent of workers are paid in cash. In addition to increasing the tax base – only one percent of Indians pay income tax – the move would also allow authorities to monitor whether people are being paid the minimum wage, something that is rare today. According to India’s Finance Minister, Arun Jaitley, by the end of December, there had been a 14.4 percent increase in the value of income tax collected since the policy was introduced, while indirect tax collection had grown by 26 percent, reported The Guardian.
Indonesia Indonesia’s Bank Indonesia Governor Agus Martowardojo announced in December 2016 that the country plans to cut tree zeros off the face value of the rupiah in a move to simplify the currency system. Indonesia is one of the few countries in Asia where the term “millionaire” applies to the majority of the population. Due to hyperinflation, Indonesia’s currency has been devalued several times, the last time in 1965.
A plan to redenominate the currency was shelved in 2013 due to instability in the financial markets at the time.
According to the governor, if the bill is accepted this time, the central bank would need two years to prepare the new notes and it would take as long as seven years to fully implement the scheme. In order to control inflation, the bank would allow for a long period of time where people will be able to use both the old and the new notes, said the governor. He said the denomination would not decrease consumers’ spending power as the prices of goods and services would be adjusted.
Left: Long queue of people outside bank in Gurgaon, Delhi to deposit old 500 and 1,000 currency notes to get new currency in November 2016.