India’s bold move is painful but necessary for the economy
elivering one of India’s biggest-ever economic upsets, Prime Minister Narendra Modi last week declared the bulk of Indian currency notes no longer held any value and told anyone holding those bills to take them to banks.
Only those holding huge stashes of untaxed “black money” need worry, Modi said. But in India, many others are deeply worried. About 80 per cent of India’s financial transactions are conducted in cash, often to evade taxes.
While some of that activity is illegal, hundreds of millions of rural poor, scrappy entrepreneurs and small-time traders also keep their savings in cash, sometimes just because there is no bank branch nearby.
India’s industry leaders, bankers and market analysts rallied behind Modi’s move, viewing it as a much-needed corrective in a cash-reliant culture that has enabled corruption. Within hours of Modi’s announcement that all 500 and 1,000rupee notes – worth about $7.50 and $15 – would hold no value as of Wednesday, the hashtag “ModiFightsCorruption” began trending on Twitter.
In the short term, economic activity is slowing until new notes worth 500 and 2,000 rupees can be printed and put into circulation, analysts said. They also predicted a rush on gold, foreign currency and other forms of wealth.
“The eradication of the black money menace from the Indian economy is a big positive in the long-term, and the Indian economy will be on a very strong footing once the short-term teething problems are done,” said Sachin Shah, fund manager at the Mumbai-based Emkay Global Financial Services.
Morgan Stanley hailed the demonetisation as a “bold move to curb black money” and bring millions more Indians into the tax regime. As of now, only about 1.6 per cent of India’s 1.25 billion people are paying income tax.
The surprise currency swap would “have a debilitating impact on the parallel economy in the country”, said Harshavardhan Neotia, the head of the Federation of Indian Chambers of Commerce and Industry, referring to business conducted using illicit cash.
“We appeal to all sections of society to support this initiative,” he said. Not everyone is on board. “Will it put an end to black money? Hardly. People with large amounts of black money will convert it into gold and foreign currency,” the newspaper Economic Times said in an editorial.
Citigroup warned that scrapping so much currency would spur short-term market volatility, though it said it does “expect longerterm positives for equities”. As expected, Indian stock markets tumbled on Wednesday before recovering some ground before closing. It was hard to tell how much came from the Modi currency shock and how much was due in reaction to Donald Trump winning the US presidential election.
Modi has been seeking to eliminate black money since his 2014 election, launching a government scheme to open bank accounts for all citizens and granting wealthy Indians a tax amnesty for disclosing undeclared assets and cash holdings.
The one-time amnesty raised $10 billion – far less than what the government expected.
Modi said in his televised address on Tuesday night that authorities had discovered 1.25 trillion rupees, or about $18.8 billion, in illegal cash over the last two and a half years.
CHANGE: Indians form long queues at a bank to exchange or deposit the discontinued currency notes