What’s happening in India?
500 Indian Rupee note. Source: Wikipedia
Three weeks ago the Government of India declared that all of the current 500 and 1000 Rupee banknotes—the highest denominations—were no longer legal tender. At the same time, the Government issued new 500 and 2000 rupee notes. For reference, 1000 Rupees is worth about $15, and a loaf of bread costs about 25 Rupees. Prime Minister Narendra Modi announced the change in an unscheduled, live television address. In his speech, Modi said that demonetization was designed to crack down on corruption, counterfeiting, and tax-cheating.
Almost immediately, massive lines formed outside banks and ATMs across the country as people rushed to convert their current cash holdings to the new notes. Citizens were restricted to converting only 4,000 Rupees per day, and ATM withdrawals were limited to 2000 Rupees per day.
Photo: Biswarup Ganguly. Source: Wikimedia
The surprise announcement created a lot of confusion. ATMs quickly ran out of cash. Around 400,000 trucks became stranded on major highways across India because drivers did not have enough valid currency. Toll-plazas saw endless lines as plaza operators refused the old banknotes. The Indian stock market fell by almost 10%, while the price of gold in Rupees jumped by up to 30%. Some think this could derail India’s economy—currently growing 7%.
This isn’t the first time India has done this. In 1946, 1954, and 1978 the Government demonetized highly-denominated bank notes to try to hamper the underground economy. But it’s unclear how well this will work now. Much of the black market also operates via bullion, jewelry, and bitcoin. It’s possible that the latest demonetization will prove to be only a speed bump on illegal transactions.
India is a cash economy. Almost everyone keeps a few thousand Rupees in around as a nest egg. 500 and 1000 Rupee bank notes comprised about 85% of the outstanding currency. There will continue to be a lot of disruption as people adjust to the new regime. But India’s underground economy is estimated to be 50% of their GDP. If this brings a significant portion of that black money out into the open, Modi’s bold stroke just might be worth the trouble.
Douglas R. Tengdin, CFA
Chief Investment Officer