In a world where most governments and financial authorities often do everything in their powers just to avoid surprising the markets, India has certainly proved itself an exception. On the evening of 8th November, Prime Minister Narendra Modi announced in a televised statement to his people that all of the 500- and 1,000-rupee notes, the country’s highest denominated bank bills (worth the equivalent of about $8 and $15 each respectively), would be taken out of circulation at the end of the year.

At 86 percent of the nation’s overall currency in circulation, it’s probably not hard to imagine the scale of shock the announcement delivered. The surprise move is certainly unprecedented in recent times; not just in India, but also on a worldwide scale too. To put it in context, taken together the notes to be withdrawn and cancelled currently amount to 23 billion pieces of paper. As a Bloomberg article aptly put it recently, stacked one on top of the other, the notes would form a structure 300 times as high as Mount Everest.

Modi Announcement of Money Ban - Alvexo

Everyday Life Disrupted

Although the notes would still be accepted at banks’ cashier desks for exchange with smaller-denominated currency until the end of the year, the move effectively left many Indians out of pocket overnight. Those citizens unlucky enough to only be holding the notes to be withdrawn at the time of the announcement, suddenly found their wallets practically empty. Virtually all businesses, from shops to taxis and even hospitals in some cases, stopped accepting the notes as currency. On top of that, all of the country’s ATMs remained closed as well, resulting in long queues outside bank branches.

People waiting to withdraw money from ATM - Alvexo
People wait to withdraw and deposit their money at an ATM kiosk in Kolkata, India, November 8, 2016. REUTERS/Rupak De Chowdhuri

Everyday life was thus clearly disrupted in the immediate aftermath of the announcement; some of those affected even described it as completely paralyzed. It certainly sounds almost like an apocalyptic scenario and begs some obvious questions, at least to anybody who’s not actively involved in matters relating to India’s economy. Why did Modi’s government decide to take such a drastic decision, and what was the rationale behind the current timing?

The government said that the demonetization move was a necessary step in its effort to tackle widespread corruption and tax evasion through black market trade. What they wanted to do was to account for each and every one of the high-denomination bills in circulation. And indeed, black market trade is a well-known problem for the world’s second most populous country. According to a 2010 study sponsored by the World Bank, its size amounts to about a quarter of its official GDP.

Mixed Reactions to Unexpected Move

The timing of the unexpected move has caused mixed reactions. The vast majority of Indians have been understandably critical, because of the short timeframe available for the exchange of the old notes and the resulting turmoil this has brought to their daily lives. But there have also been voices who saw the timing of the announcement as ideal; it comes right after the Diwali season, which means many people have received cash bonuses, and just before the local municipal elections, a period during which politically-related bribing activity is generally expected to run higher than normal.

Common people not happy about money ban - alvexo

For his part, Modi has asked for patience from his people until the demonetization process is complete. “Give me 50 more days”, he said during an address to the nation four days after the surprise move. “After that, if any fault is found in my intentions or my actions, I am willing to suffer any punishment given by the country”.

His dramatic appeal for calm is certainly not going to be an easy one to follow, though. The first signs indicate that his planning has not been optimal. Approximately half the country’s population, some 600 million people, don’t even have a bank account, and earn their daily wages in cash. The resulting cash shortage is certain to have a huge negative impact in their daily life. Even the printing of the new notes, which will replace those withdrawn, could take another six months by some estimates, an unmanageable length of time for this kind of disruption.

What This Means for Investors

On the other end of the spectrum, this move seems set to produce some very big winners. Naturally, first in line will be all the companies and organizations associated with plastic money or online payments. Visa and MasterCard have already seen their daily volumes spike, as have services such as Paytm and Freecharge.in. But again, the sad reality is that the vast majority of everyday Indians are not even aware of these alternative payment options. Internet penetration amounts to less than 300 million people, out of a population of 1.2 billion, while smartphone usage, essential for the use of online payment systems, is also very low.

So in effect, regardless of the boldness of the demonetization move and the government’s good motives, it looks like there’s a real danger it will find itself back in square one, if not worse. With its citizens relying on cash for the vast majority of their daily transactions, but with less of it being available for a considerable amount of time. Let’s hope this isn’t the case.

 

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