Global Glance: February 6, 2017
A quick look at intriguing international stories
By John Bostwick, Managing Editor, Radius
India’s Demonetization Experiment
On November 8, two surprises rocked the world's political-economic landscape: The US elected Donald Trump as its president, and Indian prime minister Narendra Modi declared by fiat that two of his country’s most-used bank notes would be worthless starting January 1, 2017. (Readers experiencing Trump-fatigue will be relieved to hear this post addresses only the second event.)
A New York Times editorial published about a week after Modi’s declaration described the prime minister’s announcement as “shocking,” particularly given the importance of cash payments to India’s large and growing economy. The Times explains that cash “is used in an estimated 78 percent of transactions, compared with 20 percent to 25 percent in industrialized countries like Britain and the United States.” The Times adds that many Indians don’t have bank accounts or credit cards and that many businesses in India are cash-only.
This outsized reliance on cash has perpetuated a number of problems that Modi hopes to address with the demonetization, including the fact that many transactions in India involve so-called “black money” — that is, cash that’s effectively kept under mattresses or used in under-the-table payments to avoid paying taxes. An article in Forbes reports that India’s “shadow economy” represents about a quarter of the country’s GDP. Also of serious concern: Since black money isn’t traceable, it can be used to fund terrorist activities.
Whatever its justifications (and ramifications), the basics of Modi’s plan are simple. Indian citizens had from November 8 to December 30 (i.e., less than two months) to go to a bank and exchange or deposit their 500- and 1,000-rupee notes (worth about $7.50 and $15 respectively). These bills, according to various sources, made up a stunning 86% of India’s circulating currency. The bills will eventually be replaced by new ones. The Wall Street Journal reports that Modi’s government “has slowly rolled out a redesigned 500-rupee bill and a new 2,000-rupee bill.”
Modi has come under severe criticism for this experiment. The Times notes that his “poorly thought out and executed” decision “has thrown the economy into turmoil, with many millions of people forced to line up at banks to deposit or exchange their old bills,” while “many traders have established lucrative money-laundering services to help the cash-rich get rid of their old bills.”
Most sources have noted that poor and rural Indians have been particularly hard-hit by the program. The Forbes article indicates that, incredibly, 600 million Indians don’t have a back account, and about half of those don’t even have the official identification required to open an account. An article in The Diplomat observes that “days spent in ATM lines” by low-wage Indian workers “have a tremendous opportunity cost in the form of lost wages.” The article adds that “from a macroeconomic perspective, because more than 90 percent of all transactions in India are conducted in cash, taking 86 percent of the country’s cash out of circulation has stifled transaction volumes in almost all industries.”
Some industries have been more seriously negatively affected than others. The Financial Times notes that consumer goods companies, which deal mainly in cash in India, have experienced a decline in sales and “are trying to determine whether the interruption … might lead to a more protracted downturn.” The Financial Times and other sources have noted that India’s real estate market has also been hit, in large part because property transactions often involve two payments, one “official” payment and another unreported black-money cash payment. The Wall Street Journal article says that falling sales in general “have begun to translate into layoffs spanning various sectors, including construction, textiles and jewelry.”
The Financial Times reported last Tuesday that a representative from Modi’s government estimates the bank-note ban “would shave a quarter to half a percentage point off [India’s] GDP growth” in the next fiscal year, which starts April 1. The same article notes that even with this downward adjustment, India’s economy “is expected to grow 6.75-7.5 percent” next year, a rate most countries can only dream of these days. The Financial Times cautions that India’s economy, despite its robust growth in recent years, has problems beyond those related to the recent demonetization, including “overleveraged companies and banks burdened with high levels of non-performing loans.”
There are other negative and potentially negative consequences of the cash ban. The Diplomat article points out that Modi has “torched” his political and social capital with the decree, and that his reputation — and perhaps even India’s political future — are at stake. The article concludes: “By acting unilaterally, rather than by legislative mandate, Modi has further undermined the tenants of India’s democracy and stoked fears about his authoritarian inclinations.”
Modi’s demonetization does have its supporters, however, and some of them are prominent. Last week, for example, Apple, Inc. CEO Tim Cook told The Wall Street Journal that while India’s demonetization “created lots of economic pressure there last quarter … [Apple] had all-time record revenue results” in India. Cook added that in the long term, demonetization is “a great move.”
It’s not surprising a tech giant like Apple would laud Modi’s gamble, not just because (as the Journal article notes) the company is looking to manufacture products in India as “sales in China stagnate,” but more generally because demonetization has dramatically forced India to shift towards electronic commerce. Indeed, a number of commentators have observed that Modi’s public justifications for the initiative have evolved to emphasize the benefits of digitization. A Forbes article published last month, for example, points out that “as the demonetization campaign progressed, its narrative gradually transitioned from being a measure to fight corruption to one to modernize a large swath of India’s economy.”
The first Financial Times piece mentioned above says that in the wake of the cash ban, digital-payment companies “are reporting that demand for their services has increased several hundred per cent, and some have brought forward their growth targets by a year or more.” Other ecommerce companies “including Amazon, Flipkart and Snapdeal — India’s biggest online retailers — have welcomed the move,” and have taken it as an opportunity “to hoover up market share.” Meanwhile, bank accounts, the Forbes piece notes, “have been getting opened across India at an exponential rate,” which will of course support digitization while getting millions of Indians onto the official, taxable economic grid. A research expert from Deutsche Bank is quoted by The Financial Times as saying: “This could go down in the annals of Indian history as a massive transfer of wealth from those who were hoarding cash to ordinary people.”
An Indian government official said last week that the process of replacing old currency with new will be complete by April, in time for the new fiscal year. Modi’s government also announced its annual budget last week. In his budget speech, finance minister Arun Jaitley said, according to The Financial Times, “We are largely a tax non-compliant society. … The predominance of cash in our economy makes it possible to evade taxes. The burden of their share falls on those who are honest and tax compliant.” This is a clear reference to, and justification for, the demonetization program. In order to ease these burdens, and no doubt restore some of the good will recently lost as a result, the new budget will “cut taxes for poorer Indians and small companies and invest nearly $60 billion in infrastructure, as it seeks to revive demand and widen the tax net.”
The consequences of Modi’s demonetization have been significant and will continue to be felt for years. I won’t step into the ring with economic, political and other experts to weigh in on the potential short- and long-term benefits and disadvantages of the move. But I admire its boldness (while admitting that admiration comes easy from half a world away, with no bank lines to stand in, no lost wages, etc.) Modi could have chosen other measures to move much of his economy out of the shadows and into the 21st century, but few of them could have forced so many Indians to so quickly open bank accounts and begin moving away from cash payments and cash hoarding.