Amid scenes of panic across India, following PM Modi’s shock decision to withdraw high-value bills in the middle of the sowing and wedding season, Reuters reports the move, aimed at cracking down on the shadow economy, has brought India’s cash economy to a virtual standstill. With over 90% of all transactions done in cash, money flows in and out of the black-and-white system… until now, as Devangshu Datta exclaims, “The system works because everybody believes that those pieces of paper will be accepted by everybody else… This move has shaken that trust.”
Farmers have been left stranded as traders have no cash to pay for their produce, while millions of Indians lined up outside banks and post offices for the ninth day to exchange old banknotes or withdraw rationed money from their accounts.
Many of India’s 260 million farmers have no bank accounts and depend on local money lenders to fund sowing, which means those that have to borrow to sow winter crops like wheat or rapeseed could face debt trouble without a good harvest.
And so India’s government on Thursday announced immediate steps to ease a cash crunch for farmers amid widespread criticism. In the latest in a series of ad hoc steps, Modi allowed farmers to withdraw up to 25,000 rupees ($368) a week against their crop loans to ensure that sowing of winter crops “takes place properly”, a senior finance ministry official said.
But, as Devangshu Datta explains, the demonetisation of Rs 500 and Rs 1,000 currency notes came as a surprise to almost everyone. The details of re-monetisation are still to become entirely clear. What follows is a set of personal opinions of likely outcomes arising from this move to demonetise. Each of those opinions could be entirely wrong but they are all centred on subjects that are worth thinking about.
But, first, some basic statistics.
About 85% of all currency in circulation has just been turned into coupons that can only be exchanged in specific places. These notes can be converted into currency again only with identity proofs (which hundreds of millions don’t have) and the additional hardship of standing in many queues for many hours.
Over half of India’s population doesn’t have any sort of bank account at the moment and about 300 million don’t have basic ID such as Aadhaar either and hence, cannot access the banking system at all. About 130 million Indians have mobile wallets (about 25 million have credit cards) and there are maybe 550 million-600 million debit cards in circulation. So access to cash is very, very important for average Indians.
Liquidity in the economic system will be sucked out for several weeks at the very least, due to the very stringent restrictions on cash withdrawals from ATMs, and bank accounts. Plus there’s the sheer logistics of getting that massive volume of new notes into circulation. In addition there will be a cost to printing and distributing the new notes and taking the old currency out of circulation.
India is a cash economy. Well over 90% of all transactions are done in cash. Most of these transactions are legal, consisting of relatively small amounts, and frequently done by people who don’t make enough money to pay income tax. Your domestic worker pays for her bus ticket. You pay her husband, the plumber, for fixing your flush. The security guard at the bank ATM buys cigarettes.
Money flows in and out of the black-and-white system. The paan-wallah pays the fast-moving consumer goods companies for the cigarettes and chewing gum he sells, and keeps the retail margin. That’s white. He ploughs the surplus cash into buying paan leaves in undocumented transactions: the farmer who grows the paan pays no tax; the trader who sells paan under-reports the transactions. That’s black. The mechanic (who is outside the tax net) receives an (undocumented) tip for changing a flat tyre and buys a metro token (putting cash back into government coffers), or goes to see a movie (paying service tax).
Industries like fashion, retail, interior decoration, furniture, laundry and dry-cleaning services, hospitality, medical services, gems and jewellery, et cetera., are large conduits for these flows. We could call them black and white industries. Construction and real estate are totally built around black and white. Land is always sold with part of the price being paid in cash. The real-estate developer buys in black and white and he sells in black and white. The construction process is also black and white (carrying ghost workers on the construction rolls is one easy way to generate black money for example).
These are the facts.
Slowdown in growth
And now for some estimates and opinions.
By all estimates, the size of the black economy in India is large and the undocumented, informal but legal economy is also large. Estimates range from 20% of official Gross Domestic Product to 40% of official GDP. Many assets are held in the form of real estate and jewellery or assets stashed abroad in bank accounts or real estate, etc. However, political parties and religious bodies tend to hold trunkfuls of physical cash and some cash-intensive businesses also have large floats sitting around.
Now we come to the opinions.
The informal economy will be badly impacted. The non-cash assets will remain but those will be “frozen” for a while in that it will be difficult to convert those assets immediately. Cash assets will need to be laundered in some fashion (maybe by opening religious trusts and trustees “donating” notes to the trust, etc.) and will probably incur massive discounts in conversion. There will be blackmarket conversions to hard currencies and bullion, with rupee notes being accepted at massive discounts (anecdotal conversations suggest that the United States dollar is now trading at 15% premium to the Reserve Bank of India rate).
All the black and white and cash-intensive industries will be impacted for a while by the liquidity freeze. So will other industries with high cash turnovers (such as roadside vegetable sellers). This will show up in serious economic under-performance and in a slowdown in GDP growth.
The slowdown in GDP growth will not be completely captured in official statistics but there will be signs for sure in terms of consumption falling. Since consumption contributes much more than investment to India’s GDP growth, it will certainly hurt. Almost certainly, GDP growth estimates will be revised downwards (even if the government is reluctant to do so).
Who will it hurt?
This move will certainly hurt cash-intensive political parties, which have undeclared trunkfuls of cash. in fact, the conspiracy theorists will assume that this move is largely driven by tactical considerations about funding the upcoming assembly elections in Punjab, Gujarat and above all, Uttar Pradesh.
Political parties can now accept donations from abroad and the Bharatiya Janata Party has an obvious advantage, given its major outreach to non resident Indians. So the BJP could produce money from abroad which it can convert into rupees. The BJP is also aided by its links to a non-governmental organisation, the Rashtriya Swayamsevak Sangh, which can campaign on its behalf, with the tab for that campaigning not picked up by the BJP.
The move to demonetise will hurt the very rich in absolute terms but it will mean marginal damage to their assets. It will impact the middle class in terms of inconvenience for several months. It will gut the very poor and the lower income groups. These are people with little in the way of ID proof and they often keep cash stashed under the bed because they have no bank accounts.
Your domestic worker, whose ID (if she has one) says she lives in a village a 1000 km away. Your driver, who saves a chunk of his salary and sends it home to his family. The disabled flower seller/beggar at the traffic lights. The 12-year-old selling pirated books who ran away from an abusive home. The waiter-cum-delivery boy at the local dhaba. The massage parlour therapist. These are the people who will get really badly hurt. They all have high proportions of their income stashed in cash and they will have to pay large sums under the table to legitimise it.
What next?
The long-term impact of this move might be hard to assess. Once cash liquidity comes back to the economy, will there be reforms in the actual way that black and white business work? Or will people simply find new ways to game the system? I am cynical enough to suspect the latter will happen. It happened in 1978 when the Janata Party demonetised. While the Indian economy has changed considerably since 1978, Indians have also developed a global reputation for ingenuity and jugaad in the last 40 years. A lot of very smart people now have skin in the game when it comes to gaming the demonetisation.
There could be two types of political backlash as a result of this move. The rich trader class may move away from the BJP because many stand to lose large sums in absolute terms, and their assets will be frozen for a while. The second backlash will come in terms of voteshare shift from lower income groups, who will lose a large proportion of their savings and spend large quantities of time trying to convert hard-earned cash.
There are a couple of other points to ponder. The Income Tax and Excise Departments’ ability to gather data will increase exponentially. So will their discretionary powers, when they can query people who pay large sums in cash into their accounts. This might lead to an exponential rise in demands for under-the-table payoffs to officials in those departments in the next year. Also, India has no Privacy or Data Protection Laws. That data could be sold to all sorts of people and I cannot begin to guess what the consequences could be. Let us see.
A final philosophical point. Our entire monetary system depends on trust. A banknote is a piece of paper that says the RBI will give the bearer another similar piece of paper, or make an entry in an electronic ledger for that amount. The system works because everybody believes that those pieces of paper will be accepted by everybody else and therefore, money serves as an useful medium of exchange. This move has shaken that trust.
Davy on Fri, 18th Nov 2016 6:12 am
“Euro In Historic Slide As Dollar Surge, Bond Rout Continues”
http://tinyurl.com/h6noxsp
“As a result of Yellen’s hawkishness, overnight the dollar DXY index rose as high as 101.43, a new 13 year high, sending the offshore Yuan to record lows above 6.90, and unleashing a Yen selling frenzy, before moderating some of its gains after the European open. The Bloomberg Dollar Spot Index climbed 0.4 percent to trade at its highest level since February. The yen retreated 0.4 percent. “Right now it is a dollar-dominated story,” Philip Borkin, a senior economist in Auckland at ANZ Bank New Zealand Ltd., said in a client note.”
“But beyond a Fed rate hike next month, many questions remain over the path of policy going forward – for both fiscal and monetary.”
“Away from the frenzied dollar rally and the equity reflation trade, the biggest concern remained global bonds and at what point will the rising yields put a damper on the risk-on euphoria. As noted earlier, the bond selloff deepened Friday, with yields on U.S., European and Asia-Pacific sovereign debt increasing. The Bloomberg Barclays Global Aggregate Index fell 4 percent from Friday Nov. 4 through Thursday. It’s the biggest two-week rout in the data, which go back to 1990. Yields on Australia’s 10-year notes jumped 15 basis points to 2.72 percent. Yields on similar-maturity Italian debt rose 9 basis points, while those on Treasuries increased two basis points to 2.33 percent, extending the eight basis-point jump last session.”
“At some point very soon, the financial tightening as a result of surging yields and USD will become self-defeating and lead to a revulsion from risk assets, however for now the markets continue to ignore this flashing red warning.”
Davy on Fri, 18th Nov 2016 6:16 am
Deglobalization VW style!
“Volkswagen To Cut 30,000 Jobs, 5% Of Workforce”
http://tinyurl.com/h8ncgmp
“There was also some bad news for Tesla. In a concession to workers, Bloomberg notes that the manufacturer agreed to build two electric cars at German sites, one in Wolfsburg and one in Zwickau. The company will add as many as 9,000 positions for future-oriented projects such as electric vehicles and digital features. The state of Lower Saxony, where Volkswagen is based, will become a technology hub for the manufacturer, and many of the 1,000 jobs to be created there will be for software engineers and cloud-technology experts. Electric motors will be built in Kassel, and VW will start battery cell production and development in Salzgitter. Volkswagen will also build battery packs for electric and hybrid cars at its plant in Braunschweig, the company said.”
Revi on Fri, 18th Nov 2016 8:01 am
Nice example to everyone else in the world economy! Let’s see what will happen? What’s the worst thing that could happen?
Shortend on Fri, 18th Nov 2016 8:04 am
The poor will get hurt worse….
The rich will get a bump up….
Coming to America…
paulo1 on Fri, 18th Nov 2016 9:20 am
Time for pitchforks and the harassment of Federal SENIOR employees at their homes and in public.
The manipulators of our lives have to be afraid of certain ‘no cross’ lines. A cash ban is one of them.
brough on Fri, 18th Nov 2016 9:59 am
Sad but true, the poor in India are use to politicians making wide sweeping changes that makes thier lives more difficult. Whats a couple more million farmers forced off the land to go and live in India’s ever increasing urban slums. Whats more interesting is Davy’s summary of global finance and currency fluctuations and also news from Germany. Question I need to ask. following news from VW. Have we reached peak global ICE manufacture ?
Interested in anyone who has hard data. Many thanks Davy for opening a whole new ‘can of worms’.
Ghung on Fri, 18th Nov 2016 10:21 am
Playing the Devil’s advocate here, India had to do something. Less than 2% of Indians pay income taxes and many of those are higher-income people who do large transactions in cash to avoid said taxes. Hard to run a country that size without a reasonable tax base. As always, it’s the poor that get screwed, either way, and the poor can’t afford to be corrupt (or not) in the sense that the wealthier can. Corruption at mid-to-high levels in India is fairly complete. Anyway, I get calls almost every day from Indians trying to steal my money (Windows technical support? Anyone?) I doubt it’s the dirt-poor running those scams.
Not sure how you change a culture where that level of corruption is the norm, but getting control of the currency is a necessary start. Me? I think India is toast as overshoot saturates world economies,, but what do I know?
As for Davy’s post, re: VW and EVs; VW has made it clear that they are going into the EV market in a big way:
VW’s new electric car will cost less, and go farther than, Tesla’s Model 3
onlooker on Fri, 18th Nov 2016 11:19 am
This occurrence in India can provide a rehearsal for how things will develop in other rich Western countries. The Debt situation is becoming untenable as overinflated asset prices and vast overflowing liquidity is setting the stage for a super duper Stagflation period. Not to mention the wobbling Oil Industry. Under these collapse pressures do not expect any more credit to be offered but rather a hunkering down of Economies to attempt to increase domestic production and stimulate employment. It will not work but in provides a glimpse into an opposite effect to the situation in India in which cash and even barter economies will spring up in response to all these economic disturbances.
Seems thus that India is reading the wrong tea leaves.
Outcast_Searcher on Fri, 18th Nov 2016 1:11 pm
Frequent result of government who is “here to help”.
From a “surprise the black market economy” and “hit the rich guys hiding cash, not paying taxes”, etc., it’s brilliant.
From the perspective of dealing with the little guy, assuming the article (and I’ve seen others with similar messages) is accurate, it’s a disaster.
For one thing, given how hard it will be for the rich bad guys to usefully spend suitcases full of banned cash, they should call this off. Then they should do it again with better planning, and ensuring the new bills are widely available.
All they have to do is track large sums being exchanged, and it will be very hard for the bad guys to do that. And that’s what’s purported by the government to be the whole purpose.
But like the failed “war on poverty”, the ACA, etc. in the US, getting government to admit to mistakes, much less fix them — is often impossible.
HARM on Fri, 18th Nov 2016 2:21 pm
“Less than 2% of Indians pay income taxes and”
Kind of like how only a small % of Fortune 500 companies in the U.S. now pay any corporate income tax –despite reaping $Billions in profits every year. We are hardly the ones to point the finger in that regard.
makati1 on Fri, 18th Nov 2016 5:49 pm
Just another country the banksters are trying to switch to plastic electronic money they can control. All kinds of ‘reasons’ but the underlying one is total control of ALL resources, especially your money.
Worth watching, or at least listening to, this video if you do not agree:
https://www.youtube.com/watch?v=J8oLMS11Ht4
onlooker on Fri, 18th Nov 2016 6:10 pm
I was wondering if any of you credit card holders have the new chip cards. Supposedly its for added security, I suspect its another way to monitor and gather info of people
makati1 on Fri, 18th Nov 2016 7:18 pm
onlooker, almost all cards have them. My bank made me get new cards when the ‘requirement’ went into effect. My old card no longer worked. And it is in ALL Credit or Debit cards, (I.D.s etc.) or soon will be.
Yep, easier for them to track your life now. Eliminate cash and they have total control of your life. “Sorry, your card has been rejected. Please call xxx-xxx-xxxx for more information or come into our office.” LMAO
onlooker on Fri, 18th Nov 2016 7:46 pm
It really is crazy, it seems the TPTB, persist in their quest to establish their new world order even while the very fabric of industrial civilization is being torn apart. Reminds me of the title to a song I have heard King nothing umm Kings of nothing
makati1 on Fri, 18th Nov 2016 9:21 pm
Onlooker, have you considered that these are not ‘mistakes’ but planned crashes? How do they get to their 500 million world population goal if not by doing things that take down the civilization the Westerners know? They think they can save the rest of the world’s resources from the “eaters” if they destroy them soon.
GMO, vaccinations, glyphosphate, etc. by Dow and Monsanto and others, kill far more people than Winchester or Colt or even the M.I.C.. You have to think big. With the world population increasing faster than people were killed in both of the world wars, what do you do? Encourage obesity, drug use, alcohol, abortion, junk food, tobacco use, cocaine, crack, etc. You prevent any cancer cures from reaching even the news. You encourage anything that increases the death rate among the serfs.
A neocon One World Government does NOT need at least 7 billion of us. Bots and a much smaller population of servant/serf/slaves is their ‘civilization’. You have to get outside the box if you want to understand today’s events and into ‘tinfoil hat’ territory.
A plantation ran on a rich family and maybe a hundred slaves. 500 million ‘slaves’ equals about 5 million families in control. How many 1/10%ers are there today? About 5 million? That is a nice gene pool. No serfs allowed. LOL
makati1 on Fri, 18th Nov 2016 9:26 pm
BTW: If anyone wants to see the max result of their neocon plans, read the two SF volumes by Peter F. Hamilton called “Pandora’s Star” and “Judas Unchained” where this corporatocracy encompasses over 400 planets and one dynasty can own a whole planet. Fascinating and even interesting, by a very good author.
onlooker on Fri, 18th Nov 2016 10:51 pm
Yes Mak. Even have it written down on the Georgia Guidestones. Envisioning a population of 500 million. They have their seed vault and fancy bunkers also. Absolutely. But again they waited too long Mak. They are unleashing a fury of devastation and collapsing man made and natural systems that nobody and I mean nobody is assured survival. Just with the climate change is enough. On the main forum a poster Cid Yama has made what I feel is a credible case from his extensive investigations and citations that we have unleashed a mass extinction event with runaway global warming. So, all I can say is I am NOT looking forward to surviving on Earth knowing what Earth will be like in the not too distant future. Grim but Reality and I like you are unflinching analysts of Reality
makati1 on Sat, 19th Nov 2016 12:06 am
Maybe, maybe not, onlooker. We certainly are going to decrease the livable area of the planet, but, not all of it. And, true, you and I will not survive. We don’t have the resources (money) to prepare thoroughly. Some do. What can $1 billion buy today? 2,500 billionaires can afford a refuge you and I can only dream about. Or even $1 million well spent can provide a lot of refuge.
“According to the Credit Suisse global wealth data report of 2015, Egypt has 23,000 millionaires in comparison to 12,000 in Morocco, 35,000 in Qatar, 60,000 in UAE, 70,000 in Turkey, 85,000 in Israel, 180,000 in India, 350,000 in Spain, 1 million in each of China and Italy, 1.5 million in Germany, 2 million in the UK, and 15 million in the US, which ranks at the top of the list.”
How many will survive? I would say that, if anyone survives, it will be mostly those be$t prepared. It will not be you or I. LOL
Ghung on Sat, 19th Nov 2016 8:28 am
Harm said; “Kind of like how only a small % of Fortune 500 companies in the U.S. now pay any corporate income tax –despite reaping $Billions in profits every year. We are hardly the ones to point the finger in that regard.”
Not pointing fingers, Harm, or even being critical. Just pointing out India’s deeply systemic and cultural predicament that they are trying to deal with. Has nothing at all to do with the problems in the US.