India rebounds from cash crunch
Hiding on a bus from the unrelenting 42°C heat, a young Gujarati man, Vaughji Desai, tells me with great fervour and in great detail about the day it happened. The shock announcement by Indian prime minister Narendra Modi was on the same day that the world reeled from the news that Donald Trump was elected president of the United States.
I have come to India to attend the African Development Bank’s annual meetings, but I can’t resist asking about the effect of a recent and major economic event – demonetisation.
“Modi declared it at 8pm on 8 November 2016. At that time, all the Indian people had started eating dinner at their houses. No one could believe 500 rupee [about R100] and 1 000 rupee notes were not legal tender from that night at 12pm.
“At that time, the Indian people started running everywhere to purchase something with those 500 and 100 rupees.”
Desai was not alarmed because, unlike many Indians, he had a bank account. He also took comfort in knowing he had two months in which to change his old notes at the bank.
But not everyone was reassured by this. He recalls how he visited several parlours that evening as part of his job. “All the people were coming in and giving shopkeepers 500 and 100 rupees and taking things for just 10 or 20 rupees.”
Demonetisation, as the Indian government called it, is not new. Around the world, and from time to time, central banks withdraw particular notes or coins from circulation, which they then no longer recognise as legal tender, and replace them with new ones.
India has carried out demonetisation before, in 1946 and 1978, although the total value of the notes demonetised was fairly small and so the effect was limited. But this time around the 500 and 1 000 rupee notes accounted for 86% of the total value of notes in circulation.
A shortage of new notes became an instant problem, Desai says. “For the first seven days, there was a shortage of money. At all the banks and ATMs, there was no money. There were long, long queues in front of banks.”
Another young man, Serket Thakal, adds: “We couldn’t even purchase something like this water,” he says, pointing at the 125ml bottle of mineral water in his hand.
India is unusually cash-dependent. Its cash to gross domestic product (GDP) ratio before December 8 was 12% – much higher than an average of 4% for other emerging markets, according to Nomura global markets research.
Sonal Varma, a research analyst for Nomura’s Asia economics, says consumption and services were worst hit initially because of their higher dependence on cash.
Even now, leafing through Indian newspapers, I read articles about a number of areas that were badly affected by demonetisation. The Bollywood film industry was one. The Indian shoe manufacturer Bata posted disappointing results because of decreased sales.
India’s agriculture was also hit, with some media reporting how some small farmers had to dispose of truckloads of produce because people didn’t have money to buy the goods they were selling.
On Thursday last week, GDP data showed India’s economic growth had slowed to 6.1% in the first quarter of 2017, compared with 7% in the fourth quarter of 2016.
On the supply side, the cash shortage led to a contraction in the growth of the construction, manufacturing and private services sectors, and on the demand side it resulted in a contraction in fixed investment growth and private consumption, Varma says.
Despite an “absence of planning” on the government’s part, Desai, like many other Indians, supports demonetisation and its aim to eradicate “black money”, often in the form of fake 500 and 1 000 rupee notes.
“The government’s decision was motivated by the need to eliminate the black economy and curb the financing of terrorism through fake currency notes,” Varma says.
India’s shadow economy is particularly large – estimated at about 23% of GDP.
“The shadow economy is the market-based production of goods and services, whether legal or illegal, that escapes detection in the official estimates of GDP,” Varma says. “Hence this encompasses any income on which government taxes have not been paid.”
Based on the 1978 experience, Varma says it was estimated about 20% of the notes would not be tendered, resulting in wealth destruction of about 1.9% of GDP. But, in January, an estimated 97% of demonetised notes had been returned, amounting to wealth destruction of 0.3% of GDP.
Demonetisation was bound to cause short-term disruptions but the long-term benefit will be that the formalisation of the Indian economy will be accelerated, he says.
Varma expects the economy to bounce back quickly and he forecasts 7.5% GDP growth in the second half of the year.
As I navigate my way around the thronging city of Ahmedabad, the Indian economy seems to be very much alive. Green-and-yellow tuk-tuks frantically buzz around, dodging the free-ranging cows, the streets hum with people selling their wares and the ATMs spit out cash.
Demonetisation has also been used as an anchor to establish a more digital economy, Varma says.
Mobile payments are becoming more popular and Paytm, India’s largest mobile money company, has seen its user base grow to 225-million, thanks to a substantial boost from demonetisation. And transactions through United Payments Interface, another widely used mobile payments system, have grown more than 20 times.