Recall that in May, we wrote about the European Central Bank (ECB) putting the kibosh on high-denomination cash, specifically the 500-euro note.
The reasoning behind that move was ostensibly to limit the so-called “Bin Laden bank note,” as the 500-euro note is known to be used to finance terrorist and other criminal activities.
In India, the Nov. 8 surprise decision to quickly scrap the 500 and 1,000 rupee note by declaring the bills no longer legal tender is a step that’s also being taken with the ostensible reason of cracking down on corruption and illegal cash holdings, known in the country as “black money.”
According to the Indian government, the move represents an attempt to curb tax evasion so that the government can bring the billions of dollars of unaccounted cash into the official economic accounting.
So, what’s the problem with the government wanting a full accounting of the actual commerce conducted by the Indian people?
Well, in theory there isn’t anything wrong with it, and I understand the need for a full accounting. However, the way Prime Minister Narendra Modi made the move has caused chaos in one of the world’s fastest growing economies.
The shockwaves for the Indian economy began with the Nov. 8 announcement from Modi that the nation would have just four hours’ notice — that’s right, four hours — to deal with the proclamation that the current outstanding 500 and 1,000 rupee notes would no longer be legal.
The reason this was such a shock is that these bills make up an estimated 80% of the currency in circulation. Moreover, India is predominantly a cash economy, as an estimated 90% of all business transactions in the country are in cash.
According to a story in the BBC:
People were told they could deposit or change their old notes in banks until 30 December and new 500 and 2,000 rupee notes would be issued.
Until 24 November Indians will also be able to change a small sum of old cash into legal tender as long as they produce ID. This amount was reduced from a total of 4,500 rupees to 2,000 rupees on 17 November. Anything above this needs to be credited to a bank account.
As you might imagine, the surprise declaration from the Modi government was met with shock, disbelief and a sense of fear and dread.
The multiple accounts I’ve read of the reaction by Indian citizens confirms that, but to confirm it for yourself all you need do is imagine if the cash you had in your safe, or safe deposit box, was suddenly declared illegal.
It doesn’t take a novelist’s imagination to plug into the sense of dread that accompanies this condition.
The result was a run on banks, as people went to ATMs to withdraw cash and exchange their old bank notes.
Per the BBC story:
The queues are long and people are short of cash — even buying daily essentials like milk and bread has become difficult. Police have had to be called in at some banks and ATMs to calm tempers.
If you’re a country proud of your recent pro-capitalist reforms, as India rightly is, then this move isn’t very comforting. It also represents a rash move that will undoubtedly stunt at least the short-term economic uptrend.
According to an article at CNNMoney.com,
Analysts estimate India’s shock decision to scrap its 500 rupee and 1,000 rupee notes — accounting for about 86% of cash in circulation — will shave at least 1% (and possibly much more) off India’s current GDP growth rate of 7.1%.
If that decline does take place, it will push India’s growth below that of rival China.
One recent victim of India’s war on cash is Indian stocks.
The chart here of the PowerShares India Portfolio (NYSE:PIN), the benchmark exchange-traded fund holding the top Indian stocks, shows the big plunge since the Nov. 8 announcement.
Shares of PIN are down nearly 6% from their Nov. 7 close, and the decline has sent the ETF below support at the 200-day moving average. And though shares have come back off their lows of the month, the immediate damage to Indian equity values — and shareholder portfolios — has certainly been done.
The moral of the story here for U.S. investors is to be aware that investing in emerging markets such as India, China, etc. often comes with political, social and central bank policy shocks that you usually won’t see when investing in mature markets.
While one can make a lot of money in emerging markets when conditions are right, you have to know going in that your money is susceptible to impulsive government proclamations.
Now, it may turn out that the move by Modi to essentially ban the current 500 and 1,000 rupee notes will be a long-term positive for the economy, and for the companies held in PIN. If so, then the move may turn out to be a long-term positive for those with Indian equity exposure.
Yet for now, Indian citizens are feeling the pain of fiat monetary policy decisions … and that’s something I hope their growing economy can work through quickly.
This article is brought to you courtesy of Uncommon Wisdom Daily.