Prime Minister Modi’s radical decision to cancel 500 and 1000 INR notes was unprecedented and unexpected. It was designed to stamp out the black economy and in a sop to nationalists was sold as an anti-terrorism measure. No mention was made of the likely impact on political parties who rely on cash donations to grease wheels during election time.
In the short-term the measure has drawn attention to India’s corruption problems and the importance of undisclosed cash payments in all spheres of the economy: 86% of transactions are in cash and much of the paperwork is inaccurate. If successful, the longer term outlook will be beneficial if it leads to a more transparent economy. The challenge will be changing the culture of backhanders and inaccurate invoicing. The question will be if this is just a clearing of the balance and the citizenry will start hoarding the new notes as fast as the old!
Businesses and citizens rely on the stability of the currency to plan for the future. Modi has show himself to be bold, but the question is whether this will worry people about what else he can do in the future. What other tricks does he have up his sleeve and what impact might that have on investment decisions.
Money is a figure of trust – it means nothing if you cannot trust it – simply a piece of paper to light a fire. Indians have discovered that bundles of paper that were designed to tied them over in the future are now worth nothing. What will be the longer-term impact on citizens? Indians already have an obsession with gold and other portable stores of wealth – will that increase in future?