India's Bold Demonetization Policy: A Primer

Last week, Indian Prime Minister Narendra Modi executed what will definitively be considered one of the most noteworthy and indelible policies of his regime. Citing measures to combat the proliferation of illicit/untaxed money, corruption, and the funding of terrorism, the government announced the demonetization of all Rs. 500 and Rs. 1000 notes currently in circulation, effective immediately.

A closer examination illustrates the tangible effects and impacts of this bold strategy.

Corruption

The measures were originally touted as a means to combat corruption, as the Indian elite have a notorious history of stashing their wealth in cash. As the Rs. 500 and Rs. 1000 denominations account for nearly Rs. 14.18 lakh crore (approximately USD $210,000,000,000) of the current bank notes in circulation in the Indian market, the ban was introduced as a surprise measure in order to prevent hoarders from quickly dumping their cash assets into usable instruments. Moreover, the government has issued strict daily and weekly conversion limits before the year-end deadline, effectively preventing large stockpiles of illegal cash from being redeemed and rendering the billions of unaccounted notes valueless.

This new initiative will not only nullify any unaccounted for or untaxed hoards collected by businesses or individuals, but will also place an imposition on politicians that are employing illegal cash sources to promote personal political agendas. Unfortunately, however, the measures do not extend far enough to abolish the questionable foreign holdings of many politicians.

Peripheral Effects

As for the masses, life has yet to normalize. Millions of people are rushing to ATMs and local banks in order to exchange their now void bills for newly issued currency. As a hyper cash-dependent economy, a majority of the countrys population was swiped of its purchasing power overnight, following the surprise announcement. In congruence with the governments warning that the transition to the new currency would render a temporary inconvenience to the public, the distress of not being able to execute their day-to-day purchases and activities still plagues many Indians.

Especially hard hit includes those who depend on cash for daily sustenance. Thousands of tragic accounts have emerged in the last week, ranging from struggling migrant workers who work in cash-only positions scrambling to purchase food, to desperate hospital patients that have been denied service or have had to arrange onerous alternative measures due to lack of usable cash.

Other savvy Indians have scrambled to unorthodox sources to get rid of their old cash, enervated by long waiting lines and dysfunctional bank service. Many have turned to hard assets such as gold, dumping their old cash notes in exchange for the invaluable bullion. Jewelers, in exchange, are marking up gold prices and selling at a remarkable premium, while still being watchful of recent government raids aimed at ensuring that proper receipts and sales protocols are being followed.

Finally, Indian real estate markets are also expected to take a temporary hit. Traditionally a safe haven for proscribed cash sources, housing developers who have amassed significant stockpiles of cash from years of profitable illicit transactions will likely find themselves in a bind to continue to fund and deliver promised projects, let alone be able to develop on recently acquired and empty lands. Nonetheless, as the real estate market trend has slowly started to transition to a Western-style mortgage system for many commercial, large scale real estate projects in the past decade, the hope is that this temporary setback in the market will only help weed out the corrupt proprietors, and ultimately embolden the legitimate market players.

Other noteworthy effects on the Indian economy and people, which will continue to emerge in the coming fiscal quarter, will have to be similarly analyzed and tackled to determine the ultimate efficacy of Modis new policies. Yet to be seen are the long term effects for non-resident Indians (NRIs), many of whom likely have legitimate cash assets abroad, and may not be able convert prior to the year-end deadlines. Additionally, it will be intriguing to determine what steps the government will take to further cultivate its anti-corruption agenda, specifically regarding well known assets which many prominent politicians hold abroad . Ultimately, though a bitter pill to swallow, the demonetization scheme serves to fulfill a longtime agenda of New Delhi: to promulgate a transparent transaction economy.