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India Reels Under Modi's Rupee Whiplash

Forbes logo Forbes 25-11-2016 Naazneen Karmali, Forbes Staff

© Cashless in India (Photo credit:SAJJAD HUSSAIN/AFP/Getty Images)

Soon after Indian Prime Minister Narendra Modi announced on Nov. 8 that all Rs. 500 and Rs. 1,000 notes (the equivalent of $7.3 and $14.6) would, in a few hours, turn into “worthless pieces of paper”, Seemaa Makhija’s phone started ringing. The owner and managing director of Travel Voyages, a Mumbai travel firm, was swamped with calls from clients who wanted to cancel their bookings, some for departures that very evening. “Overnight our business has halved,” says Makhija, whose firm, part of the Lufthansa City Center network, clocks in annual revenues of $20 million.

While Travel Voyages mostly has corporate clients who pay by check, the cash crunch is posing daily difficulties. Certain foreign consulates accept visa fees in cash only, as does the government’s passport issuing office, Makhija explains. Her staff of 80 has been taking several hours off from work to line up at crowded banks to withdraw money for personal expenses. “How do I run my company?” she asks.

India’s cash crisis, brought on by Modi’s demonetization, which canceled 86% of all banknotes, equivalent to $207 billion, has hit businesses, and indeed all Indians, across the country in varying degrees. One of the world’s fastest-growing economies is now bracing for an inevitable slowdown that by some estimates could cause economic growth to plunge from an estimated 6.8% to 3.5% in the year ending March 2017. More sanguine predictions maintain that the economic disruption will be short-term, causing not more than a 1% decline in GDP.

On its part, the government has admitted that the economy will dip slightly in the next two quarters but get turbocharged again once the benefits of greater liquidity in the banking system kick in. In a recent interview to financial daily The Economic Times, Delhi economist Jean Dreze said that demonetization carries a huge economic risk that could derail India’s growth trajectory: “In a booming economy, blanket demonetization is a little bit like shooting at the tires of a racing car.”

Ajit Ranade, chief economist at Aditya Birla Group, a commodities conglomerate controlled by billionaire Kumar Birla, doesn’t foresee such a dire outcome or any long-term negative impact. “It’s extreme to say that demonetization is like shooting the tires; it’s more like deflating the tire pressure somewhat.” Adi Godrej, chairman of the Godrej Group, says that the economy can recover lost ground if the stock of bank notes is replenished quickly. (So far, only 10% of the banned notes have been replaced.)

The drastic measure to withdraw high-denomination banknotes was part of Modi’s crackdown on counterfeit currency and “black money”—illegal earnings on which tax isn’t paid—that amounts to close to one fourth of GDP. One of the electoral promises made by Modi’s Bharatiya Janata Party (BJP) when it was swept into power in 2014 was to bring back illgotten wealth stashed away overseas. A voluntary-disclosure scheme this year that imposed a 45% tax drew hidden wealth of $10 billion, a paltry amount compared with the $266 billion declared under the first phase of Indonesia’s recent tax-amnesty program.

Rumors of new banknotes had been making the rounds for a while, but demonetization had been ruled out by Raghuram Rajan, the former central bank chief, who stepped down in September. In Rajan’s view, a currency change wouldn’t root out the menace of black money as tax dodgers would find ways around it and might well hold their pile in other forms, such as gold. Therefore Modi’s “surgical strike,” presumably endorsed by Rajan’s replacement, the more pliant Urjit Patel, caught everyone unawares. Curiously, Patel has been invisible and totally silent since November 8.

While Modi was initially lauded for his bold gamble, the currency swap is now being talked about as an ill-judged “carpet-bombing” because of the widespread chaos it unleashed. There were scenes of utter mayhem as banks, which had also been kept in the dark, struggled to cope with the ensuing stampede. Not only was the supply of new rupee refills fallen woefully short of demand but the country’s 200,000 ATMs also had to be reconfigured to accommodate the new notes, which are a different size than the old ones. (Reportedly, around 40% of all ATMs have been fixed to date).

Daily missives from the government about how much money could be exchanged or withdrawn only added to the confusion, underscoring the fact that the logistical and other challenges of such a massive operation had been grossly underestimated. The government recently conceded to a partial rollback for poor, cash-strapped farmers, allowing them to use banned currency of up to $365 to buy seeds for the current winter sowing season.

While private-sector banks, such as HDFC Bank, provided seating arrangements, water and refreshments for their urban customers, with separate queues for older folk, harrowing scenes played out elsewhere, especially in the hinterlands, where bank branches are few and far between. So far more than 60 people have lost their lives in the rupee rush. Modi has pleaded for patience, breaking down in tears in a public address while promising that normalcy would be restored by December 31.

“Demonetization was a clever strategy to flush out illicit funds, but it required flawless planning by a crack team. The government has goofed up in its implementation,” says Kiran Mazumdar-Shaw, chairman and managing director of Biocon. The Bangalore biopharma firm ensured that its 7,000 staffers faced no hardship by keeping the half dozen ATMs on its plant site stocked with cash and running 24-7. Modi’s predecessor Manmohan Singh, who sits in the Opposition, lashed out at the government for its “monumental mismanagement” of the currency swap.

While Mazumdar-Shaw is forthcoming, much of corporate India is circumspect. A spokesperson from Reliance Industries, controlled by billionaire Mukesh Ambani, declined to offer any comment, saying that the group does not comment on government policy. A billionaire who prefers anonymity says that 90% of Indian businesses are unhappy but no one dares criticize the government for fear of incurring Modi’s wrath or being called unpatriotic.

One sector that isn’t complaining is the providers of mobile payments  who have recorded a boost in usage since November 8. Delhi mobilepay firm Paytm, whose founder, Vijay Shekhar Sharma, is among India’s new crop of billionaires, signed up 5 million users in two weeks and clocked a record 7 million daily transactions on a recent weekend—a number equivalent to all the combined daily transactions involving credit and debit cards.

Paytm has been splurging on full-page newspaper advertisements urging Indians to “become a part of India’s Digital Revolution.” Its newest TV commercial shows a housemaid assuring her harried, cashless employer that she’s willing to accept her salary via Paytm. Economist Ranade believes that demonetization could be the trigger for the cashless economy to take off. But that it is likely to remain an urban phenomenon until the digital infrastructure is built out.

Critics argue that while the currency switch could partially flush out existing stockpiles of black money-the government expects more than $50 billion of old notes not to be returned-to stop the flow requires a multipronged approach such as sweeping reforms to curtail the discretionary powers of government. Former U.S. Treasury Secretary Larry Summers recently expressed doubts that Modi’s currency reform would have lasting benefits: “Corruption will continue albeit with slightly different arrangements.” 

Opposition parties that have led protest marches across the country have alleged that the forced rupee conversion was done with an eye on upcoming regional elections to put cash-strapped rivals of the BJP on the back foot.  Modi on his part has hinted that there are more tough measures in the offing, targeted at uncovering illegal holdings of assets such as land and jewelry. But that will depend on how much political capital he retains once the currency storm settles.

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