My Money Is Broken!

January 19, 2017

Broken Piggy Bannk

Imagine waking up one day to find that most of your money is about to become worthless.  This past November, Indian Prime Minister Narendra Modi surprised many people by declaring that India’s 500- and 1,000-rupee notes would become worthless.  These notes represented 86% of the country’s currency and was to be removed from circulation and made illegal.  He gave Indian citizens until December 30th to swap the old notes for new versions.

The purpose of the move was to curb the untaxed black market.  Since about 90% of the country’s transactions involve cash, there was a large market for fake currency, and that’s why Modi took the bills out of circulation. 

Our Analyst, James Mantosh, recently spent two weeks in India.  I’ve asked him to give us some insight into the effects of the currency move and the realities for Indians.

How has the day-to-day transaction experience changed since you were last there?

Since my last visit to India about three years ago, the biggest change that I witnessed is the fact that people are using their credit and debit cards more frequently. After speaking to a few people, I learned that the transition to digital currency was only recent and a result of the demonetization (removing the 500- and 1,000-rupee notes as legal tender).

What real-life impact did the currency swap cause?

I was in India approximately two months after the initial announcement, so quite a bit of the dust had settled. However, in speaking to members of my family and others, I did learn of the turmoil that the country faced. Long lines at banks, ATMs being taken out of service (because the new notes are smaller than the old ones and ATMs needed to be configured as such), and some companies even missing payroll deadlines are just some of the issues that the people of India had to face.

What did your acquaintances say about the currency change?

I met people from two camps; a group who felt that the change was necessary and a group who felt that the surprise decision was antidemocratic.

The group who said that the change was good believe that it will put an end to the black money in circulation and also aid in tax collection. The group who are against the move are not necessarily unhappy with the decision itself but with how the decision was made. This group is unhappy because the decision was made swiftly and unilaterally by the current administration which, they claim, is something done only in a dictatorship, not a democracy.    

What do you see as the short- and long-term consequences of the currency change?

In the short-term, there will be some negative impacts and some positive ones. The economy as a whole is heavily dependent on cash and most Indians don’t like to use credit and debit cards. This will translate into a lot of delays and frustration for Indians; that’s the negative. On the positive side, the sudden demonetization should prove to be somewhat of an economic stimulus as a contraction in the money supply will lead to lower interest rates and lower inflation.

In the long-term I believe that the intended benefits of the decision will come to fruition. These include increased tax revenue, the move to digital currency, and less black money.

How is the Indian economy doing currently?

As Asia’s third largest economy, India is growing fast. From the constant construction to the growing middle class, evidence of growth can be found everywhere you look in India. While the Indian stock market did fall immediately following the announcement of demonetization, it did recover during the last few days of my visit as market participants began noticing the country coming out of this crisis period. In terms of numbers, the Indian economy is growing like clockwork with annual growth averaging between 7% and 8%.

Is inflation a reality, and how does that affect daily living?

While still a reality, inflation in India has eased quite a bit over the past few years. With an average rate of 7% over the past five years, a lot of the inflationary pressures have subsided only after the demonetization.

What other insights can you give us into Indian living?

India is the textbook definition of an Emerging Market where the rich are very rich, the poor are very poor, and economic progress is being achieved at the cost of the environment. While the country is moving forward steadily, Indians still have to deal with things like over-population, pollution, high taxes, and extreme amounts of red-tape. Nonetheless, the country is becoming more and more globalized and I can see the progress every time I go back.

Lance Gunkel, CFP®, CFA
Chief Investment Officer