In India, is it “creative destruction” or economic growth v/s morality + financial security?

India’s government suddenly declared all 500 and 1,000 rupee notes worthless earlier this month, intentionally sapping its enviable economic growth for who knows how long. The country of 1.25 billion people happens to be a largely cash economy. Prime Minister Narendra Modi made the surprise currency announcement ostensibly to stop corruption, counterfeiting and black market commerce, all crimes that leaned heavily on the larger bills. Those bills were 86% of the cash in circulation.

No other country has taken this kind of step so suddenly, making it hard to predict the fallout in India. But analysts forecast a harsh shock wave throughout a fast-growing but still hesitant economy where investment bank BNP Paribas estimates that 90% of transactions are made in cash. The country’s GDP, which grew at a brisk 7.6% in the latest fiscal year, is on track to take a hit as consumption declines along with government revenues.

 These changes will probably last several months as Indians trade old notes, worth about $7.5 and $15, for new ones. “Households and businesses will experience liquidity shortages, which will result in temporarily weaker consumption,” says William Foster, Vice President-Senior Credit Officer at Moody’s. “For corporates, decline in economic activity will lower sales volumes and cash flows. Foreign trade could be disrupted temporarily if business operations rely heavily on cash.”
 Removal of the bills would also weaken real estate, one of India’s boom industries. Currency in the black market could take “years” to replenish, hurting property, land transaction volumes and prices, Credit Suisse says in a Nov. 15 research note. That pain will extend to 80% of construction jobs, 60% of cement demand and discretionary consumption, the note says.
A setback in economic growth would particularly hit the poor. India has the world’s highest number of poor for a single country, around a third of the population per a 2015 estimate. Economic growth since the 1980s, fueled largely by foreign investment and industry, has eased poverty by adding jobs and raising incomes in the absence of any strong governmental push to solve the problem. India has a chance at economic stabilization after what Credit Suisse calls a “winter” of coping with the removal of bank notes. And that’s the government’s real long-term cause: a not-so-cash-dependent economy with a bigger role for banks, credit cards and tax collection.

Common people will eventually exchange old bills for new ones being minted by the central bank. The prime minister’s ban on bills Nov. 8 took effect immediately. Exchanges of bills already explain a quick rise of bank deposits. Those deposits should ultimately grow for normal reasons, economists expect. BNP Paribas forecasts a “durable increase” of 2-3 trillion rupees in deposits. More money in savings would offset borrowing costs and let banks cut the costs of funds, the investment bank says in a Nov. 24 research note.

More people are likely to open bank accounts, which are used by just 60% of Indians now. Growth in new accounts would stoke gains in digital payments and make tax collection easier by creating a paper record of transactions.

“While this (currency move) undoubtedly means some short-term pain for growth in cash-intensive sectors such as real estate, construction and discretionary household consumption in general, we believe this monetary ‘creative destruction’ also bears the potential to propel India from its traditional cash-intensive economy into a more modern one with a reduced parallel sector,” BNP Paribas says.

Author: Ralph Jennings

Credits Forbes

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