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.
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