I was in India last week and the hot topic is the demonetisation of Rs. 500 and Rs. 1000 notes.  This is a (very) big deal, is dominating the discourse in India, attracting press coverage around the globe and is generating a fair amount of angst.  While I managed to survive a whole week in India just by using cards (it can be done!), I realise that most people don’t stay in hotels and take cabs that accept cards.

So why all the fuss and what is all this about?

India last week, overnight, removed Rs. 500 and Rs. 1000 notes from being valid currency.  People have until the December 30 end of this year to deposit these notes in their banks.  In parallel, new notes will be introduced, starting with a Rs. 2000 note.  Deposits over Rs. 250,000 are taxable, with material financial penalties applied.

So, in practical terms, what does this all result in?

  • Constant long queues outside ATMs (there are daily limits on what can be withdrawn per person) and ATMs regularly running out of cash (largely due to machines only issuing Rs. 100 notes since they need to be re-calibrated to accept the new notes).
  • Constant long queues in banks
  • The inability for people to pay for things and / or receive monies.  This is particularly hitting those on lower incomes who rely on small change transactions
  • The inevitable political wrangling from making the change

The banks are doing everything they can but it’s fair to say that the scale of the challenge is immense.

So why bother inflicting such a change?  What is the upside?

Ultimately this is about a major attack on the black money economy.  India has long operated with a very material black economy which Prime Minister Modi is attempting to dismantle.  He has made some very vocal remarks to expect further change over the coming months and is selling the longer term vision to the population as being short term pain for longer term gain.

Given the scale of the cash economy (most was largely held in Rs. 500 and Rs. 1000 notes), this should result in a massive injection of cash into the banking sector which should have a very beneficial effect; ultimately reducing interest rates (although the ability to do this will somewhat depend on the impact on inflation), increasing the capacity of the banks to lend and improve the portion of non-performing assets for the banks.

Additionally, the government expects to see a shot in the arm in terms of tax revenues both through tax and penalties on monies deposited but also via indirect tax revenue (service tax and VAT) as cash is booked as revenues by businesses who hadn’t previously been declaring the revenue.  With an increase in cash in the economy, ongoing tax receipts should increase as well.

On the flipside, where are the pain points?

It is hoped that those materially operating in the black economy feel greatest levels of pain.  However, there are many who are not who are going to have to go through a period of discomfort.  For example:

  • While the e-payment infrastructure exists, it is not yet pervasive.  As such, for some time to come, people will require cash.  With daily withdrawal limits and a lack of available cash, it will take some time for the cash availability to re-balance.  This is going to be particularly challenging for those in rural locations.  Essentially the entire population is impacted here.
  • Shops / restaurants / small businesses – in the short term many have had to close until they have adequate small denomination cash and / or electronic payment facilities
  • Those who do not have bank accounts – unfortunately this is typically applies to those low earners in society who will now have to go through a process to have an account set-up and get used to receiving and spending monies electronically.  This is going to keep the banks busy.

Any sectors particularly affected?

The effect of this change will be felt in many sectors. One example is in real estate.  Buying a house in India has involved, as a common practice, part cash and part cheque / transfer meaning that part of the payment has essentially been undeclared.  Changing this practice is clearly welcome but there will surely be a ripple effect on the market with price adjustments likely.

And then there are discretionary purchases which are typically made with cash; luxury items, some retail transactions and cash on delivery e-commerce transactions.  For some time, these will experience reduced levels of demand.

So, overall thoughts?

While the politicians engage in the usual theatre of debate on television, Narendra Modi continues to bang the drum against corruption.  There is clearly some very real pain on the streets of India and I imagine there will be both negative and positive unintended consequences that will play out.  However, certainly based on what I saw, people are queuing in an orderly manner and for the most part are accepting of the big picture reasons for doing this.  Credit to the Prime Minister in showing brave leadership and credit to the people of India for digesting this in the way they are.  I only hope that this spirit is maintained through the coming weeks while things settle down.

One final thought.  The other big bang reform expected from India is just around the corner and was expected to be finalised in the latest session of parliament (which started this week); the introduction of a single goods and services (GST) tax.  Will this change delay those plans?  It is hard to see how this is going to get the air time that was planned; I remain hopeful as its important that momentum is maintained on this big bang change.

Whatever your politics, no-one can now accuse the Prime Minister of not implementing large scale change!

The article is written by Edward Dixon, Group COO & Managing Director.

At Sannam S4 we see both these major initiatives (and others) as driving material improvements in the ease of doing business which we believe can only be positive for the country and for foreign organisations looking to work with and in India.

Sannam S4 – International Market Entry, Expansion & Compliance

© 2008-2021 Sannam S4 | Sitemap | Privacy Notice