“The End Has Corrupted The Means”
The banning the use of old high-denomination banknotes (INR500 and INR1000) announced by India’s Prime Minister Modi on November 8 is likely to have only a short-term impact on corruption and black money (two driving factors behind the move) unless it is followed by “multiple other moves aimed at curbing these issues,” market analysts say. In the short-term, disruption of the economy.
“We do expect short-term disruption to the economy, especially in rural areas, due to a sharp drop in consumption as the cash crunch hits,” Kunal Kumar Kundu, India economist with investment bank Societe General wrote in a note to clients on November 18. “The extent of the disruption will depend on how soon new banknotes come into the system”. Should this materialize as promised by the government)=, the damage should be limited. “Otherwise, the disruption could be prolonged,” Kundu said.
The possibility still remains of a short-term increase in tax revenue collection within India, which could enable the government to keep its deficit within target as well as continue with all its desired expenditure (including capex). This, says Kundu, raided worries that the initiative “may have to be curtailed as deficit challenges manifested.”. In the interim, he says, sectors that are and remain heavily dependent on cash transactions (essentially because these are gateways to parking black income), including construction, real estate and jewelry are likely to be adversely affected over the short- term.
Consumption, Inflation Still A Factor
On the macro front, weaker consumption could mean lower inflation which would lead to an opening of a possibility of an earlier rate cut by the Reserve Bank of India. RBI. And now, with citizens being forced to deposit large quantities of high-value notes, banks are seeing a surge in low-cost deposits which should lower cost of funds, leading to and and resulting in “faster transmission of monetary policy action through the interest rate channel”. However, given the current weak credit environment, “we see a spike in credit growth as unlikely,” Kundu said.
One only potential long-term effect of PM Modi’s move could be deterioration in India’s current account deficit (CAD), as people will now be more inclined to park their “black” income in gold rather than in currency. This will then begin to trigger a sharp rise in gold imports.
India’s fight against black money – “the end has corrupted the means,” says Kundu.
This is the third in series of reporting on India and its move to demonetize.