India Industry Say Shock Currency Swap Painful But Necessary

Only those holding huge stashes of untaxed “black money” need worry, Modi said.

But in India, many others are deeply worried. About 80 percent of India’s financial transactions are conducted in cash, often to evade taxes. While some of that activity is illegal, hundreds of millions of rural poor, scrappy entrepreneurs and small-time traders also keep their savings in cash, sometimes just because there is no bank branch nearby.

India’s industry leaders, bankers and market analysts rallied behind Modi’s move, viewing it as a much-needed corrective in a cash-reliant culture that has enabled corruption. Within hours of Modi’s announcement that all 500- and 1,000-rupee notes _ worth about $7.50 and $15 _ would hold no value as of Wednesday, the hashtag “ModiFightsCorruption” began trending on Twitter.In the short term, economic activity is slowing until new notes worth 500 and 2,000 rupees can be printed and put into circulation, analysts said. They also predicted a rush on gold, foreign currency and other forms of wealth.

“The eradication of the black money menace from the Indian economy is a big positive in the long-term, and the Indian economy will be on a very strong footing once the short-term teething problems are done,” said Sachin Shah, fund manager at the Mumbai-based Emkay Global Financial Services. Morgan Stanley hailed the demonetization as a “bold move to curb black money” and bring millions more Indians into the tax regime. As of now, only about 1.6 percent of India’s 1.25 billion people are paying income tax.

The surprise currency swap would “have a debilitating impact on the parallel economy in the country,” said Harshavardhan Neotia, the head of the Federation of Indian Chambers of Commerce and Industry, referring to business conducted using illicit cash. “We appeal to all sections of society to support this initiative,” he said. Not everyone is on board. Will it put an end to black money? Hardly. People with large amounts of black money will convert it into gold and foreign currency,” the newspaper Economic Times said in an editorial Wednesday.

Citigroup warned that scrapping so much currency would spur short-term market volatility, though it said it does “expect longer-term positives for equities.” As expected, Indian stock markets tumbled Wednesday before recovering some ground before closing. It was hard to tell how much came from the Modi currency shock and how much was due in reaction to Donald Trump winning the U.S. presidential election. Former Finance Minister Palaniappan Chidambaram, of the opposition Congress party, warned that poor farmers, workers and small traders would be hit hard. He urged the government to swap in the new bills quickly.

“The government and the banks will be on test on how well they handle the implementation of the decision,” Chidambaram told reporters Wednesday.

But apart from the immensity of Modi’s currency overhaul, the suddenness of it took the country by surprise. Analysts questioned how they could have missed the signs it was coming.

Modi has been seeking to eliminate black money since his 2014 election, launching a government scheme to open bank accounts for all citizens, and granting wealthy Indians a tax amnesty for disclosing undeclared assets and cash holdings. The one-time amnesty raised only around $10 billion _ far less than what the government expected.

Modi said in his televised address Tuesday night that authorities had discovered 1.25 trillion rupees, or about $18.8 billion, in illegal cash over the last two and a half years. The only way to reclaim such sums would be to do it without warning, to prevent tax dodgers from converting illegal cash holdings, he said.