While rest of the globe was busy predicting US Presidential Election outcome and were staring at primetime news on late-Tuesday, Indian Prime Minister, Narendra Modi, came on-air in an unexpected-way with the announcement of revoking INR 500 and 1,000 notes' legal existence within few hours before the day-end. The move was boldly termed by Mr. Modi as a requisite to "break the grip of corruption and black money".
The announcement rattled the Indian economy where formal and informal financial channels run side-by-side. The locales were standing in a long queue in front of the ATM machines and news related to tragic actions of big black-money holders went viral.
During the next day, the financial markets also responded with a bang, mainly led by infrastructure companies, while bullion prices suddenly spiked in domestic and national markets.
Let's quickly understand such a bold step from Indian PM and how would it affect the economy.
The Decision
Indian Prime Minister, together with newly positioned RBI Governor, announced that Rupee 500 and 1,000 notes will no longer be a legal tender from the Tuesday mid-night of Indian Standard Time. All those who were holding these currency notes were advised to approach banks and post-offices to exchange them with the new notes of 500 and 2000, which will be out soon. Additionally, it was also announced that the banks and ATMs will be closed on Wednesday while ATMs can also disburse a limited INR 2000 amount for few days and the exchanging limit for a person into a bank/post-office is INR 4000.
The reason the Indian leader mentioned was to extract all the black-money from the economy and put them into the legal banking system so that tax-evaders can easily be targeted. Moreover, there were also speculations that terrorist institutions print fake currencies of such denomination and hence having fresh currency will save the nation from any such causalities in future.
The general people's favorite PM also assured nationals to not worry about the decision even if it might disturb routine-life a bit as such a step will help the economy with much more force in near-future.
Market Reaction
With such a sudden announcement from a reputed leader, everyone from India panicked and rushed to cash-out from ATMs while some of them wanted to purchase Gold in exchange of their hard-cash, which in-turn fueled the domestic prices of 10 grams of Gold from nearly 31,000 to 41,000 in physical markets.
Leading Indian equity indices, namely BSE and NSE, plunged around 5-6% during the start of trading-day but later on recovered some of their losses. Though, both these indices had to close the day in red with 1.23% and 1.31% negative-marks. Further, the Gold prices gained 2.3% on a closing basis at local bourse and the INR remained mostly sluggish across the board. Additionally, banking and reality shares were also down from 2.5% to more than 10% in some cases as traders perceived such action as hurting the immediate economic-flow while builders were thought to have more hard-cash and might be hurt by the move.
What's there moving forward?
With a "surgical-strike on local tax evaders", as the term was popularly known, BJP government again proved its readiness to take any bold steps to eliminate the corruption from the economy. The Government already took one such move around previous financial year closing when they announced income-declaration-scheme wherein the back-money holder can declare their hoarded funds and rest assured of not bearing 45% tax and penalty. Another case of the ruling party's bold efforts is their surgical-strikes against Pakistan at Line-of-Control before few months.
As such bold steps consistently show the BJP's capacity to take unconventional steps to nurture the Indian economy, the party becomes favorite amongst the voters who have to decide for its future in 2017 general election.
From the economic perspective, such an action will give rise to creation of formal economy and transparent process, which in-turn indicates better Indian growth and a strong INR in future. Further, with this action the tax authorities will be able to easily target all those who have been hiding their funds and can collect humongous tax receipt, which could better be used to enrich the economic and geo-graphic infrastructure.
However, such a shock seems mostly unbearable for the economy wherein nearly 20% of the GDP is of these kinds of hard-cash (as per indiatoday.in) and such 500 – 1,000 notes constitute around 75% of all the physical amount.
Hence, given the Indian banking system manage to assure people with value services, this action from ruling party will be a good step to strengthen the economy and can give rise to higher Indian Rupee (INR) prices in future. Though, a failure will have hardships for the BJP Government in securing another victory in 2017 election and might give rise to further weakness of the domestic economics and INR.
Cheers and Safe Trading,
Anil Panchal