Narendra Modi faces risk of economic stress as cash runs short

Narendra Modi faces a political risk as the move to ban Rs500 and Rs 1000 notes could upset BJP’s key support base—small traders


PM Narendra Modi’s startling and sudden move to withdraw <span class='WebRupee'>Rs.</span>500 and <span class='WebRupee'>Rs.</span>1,000 notes a week ago has left India with about one-seventh of its currency in circulation. Photo: AP
PM Narendra Modi’s startling and sudden move to withdraw Rs.500 and Rs.1,000 notes a week ago has left India with about one-seventh of its currency in circulation. Photo: AP

New Delhi: Prime Minister Narendra Modi’s ban on high-value currency was initially hailed as a game-changer to check corruption and tax evasion. But as anger on the streets increases over a prolonged scramble for cash, he’s facing the risk of economic slowdown and political backlash.

Modi’s startling and sudden move to withdraw Rs500 and Rs1,000 notes a week ago has left India with about one-seventh of its currency in circulation. Small businesses, real estate, gold and the informal sectors—which see a high component of cash transactions—have been affected as hundreds of thousands of people spend time in long queues to exchange currency rather than working.

The situation is not likely to change soon. Union finance minister Arun Jaitley has said it will take about three weeks to replace the old notes. Over the weekend, Modi made an impassioned plea to the nation to give him 50 days to weed out ill-gotten wealth in the country.

Also read: The economics of currency reform

“For last five days, I have been standing in long lines to get small denominations to pay to 10 daily labourers. Only two times I have succeeded,” said Ranjan Parida, a small contractor, engaged in home renovation works in Delhi. “Now these daily laborers and me are jobless,” as house owners are not paying for jobs done and others have postponed their renovation plans.

In a sign the government is struggling to deal with the public’s reaction to the week-long cash shortage, it has already increased withdrawal and exchange limits and extended the deadline for accepting old currency at key utilities. The actions have done little to quell mounting concern from those who cannot access cash.

More than 90% of Indian workers are in what the government describes as informal sectors, including agriculture, construction, or home-based activities like pickling and tailoring. Analysts say that across the country, productivity in agriculture, small factories, shops and restaurants is falling, as is consumption, since these are areas that depend on cash.

“At the moment the focus has been on just the last point of sale, which is retail sale,” said Pronab Sen, India’s former chief statistician and country director at the International Growth Centre. “The problems are going to start at the upstream levels where production and distribution actually take place. So things can choke up and that will have a multiplier effect.”

The economic impact will be profound as the liquidity available in the unorganized sector has been significantly affected, said Sen, adding it could reduce gross domestic product by as much as 0.5 percentage points in the fiscal year ending March 2017 and also dent activity next year. “The point is people are going to take a hit both in terms of their current income as well as future prospects,” he said.

The sudden withdrawal of high denomination notes is likely to be negative for short-term growth as informal sector activities slows down in response, according to a Deutsche Bank AG report. “Weak consumption could shave off 50 basis points from growth in the October-December quarter,” analysts Kaushik Das and Taimur Baig wrote.

India’s GDP, which grew 7.6% last financial year, dropped to 7.1% in the quarter ending June 2016. Growth data for the last quarter is due on 30 November.

“There may be a negative GDP impact in the current quarter as consumption shock gets transmitted in the system,” according to a report from Deloitte Touche Tohmatsu India LLP. “Domestically, there could be some turmoil as the effect will be disproportionately felt by the lower and upper income classes,” analysts including Anis Chakravarty and Richa Gupta wrote.

With scarce money supply and some cash returning to the banking system, the negative impact on growth would be around 0.7 percentage points in the short term, said N. R. Bhanumurthy, an economist with the National Institute for Public Finance and Policy, a government-backed think tank. “But, most importantly, in the next year growth would be much higher.”

The move, however, will have a significant impact on financial inclusion and could trigger an interest-rate reduction, said Bhanumurthy.

Also read: Currency swap and the reality distortion field

Modi is also facing political risk. The move could upset his Bharatiya Janata Party’s key support base—small traders—as transactions have slowed down.

Their support is essential over the next sixth months as India holds elections in five states, including the most populous, Uttar Pradesh. Winning the polls in Uttar Pradesh and the northern state of Punjab is crucial for Modi—it would add momentum to his plan to push difficult agendas such labour law reform and help give him a majority in the upper house of parliament to approve legislative measures.

“Initially, it looked like people were facing hardship but were willing to sweat it out,” said Nilanjan Mukhopadhyay, who has written a biography of Modi. “The risk is that if this inconvenience caused to people is prolonged, then it could cause a backlash.”

Meanwhile, a majority of opposition parties criticized the government for mismanaging the partial demonetization of currency and plan to raise it in the parliament session starting Wednesday. Amidst all this, Modi’s administration wants to push the passage of goods and services tax bills in this session.

“There’s a possibility he’s in a trap, ” said Mukhopadhyay. “He can’t roll it back. It’s a one way street. Let’s see how he fights it out.” Bloomberg

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