India is now into the third week of the biggest monetary experiment in over 40 years and it appears to be working. Just three weeks ago on November 8, Prime Minister Narendra Modi launched a surprise demonetization.
Modi went on television and told his nation’s people that 86% of the country’s paper currency would be worthless at midnight. The idea was to combat crime, terrorism and tax evasion by getting rid of the 500 and 1000 rupee notes, India’s two largest bills.
Is Demonetization a Threat to GDP?
The result of Modi’s experiment might be to cut India’s gross domestic product (GDP) growth rate. Ambit Capital cut its estimate of India’s GDP growth for the next year from 6.8% to 3.8%, The Business-Standard reported. Ambit cut the GDP growth forecast for 2017 to 2018 from 7.3% to 5.8%.
That growth rate is still pretty good because the United States had a GDP growth rate of 2.9% in the third quarter of 2016. The United Kingdom had a GDP growth rate of 2.3% for the same period. The Eurozone reported a dismal growth rate of .3% for the same period.
There are also some forecasts that indicate Modi’s action will only cut growth rates by around one percent. Either way the GDP projections indicate that Modi is not taking as big a risk as you might think, there are a lot of world leaders that would kill for the kind of GDP growth India will enjoy after demonetization.
The Risk is Not that Great
The risk Modi took by wiping out all those rupees was not as a great as many people might believe. The shock to the economy does not seem that bad, more economic growth might be fueled as more money flows into India’s banking system.
The biggest shock might be to India’s real estate market where cash is often used to seal deals in an attempt to avoid the capital gains tax. A major problem is that many real estate speculators and investors might see much of their money wiped out. They will not be able to buy and sell for a while or forced to turn the banks for mortgages much like Americans do.
There has been a decline in some areas including auto sales which fell by 50% to 60% according to UBS, The Financial Times reported. That market might pick back up as people get used to the new status quo.
Wholesale business activity is 20% to 25% below usual but it is slowly picking back up largely, because the underlying economy is fairly good. Yet there are some segments of the economy that are booming.
Has Modi Saved Digital Wallets in India?
Digital wallet and payment companies such as Paytm; an Alibaba (NYSE: BABA) subsidiary, and its competitor MobiKwik reported a boom in business, The Financial Times reported. MobiKwik saw its level of downloads rise by 200% and the amount of money added to its wallets increase by 2000% after Modi made his move. Paytm reported that traffic to its site rose 700% and downloads of its app increased by 300%.
Modi’s move might rescue Paytm which lost $55 million last year. MobiKwik is also hurting it lost $6 million last year and does not expect to make a profit until 2018. Paytm was so grateful that it took out full-page newspaper ads thanking Modi for his experiment.
Digital wallets have been a tough sell in India because 78% of the business in the country is done in cash. One reason for Modi’s move is to force Indians to start use electronic banking and that seems to be working.
Another company that might benefit from demonetization is Apple (NASDAQ: AAPL) which has had a hard time getting US retailers to accept its Apple Pay digital wallet. Now would be a great time to roll out Apple Pay in India where it is not yet available. Hopefully, Tim Cook has noticed demonetization and is moving to take advantage.
India’s banks have reacted by setting up the immediate payment system for fast money transfer or IMPS. That system allows anybody with a bank account to transfer funds with a mobile number, a payment code and a personal identification number (PIN).
Will Demonetization Work and can it be Repeated?
The ultimate goal of demonetization is to drive Indians into the modern financial system whether they want to go there or not. That is sort of working for now, but there’s no guarantee of future success.
A more interesting question is, will other nations such as the United States follow suit. Eliminating the US $100 bill would be advantageous for law-enforcement; the C-note is drug dealers’ favorite means of payment, yet it would not be popular with some American conservatives.
Interestingly enough an elimination of the $100 would cause little pain in the US because the vast majority of Americans do not use them. Yet it would spark opposition from voices like talk radio show hosts; such as Rush Limbaugh, who helped elected President-elect Trump.
It looks as if India’s demonetization has been partially successful. That might inspire similar experiments in other nations which might have unforeseen economic consequences. Expect to see more such monetary experiments in other nations if it is successful. Also expect to see opposition and economic hardship spread if this idea becomes popular in other nations.