Rupee swoop: Modi’s high-stakes gamble

Until a few weeks ago, my advice to investors looking at India was broad endorsement of its prospects, but with a caveat: Be aware that Narendra Modi could be a one-term prime minister.
This raised eyebrows since Modi enjoys high popularity ratings at home. What is more, no one dominates the Indian political landscape as he does. Why would he not be re-elected in 2019?
My reasons were several. For one, it will be near impossible for him to repeat his crushing 2014 performance, especially in the heartland states of Uttar Pradesh, where his Bharatiya Janata Party (BJP) won 71 of 80 parliamentary seats, and Bihar, where the party and allies swept 31 of 40 seats. Such results helped BJP to its best-ever parliamentary showing and gave India a single-party majority for the first time in 34 years.

The risk
Secondly, Modi’s “me, my, mine” approach to all things cast him as so central a figure that come election time, opponents will find it easy to score off him for the shortcomings and failures that mark even the best governments. And of course, should opposition forces coalesce – as they did in Bihar state elections in October last year – the BJP, which had the highest vote share in that poll, could still be comfortably put down.
Today, I am even less certain about what might happen in 2019. Modi’s November 8 announcement of the cancellation of high-value currency notes – called “demonetisation” by Indian media – was so audacious that it could go either way.
Modi may feel he had good reason to use the bludgeon. Corruption has eaten into India’s vitals, weakening governments and distorting policies. Nine in 10 consumer transactions in India are in cash, mostly unrecorded. The so-called “black” economy – which also includes everything from vast rake-offs enjoyed by the political class on contracts to bribes paid to the local police post for ignoring illegally parked cars – is estimated to be as much as a quarter of India’s gross domestic product.
Besides, a mere 2 per cent pay income tax, robbing the state of funds needed for public health, infrastructure and education.
The unaccounted money is kept in cash but substantially in gold and real estate – often, as much as half of a property’s sale value is settled out of sight. This distorts prices and makes homes unaffordable to many. Any move to prod the cash economy towards paper, or digital transactions, improves monitoring and tax collection.
It is this cash stash that Modi has attacked in the hope of disciplining part of the illegal economy and bringing it to the taxman’s heel. By cancelling the 500- and 1,000-rupee notes (500 rupees is Bt260), Modi wants their holders to put them into bank accounts or exchange them for new notes with proper documentation. If not, the holders risk losing their pile. The world has not seen a move on this scale in recent memory.
It was also not short on political daring: Which politician would scrap 23 billion notes that account for 86 per cent of the total value of cash in circulation just as the wedding season was approaching? Besides, it is the merchant class, the most artful tax-dodgers, that provide the BJP’s core support.

Counting the costs 
Neither could he have been unaware of the economic cost. Farmers, who just had a good crop after two years of poor monsoons, needed money to buy seeds for the next planting. Even if all their cash is honestly owned, many of them are now short of legal tender at a critical time. Although matters are easing somewhat, the first two weeks saw many businesses stalled and long lines in front of ATMs and bank tellers.
Without question, the economy will be severely impacted this quarter and possibly in the next as well. Modi seems prepared to temporarily surrender the bragging rights to running the world’s fastest-growing major economy.
Still, Indians have already turned in the equivalent of US$80 billion (Bt2.85 trillion) – the cancelled notes are worth about $220 billion in total – mostly into bank accounts, with some $5 billion exchanged for fresh notes. By December 30, when the window to return the old cash closes, more will be scrubbed. Many who are afraid to own up to holding chunks of unaccounted cash have simply thrown bundles of notes into the river.
Although the first wave of excitement over the “surgical strike” on black money has dissipated, India, particularly its populous rural hinterland, has generally responded with stoicism. By-elections held on November 19 in BJP-controlled Madhya Pradesh and Assam states showed no apparent fall in support for it.
That could change if disruptions persist. The danger is that the initial excitement turns to despair and, eventually, anger. Modi has asked for 50 days to fix things. It may be too long.
Rather reflexively, and perhaps stung by the prospect of their slush funds proving worthless, most opposition parties – including Congress, the Marxists and others – have leapt to criticise the prime minister. 
This may work to Modi’s advantage since he will be seen as standing pristinely alone, with most of his opponents boxed into the far corner. A nationwide survey by C-Voter, a polling agency, recorded more than 80 per cent support for the move across income groups.
Modi stormed into office with a promise of “better days are coming”, but India’s economy, buffeted by a poor external environment and a banking system made sclerotic by loans that soured during the Manmohan Singh decade, is not performing to potential. The rupee is at its lowest in three years and the investment cycle is yet to power up.
Worryingly, job creation has been sluggish. On Tuesday, Larsen & Toubro, the biggest engineering firm, shed 14,000 jobs – 11 per cent of its workforce. India has 800 million people below the age of 35.
Still, for the next months at least, Modi can comfortably wear the cloak of a leader who embodies the struggle of ordinary Indians standing up to the depredations of a corrupt power elite.