Modi’s war on black money has hit India’s economy. Is the price worth paying?  

One month after Indian Prime Minister Narendra Modi announced the demonetization of 500 and 1,000-rupee banknotes in his battle against black money, policymakers in New Delhi are finally starting to acknowledge that the shock move has caused immense upheavals, loss of incomes, disruption to businesses and inconvenience to millions of hapless citizens caught in the cross-hairs, 

The economic fall-out from Modi’s November decision has been widespread, although the government and the Reserve Bank of India insist the pain will be short-lived. The central bank surprised forecasters by leaving its benchmark interest rate unchanged when its Monetary Policy Committee met on Dec 6-7. Although consumer price inflation dropped to 4.2% in October, and the RBI saw further disinflation as a result of demonetization in the October-December quarter, the central bank said it would stay vigilant to ensure CPI comes in at a targeted 5% by March 2017 as food and fuel prices trend upward, The RBI said its assessment was “clouded by the still unfolding effects” of demonetization and lowered its growth forecast for fiscal 2016/17 to 7.1% from 7.6%. Although gross domestic product grew by 7.3% in the July-September quarter, gross fixed capital formation has declined for three consecutive quarters. The RBI said demonetization could “transiently interrupt” industrial activity in November and December due to delays in payment of wages and purchases of inputs.  

It is still too early for major indicators after the demonetization move, but the Nikkei Markit India Purchasing Managers Index fell back in November after hitting a 22-month high in October. More worryingly, foreign investors appear to be fleeing Indian debt markets. A Nomura Securities report on Dec. 8 noted that foreign portfolio investors and sovereign wealth funds had pulled 141.3 billion rupees out of Indian markets in the first five days of December, after a record withdrawal of 172.7 billion rupees in November, sharply up from 71.5 billion rupees in October. Outflows spiked from Nov. 11 after Modi’s surprise demonetization announcement, which coincided with Donald Trump’s election as the next U.S. president. More volatility is in store if the U.S. Federal Reserve, as is widely expected, hikes interest rates at its policy meeting next week.

Unforeseen effects  

Demonetization has had some unintended consequences, too. State-run electricity companies across the nation, which were allowed to accept payments in the banned notes until Dec. 30, saw a sharp and welcome drop in arrears. But tourist arrivals plunged, and foreign embassies, forced to adhere to limited cash withdrawals, were furious about what they saw as a violation of diplomatic privileges. Some, like the Russian embassy, even threatened retaliation against Indian diplomats in their respective countries.  

“The consequences that have emanated from [demonetization] were taken on board, and that is why the planning, the process and the implementation was what it was, keeping in mind that high secrecy had to be maintained,” RBI Governor Urjit Patel told a post-policy meeting press conference. The problems of ordinary people, he added, were “at the top of our radar.”  

There is little doubt that demonetization has affected nearly every aspect of India’s economy and triggered a huge political row that pits Modi against all opposition parties. Parliament’s winter session, which began on Nov. 16 and will end Dec. 16, has been paralyzed by fiery speeches, daily protests, shouting matches and chaotic adjournments. Pending legislation is in deep freeze. The crucial Goods and Services Tax, targeted for launch by April 1 next year, is mired in political wrangling.  

Cracks are starting to appear in Modi’s ruling Bhartiya Janata Party (BJP). On Dec. 7, party elder L.K. Advani blasted the lower-house speaker and the parliamentary affairs minister for not controlling the uproar. A day later the normally neutral President Pranab Mukherjee lashed out in a speech, telling lawmakers: “For god’s sake, do your job. You are meant to transact business in parliament.”  

Modi has not spoken in parliament so far about his controversial decision, although he has hit at critics in speeches across the country. On Dec. 8, he took to Twitter to salute Indians for “wholeheartedly” backing his “yagna” (sacrificial fire) against corruption, terrorism and black money.  

“I always said that the government’s measure will bring a degree of inconvenience, but this short-term pain will pave way for long term gains,” he tweeted, adding that India had a historic opportunity to embrace cashless payments. He said his campaign will “empower the poor, neo-middle class, middle class and benefit future generations.”