The Daily Update - Modi's shadow

In an attempt to flush out India’s black money and line tax coffers, three weeks ago Prime Minister Narendra Modi declared 500 and 1000 rupee notes “will no longer be legal tender… just worthless pieces of paper”; despite the two major notes accounting for ~86% of rupees in circulation. In a shock televised announcement, Modi said he would give the public - who use cash for ~98% of all transactions (in volume terms) - ‘50 days to deposit notes of Rs 500 and Rs 1000 in any bank or Post office’. According to sources, roughly $100bn of the estimated $220bn of banned high denominated notes have been declared so far.

This week, Modi has said that holders of previously ‘hidden money’ can ‘voluntarily’ disclose their now banned high-value notes, and after paying fees and penalties retain up to 50% of the cash value; or else risk losing 85% of worth if caught by the tax officials. However there are concerns that there is a huge amount of fake notes in circulation and that there are a number of crafty laundering practises appearing within the system including the opening of rogue bank accounts and distribution of wealth within the less fortunate community; to then get it back later in new bank notes. Ticket sales at Indian Railways have shot up to 27,000 from an average of 2,000 a day, as launderers buy first class tickets using old notes, to only cancel the tickets and get money refunded in smaller notes; going forward however these tickets will be refunded by check, or electronically. The Finance Ministry has said, “Instead of allowing people to find illegal ways of converting their black money into black again, the government should give them an opportunity to pay heavy taxes with penalty and allow them to come clean”.

Modi’s demonetisation push to turn India into a ‘cashless society’ is something which we feel will be a huge challenge, in fact it could take generations to change the mindset alone. A large proportion of middle- to lower-income workers have had to rely on the generosity of their communities and families, and trust that their employees with eventually pay them in ‘unbanned’ notes. They have so far been remarkably patient in the belief that this will only last until the December 30, 2016, and that the government will soon release the new notes. There is however, an undertone that as much as the scheme is essential in squeezing out hidden money, fraudulent practices continue to evolve and there are growing concerns that a huge sum of undeclared money will never filter through the system. This is not to say that the aim of pushing the economy to a more digital and thus accountable system is not hugely beneficial in the longer term, there are concerns that the way in which the scheme was deployed could actually hamper growth or even darken the shadow further.

Although India is within our investable universe, it is not a country we typically look to hold. Rated one notch above ‘junk’ at Baa3 by the three major rating agencies, issues from the government and quasi-sovereigns do not offer sufficient risk adjusted returns nor credit notch protection; in fact the majority of the issues we do look at actually trade expensively.