Consumers in the world's biggest democracy just got a big surprise.
Indian Prime Minister Narendra Modi
on Tuesday announced that 500 and 1,000 rupee banknotes would be
withdrawn from circulation at midnight, saying it was part of a
crackdown on rampant corruption and counterfeit currency.
India
is hampered by so-called black money that is undeclared, untaxed or
under the table, said Sasha Riser-Kositsky, lead South Asia analyst at
research firm Eurasia Group. The unexpected step appears designed to
bring billions of dollars worth of cash in unaccounted wealth into the
mainstream economy, as well as hit the finances of Islamist militants
who target India and are suspected of using fake 500 rupee notes to fund
operations.
"The
move to restrict the circulation of large-denomination currency notes
represents a major step in the government's fight against black money,"
Riser-Kositsky said.
Speaking
in an address to the nation, Modi said that black money "and corruption
are the biggest obstacles in eradicating poverty." New 500 and 2,000
rupee denomination notes will be issued at a later date, he added.
Those
notes are worth roughly $7.53 and $30.14, respectively, but they
represent very large-denomination bills in the country. The average
daily income in India was 272.19 rupees in 2014, or about $4.09 at
today's conversion rate, according to the country's Labor Bureau.
"It
shows resolve on the part of the government to do something about black
money, which I like a lot," a hedge fund investor who is active in
India but requested anonymity told CNBC. The investor added, however,
that "I do think there's going to be a backlash. A lot of the economy is
still cash-driven, and this will inconvenience a lot of people and
transactions."
Indeed,
Sameer Samana, a global quantitative strategist at Wells Fargo
Investment Institute, told CNBC that the move could unintentionally
tighten monetary policy by reducing the circulation of larger notes.
Samana added that "in the near term, it's a negative mainly because of
the tighter financial conditions."
The iShares MSCI India ETF was lower Tuesday, despite the currency rising (Exchange: INR=). Modi's announcement came after markets closed in India.
"This
news is particularly bad for cash-driven industries like luxury,
jewelry and real estate. Stocks that could be under pressure tomorrow
(include jewelers) Gitanjali, Titan, PC Jeweller," said Neil Nathwani,
executive director of institutional equity sales, at BNP Paribas
Securities. "You're no longer going to see women going to the store with
a big stash of cash to buy diamonds."
Kositsky
pointed out that Modi's first official act after his 2014 election
campaign was to set up a special investigation team into black money and
bring it back into the above-board economy. Critics have said it had
failed to deliver on that promise.
Tuesday's
announcement comes just more than a month after the government raised
nearly $10 billion through a tax amnesty for Indians to declare hidden
income and assets. A report by Washington-based think tank Global
Financial Integrity estimated that India lost $344 billion to illicit
fund outflows between 2002 and 2011.
Modi
also said militants operating against India were using fake versions of
the 500 rupee note, worth about $7.50 at current exchange rates. India
has been locked in a perpetual fight against terrorists and insurgents
whom New Delhi claims are supported by archrival Pakistan.
"Terrorism
is a frightening thing. ... But have you ever thought about how these
terrorists get their money? Enemies from across the border have run
their operations using fake currency notes. This has been going on for
years," Modi said.
India
accuses its neighbor Pakistan of harboring militants who have launched
attacks on its troops, particularly in the disputed Himalayan region of
Kashmir, which both countries claim. Pakistan denies the accusations.
— Reuters and CNBC's Everett Rosenfeld contributed to this report.
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