India: "A Live Demonstration of What Deflation May Look Like"

A financial panic has developed in India. Quartz India explains (Nov. 14):

On Nov. 8, Indian Prime Minister Narendra Modi announced that all notes in denominations of Rs500 ($7.40) and Rs1,000 ($14.70) would be illegal in the country. These were the highest and most popular currency denominations in India, forming 86% of the currency in circulation by value. Indians have until Dec. 30 to deposit all the notes in banks and post offices to get them replaced.

Modi's decision was to tackle the corruption, black money, and fake currency that often finance terror. But Indians are panicking. There are long queues outside banks and ATMs, and the poor, unbanked section of the population is not really sure what it should do with these notes.

Indian news organization FirstPost also reported on this developing financial drama in a Nov. 14 article titled "Demonetisation seems like deflation for many people; danger signal for PM Modi." Here's an excerpt:

The [Indian] government grossly underestimated two challenges: the extent of cash holdings in the demonetised denominations held by the poor and lower middle classes, and the scale of cash used in day-to-day transactions. It is these transactions that have been decimated by the move to root out black money.

For the first time in independent India's history, we are getting a live demonstration of what deflation may look like. Deflation is more dangerous for governments in power than inflation.

With small denominations notes (Rs 100 and below) now prized possessions, people are holding back on everyday use of these notes except for immediate and urgent needs. People who used autos and taxis are going by bus, and so the average autowallahs and cabbies have seen a drastic fall in earnings; the kirana guys and vegetable vendors are finding it tough to sell enough to service our daily needs, and their turnover is down; people are putting off every day small-ticket FMCG purchases (your shampoo sachets, higher value soaps, etc) to conserve cash. Even Ola drivers, who should have seen a spike in earnings from people using digital cash, cards and e-wallets, report that people paying cash have dropped off.

A shortage of cash also drives people who were lucky enough to raid ATMs and bank branches to conserve what they have. They tend to spend less than normal, thus enhancing the deflationary downward spiral.

You can read the entire article by following the link below: