Can India maintain its status as the world’s fastest-growing economy after a massive currency recall in late 2016 left consumers and businesses strapped for cash? From my home base in Mumbai, I’ve traveled the country over the past couple months to gauge the sentiment of businesspeople, assessing the impact of Prime Minister Narendra Modi’s demonetization campaign aimed at tackling corruption.
Here is what I learned, along with my thoughts on the government’s just-released fiscal budget and key state elections.
I traveled to a handful of states in north and south India, visiting people who run a wide swath of businesses in industries from automobiles to electrical components to textiles to food. There is no doubt all these companies felt the impact of the temporary cash shortage. Most told me their sales fell 20% in November and December. Some seasonal businesses saw production cuts, but overall there have been no large-scale layoffs. Most parts of the economy are normalizing fairly quickly as currency shortages abate.
While we will never know how much India’s economy would have grown had demonetization not happened, I don’t believe the effects of demonetization will be as severe as most suspect when official macroeconomic data is released in late February.
The worst is behind us, and in the next three to six months Indian business should hit its stride again, barring any further surprise disruptions. In my view, what is being missed in news stories of dislocation and disruption is the ability of people to adapt to change.
It was clear to me in conversations with company managers that demonetization is altering the way that business is being conducted in India. The informal economy and businesses that thrived on tax evasion have been hurt badly. If this change in behavior is sustainable, the country’s formal economy will grow rapidly, resulting in a broader tax base and stronger economic growth rate.
This would help micro- to medium-sized businesses, who could tap into formal credit sources and lower their costs. This is a big opportunity for Indian banks, and already we are seeing huge spikes in mobile banking accounts. In Tirupur, a textile-producing town I visited in the southern part of the country, approximately half a million new bank accounts have been opened since November.
The government’s fiscal budget unveiled on Feb. 1 took further steps to tackle corruption in India’s economy, increase the country’s tax base and promote financial digitization.
The budget clearly showed that the Modi government’s resolve to fight black money and corruption runs deep despite the difficulties that ensued during demonetization. I believe this bolsters his credentials as a bold reformer who wants to change the way business is done in India.
One proposed measure is a ban on all cash transactions above 300,000 rupees (approximately US$4,500); such transactions will incur a 100% tax penalty.
Another series of proposals takes aim at political funding. This includes reducing the maximum cash donation that a political party can receive from any one source to 2,000 rupees (US$30) — a 90% reduction from the previous limit. The budget also cuts the income tax rate for small- to- medium-sized firms to 25% from 30%. The move is expected to benefit more than 90% of Indian companies.
To give relief to lower-middle-income households, the income tax for individuals earning between 250,000 and 500,000 rupees (US$3,725–$7,450) annually will be reduced by 50%.
State elections to send candidates to India’s parliament began February 4. Elections are being held in five key states, including Uttar Pradesh, a northern state with approximately 200 million people, and Punjab, an agricultural hub in the south that is home to roughly 27 million people.
In my view, Prime Minister Modi gained political capital ahead of the elections and has sold the narrative of demonetization quite well. The currency recall was seen by the broader middle class as an attack on corrupt businessmen and the rich.
After meeting with various business leaders during my field visits, I believe there is hope that demonetization will level the playing field and companies that have survived on tax evasion will no longer be able to do so. I believe the Modi government continues to enjoy widespread political support from all cross sections of Indian society — even in southern India, not a traditional stronghold for Modi’s party, known as the BJP.
Of course, we will know for sure on March 11, when election results are announced. It is important to note that state elections are won or lost on local issues, and are rarely seen as a referendum on the performance of the central government. However, this year the results will be read as a verdict on demonetization.
Past results are not predictive of results in future periods.
Investing outside the United States involves risks, such as currency fluctuations, periods of illiquidity and price volatility, as more fully described in the prospectus. These risks may be heightened in connection with investments in developing countries.
Markets & Economy
World Markets Review
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the mutual fund prospectuses and summary prospectuses, which can be obtained from a financial professional, and should be read carefully before investing. Similar information about collective investment trusts can be obtained from Capital Group or participants' plan provider or employer.
All Capital Group trademarks mentioned are owned by The Capital Group Companies, Inc., an affiliated company or fund. All other company and product names mentioned are the property of their respective companies.
Use of this website is intended for U.S. residents only.
American Funds Distributors, Inc., member FINRA.
This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.