Demonetisation, Modi and More

“So long.”

In a massive move, Prime Minister Narendra Modi announced the demonetising of Rs 500 and Rs 1000 currency notes. According to Investopedia, demonetization is the act of stripping a currency unit of its status as legal tender. The idea behind the effort, as Modi suggested in a long preamble before his announcement, is to attack corruption and make black money harder to use.

This isn’t the first time India has demonitised its currency. In 1946, the Reserve Bank of India actually banned Rs 1,000 and Rs 10,000 notes, primarily to deal with unaccounted money. These were then reintroduced with a Rs 5,000 note in 1954, before they were once again demonitised in 1978.

The aim of taking the Rs 500 and Rs 1,000 notes out of circulation is to reduce the amount of illicit money in the economy. Simply put, many economists believe that high-value notes make it much easier for black money to move around the country, without necessarily being beneficial for law-abiding citizens or the poor. Next government also wanted to eliminate fake currency and dodgy funds which have been used by terror groups to fund terrorism in India. The move is estimated to scoop out more than 5 lakh crore rupees black money from the economy.

However the honest taxpayers need not to worry. Even if you have Rs 10 lakhs as cash with you and you can prove its legitimacy, you don’t need to worry. The surprise move by government is a disaster for people who have accumulated lakhs and crore of unaccounted cash under their pillows and mattresses. The winter is coming and these worthless pieces of paper can provide the corrupt some ephemeral warmth.

The timing of this announcement seems obvious, in hindsight. With the massive rollout of the Pradhan Mantri Jan-Dhan Yojana (PMJDY) in India, citizens’ access to bank accounts is nearly complete. A demonetization move would have been impossible if low-income households were unbanked. PMJDY has provided them with free bank accounts, which will also be used to transfer government payments. The need for honest people to stash cash in mattresses, therefore, has diminished. This move by the PM has also followed the income disclosure scheme where people were given a window of opportunity to declare their wealth amassed through various means. It was an appropriate time, therefore, to make credible the threat of a crackdown on black money and corruption within India.

Of course, actually implementing this is something of a mammoth task. Modi explained how the country is planning to carry out this massive operation over the next few months, as millions of Indians will attempt to exchange their old notes. It will stretch the capabilities of the financial system, which already does not extend across the country, and the interim period will also see many attempts by those holding on to black money to turn their cash into legal tender. The effort also depends heavily on Indian authorities actually delivering on the promise to make it easy for people to turn their old currency into smaller denominations. After this, the government plans to reintroduce a new Rs 500-denomination note, with limited circulation.

The biggest sufferers would be unorganized and informal sector as they predominantly deal with cash. Other loser would be mid-cap and small- cap companies which collect and make payments in cash. This pain will continue till this stock of cash is replenished by the banking system, which can be a quarter or two.

On inflation, the price level is expected to be lowered due to moderation from the demand side, according to CARE Ratings research paper. Some economists say that lower money supply would lead to deflationary pressure with too little money chasing too many goods. However, on the contrary, some economists believe that the move might work the other way round and help curb inflation with lower money supply as unaccounted money would be taken out of the system. In the long run, this is a significant positive shock to the Indian economy and society. If substantially implemented, this will send a strong signal about India’s anti-corruption drive and is very likely to improve the country’s reformist stance.

In spite of the initial hiccups and disruptions in the system, eventually this change will be assimilated in the system and is to eventually prove positive for the economy in the long run. Whether this would eventually boost economic activity that is remains to be seen. But, orders of magnitude are very difficult to establish and hence, any claim of such improvement in formal economic activity with consequent beneficial tax impacts and other social economic multipliers must be deemed wholly speculative at this stage. This move by the government along with the implementation of the GST will eventually make the system more accountable and efficient.


This article was written by Varnita Deep (PGDM, Batch 22, XIME-B


The Man Who Broke The Bank of England

People in Finance are generally stereotyped as evil masterminds. If there was ever an individual who fully embodied this stereotype, it would have to be the famous English high-profile currency speculator. Meet George Soros, who is notoriously titled “The Man Who Broke The Bank of England“.


(Source: GeorgeSoros)


So, how did Soros “break” the Bank of England, the English Central Bank? For this, you need to have a first-hand understanding of how the European Exchange Rate Mechanism (ERM) works. Before the introduction of Euro as a currency, the English Pound traded against several European currencies under the purview of the ERM. The ERM basically promised a fixed rate of the English Pound against several European currencies (To put it in technical terms, The Pound was ‘pegged’ to many European currencues). That is to say, regardless of how bad the economic conditions were at home, the value of the home currency would remain about the same – the Bank of England promised this. And so, every other currency under the ERM had their exchange rates fixed (pegged) against several other ERM currencies. The elaborate and perplexing system of ERM is of little interest to anyone these days.


However, many speculators predicted that the Pound being in the ERM was not sustainable and that it would lead to a financial crisis. At the center of this huge outcry was George Soros. Known for his ability to take massive amounts of risk, Soros called a spade a spade. Under his advise, many private fund houses started selling the Pound to ‘anyone who would buy’ and started accumulating other stable currencies – the majority being the U. S. Dollar. If you’re wondering why he would advise this – remember that Soros predicted that the Pound will fall. This meant that a single Dollar note would fetch him more Pounds in the future than today. On top of this, Soros and his accompanying private funds shorted the Pound.


John Major, the then Prime Minister of England, did not like this one bit. He did everything in his power to prove Soros and his followers wrong. He asked the Bank of England to raise the policy interest rates to as much as 10 percent. He also authorized an unprecedented accumulation of the English Pound that was being sold by Soros and his private funds. These steps were aimed at maintaining the exchange rate of the Pound vis-a-vis the other European currencies under the ERM system. But soon, the Bank of England noticed that they were running out of Foreign Currency Reserves to purchase the Pound back. Meanwhile, Soros kept on selling and shorting more and more Pounds. Meaning, they stood to make massive amounts of money provided the Pound fell (On the flipside, they also stood to make massive losses if the Pound, in fact, did not fall or worse, rose instead).


But soon, the Bank of England gave up. The Pound crashed. The day this happened would later be named the “Black Wesnesday“. The losses estimated would pile up to £3.3 Billion. Soros would personally make £1 Billion out of the deal. Shortly afterwards, the Bank of England pulled the Pound out of the ERM system and promised to stabilize it in phases.


(Source: ForexIllustrated)


Later, the Bank of England bitterly blamed George Soros for turning the tide against the market and making individual profits at the cost of massive public losses.George Soros himself felt he did not deserve his infamous title. Says Soros in his book ‘Soros on Soros: Staying Ahead of the Curve‘, “If I had gone against the market, instead of guessing where the market going, my action would not have for example led to the collapse of the pound sterling. Although I believe the man who caused the bankruptcy of the Bank of England was not really me. Market was the one who did it. I guess where the market was going and was an important element of it because I gave him momentum. But I did not cause the bankruptcy of the Bank of England.”


Supporters of Soros claim that the Bank of England broke itself – and simply needed a decoy to pin the crisis on. Critics of Soros accuse that the speculator took a position and then manipulated the market participants using his expertise and knowledge, thus manufacturing profits out of thin air. This is now termed in the investment circles as “the Soros effect“.


So, is George Soros, and all Finance people in general, inherently evil? George Soros himself provides an interesting answer: “I was a Human Being before I became a Businessman“.


This article was written by Dinesh Sairam (PGDM, Batch 21, XIME-B)