What India's Demonetization Means for Investors

On Nov. 8, Prime Minister Narendra Modi of India surprised investors and consumers by declaring that 86 percent of the nation’s money stock would no longer be a medium of exchange or store of value. In meetings in Mumbai and New Delhi recently, I learned that the move was intended to ferret out illegally garnered funds, and that the prime minister’s action took aim at the national pastime of avoiding income taxes. Large bills of 1,000 rupees ($15) and 500 rupees could only be exchanged at banks by providing documentation of how the wealth had been acquired.

The move to freeze or annul a large part of the money stock had been expected to cripple the consumer-oriented economy -- household consumption accounts for 60 percent of gross domestic product in India, compared with 37 percent in China. With less usable cash on hand, equity markets had also been expected to take a hit - - the opposite of what the Federal Reserve’s quantitative easing has done for U.S. stock prices since 2009. Such expectations are consistent with economic theory.