One week after India’s sudden declaration that 500- and 1,000-rupee notes were no longer legal tender, the economy is in chaos. And that’s perhaps because the policy was designed as much to shock and awe observers with the government’s command of the Indian economy as to control India’s “black money” problem. What seemed at first to be a masterstroke by Prime Minister Narendra Modi now looks like a grave miscalculation.

Modi is beginning to sound like he may agree. His recent speeches on the subject have been frankly bizarre. In one, he seemed to laugh at those inconvenienced by the ban; in another, he broke down while speaking of the “sacrifices” he'd made for India, and warned that he might be assassinated by “forces” desperate to protect their “loot."

What’s changed in a week? Well, for one, it’s become clear that the government was simply too cavalier in its planning. Now that 86 percent of India’s currency is no longer valid, the central bank has struggled to print replacement denominations -- and the new notes are the wrong size for existing ATMs. Modi’s asked people to be patient for 50 days, but the process could take as long as four months.

You have to wonder if Modi truly sought expert advice, or relied once again on a small and trusted set of politicians to determine policy. India’s simply too big and complex for shock and awe. Large parts of the rural economy use cash for 80 percent of transactions and have been hard-hit. In seafood-mad West Bengal, for example, the fishing industry is in a state of near-collapse; in the wheat-growing states of the northwest, farmers halfway through the sowing season have run out of cash to buy seeds.

Few villagers have access to an ATM. Most have to trek to a bank branch to change their cash, which means losing out on crucial days of labor. Many Indians, particularly women, still don’t have an active bank account. Finance Minister Arun Jaitley wondered aloud how many poor people would even have 1,000-rupee notes -- probably a rhetorical question, but surely it shouldn’t have been. Someone should've sought the answer before shutting down India’s financial system.

Among India’s middle class, Modi’s “surgical strike on black money” still appears to be popular. It’s the old “vegan fallacy” -- if something tastes terrible, it must be good for you. Enough Indians are suffering that they believe it must be in a greater cause. It’s a moral project, not an economic one. Stand in line, we’re told, and you honor our brave soldiers at the border.

But will that support last? The government’s plan is likely to be ineffective in the long term. Economists agree it will have no effect on the generation of black money through corruption.

David Fuller's view

This incident has undermined confidence in both Modi and India’s economy for the medium-term.  India’s Mumbai Sensex Index is prone to volatility and the bank note debacle has occurred as resistance was beginning to be encountered near the early-2015 peak.  Medium-term uptrend consistency was interrupted with that first weekly downward dynamic in late September. 

Global investors are looking at charts of what had been their favourite emerging market and seeing a double top, with a break in the 200-day (40-week) MA which has now turned downwards.  While a short-term oversold condition has now occurred following the recent persistent decline, a sharp rally back above the MA is required to check downward momentum beyond the short term.  That may be a challenge in this environment.  While I have liked India for the long term since 2002, here is what I said in the conclusion to my comment in the lead article on 24^th October:

I do have some concerns over the short to medium term.  This year’s upward trend by the Mumbai Index shown above has lost consistency in the region of its 2015 peak.  This may lead to a further ranging consolidation phase, or a more significant medium-term setback if the rising 200-day (40-week) moving average turns downwards.  Nevertheless, I would regard any significant setback as a buying opportunity.    

Wall Street’s Trump rally shown here by the DJIA could cushion India somewhat but I do not think this selloff is sufficient to be a great buying opportunity.  Long-term investors like India for Modi’s leadership and strong GDP growth, although that made this market somewhat expensive.  The currency note fiasco will question Modi’s judgement in the short-term, while also slowing GDP growth somewhat.

Additionally, I have often mentioned that India's stock market generally outperformed when China’s was weak, and vice versa.  China fears have eased over the last several weeks while India fears have obviously increased.  I think the Sensex Index shown above could move closer to the 1Q 2016 low over the medium-term. I personally would like to see some renewed evidence of support before considering new long positions.