India's shock bank note ban sparks cash chaos

A customer waits to deposit 1000 Indian rupee banknotes in a cash deposit machine at bank in Mumbai, India, November 8, 2016. REUTERS/Danish Siddiqui

By Sankalp Phartiyal and Neha Dasgupta

MUMBAI/NEW DELHI (Reuters) - Indians struggled to pay for basics goods like food and fuel on Wednesday and fretted about their savings, after the government withdrew 500 and 1,000 rupee notes from circulation in a bid to flush out money hidden from the tax man.

The shock measure also sent shudders through the investment community on a day when the markets were also reeling at the election of Republican candidate Donald Trump as the next U.S. president.

India's National Stock Exchange share index (.NSEI) slumped as much as 6.3 percent in early trade before recovering most losses to close the day off 1.3 percent.

The currency move, announced late on Tuesday night by Prime Minister Narendra Modi, aims to bring billions of dollars worth of unaccounted wealth into the mainstream economy and curb corruption.

The biggest disruption in decades to cash transactions, which power much of the rural economy, comes months before a series of state elections including in India's most populous Uttar Pradesh state.

Critics have warned that ordinary people who do not have access to the banking system will be hardest hit, and that Modi risks upsetting his ruling party's support base of small traders and businessmen who largely deal in cash.

It will also affect politicians running for office in a country where there is no state financing for elections and many campaigns are funded by unaccounted wealth.

"This is a pre-election disaster for political parties, the piles of cash sitting with them are worthless," said one tax official, who asked not to be named.

Modi, however, came to office in 2014 promising a war against the shadow economy that won him support from middle-class Indians who accuse elite politicians and businessmen of cheating the system.

"If elections can become cheaper as a result of this decision, it would be a good beginning," Finance Minister Arun Jaitley told a news conference.

The replacement of the old currency was also designed to stop anti-India militants suspected of using fake 500 rupee notes to fund operations.


From midnight, the larger bank notes ceased to be legal tender for transactions other than exchanging them at banks for smaller notes.

Retailers refused to accept the bills, worth around $7.50 and $15 respectively, and people were unable to access ATMs after banks closed them down.

Deepak Urs, a staff trainer at a financial services company in India's southern tech hub of Bengaluru, said he would need to take time off work to exchange his old notes.

"Once the ATMs start operating, there will be long queues," he said. "Maybe tomorrow onwards, every two, three weeks, I will have to go the ATM or bank to get cash."

India's "black economy," a term widely used to describe transactions that take place outside formal channels, amounted to around 20 percent of gross domestic product, according to investment firm Ambit.

New bills of 500 and 2,000 rupees will be introduced from Nov. 10. Jaitley said it would take two to three weeks to replace the old notes, amid concerns over the availability of cash.


Deepak Chhatoi, a salesman at a car varnishing store in Mumbai, said he had to turn away customers wanting to pay with larger bills, and could not buy the popular potato sandwich known as the vada pav.

"I couldn't even have breakfast this morning because there seems to be a shortage of change in the market," he said.

The extent of the impact of the measures became evident as petrol stations and hospitals also refused to accept larger denomination bank notes, even though the government had given them a waiver to continue accepting them.

Meanwhile, bank ATMs were closed and banks prepared for a flood of people seeking to exchange larger bank notes for smaller ones.

They will have to fill a form and show proof of identity to exchange no more than 4,000 rupees worth of the old notes at any bank, which is likely to cause further chaos.

Swapan Mandal, a labourer, wanted to withdraw 3,000 rupees from an ATM and send it to his family in Kolkata, in eastern India, but was unable to do so.

"I have only 500 rupees notes at home. I don't know if I will be able to send the money," he said.

A sub-inspector in New Delhi said the police commissioner had issued orders to watch for disturbances, especially at key retail outlets like petrol pumps.

"This is a sensitive time. We have to be alert," he said.


The main opposition Congress party said it supported moves to attack the shadow economy, but that withdrawing bigger denomination notes would hit the common man first.

"Modi shows how little he cares about ordinary people of this country - farmers, small shopkeepers, housewives, all thrown into utter chaos," said party leader Rahul Gandhi.

"(All the) while the real culprits sit tight on their black money stashed away abroad or in bullion or real estate."

Indians raced to turn their cash into gold, which jumped nearly 4 percent to its strongest in more than five weeks as investors sought safety following Trump's unlikely win.

India is the world's second largest gold consumer and around a third of its demand comes from the unaccounted sector.

On Tuesday night, jewellers in Mumbai kept shops open until midnight as panicked people rushed to buy gold with cash, said Kumar Jain, vice president of the Mumbai Jewellers Association.

On the stock market, real estate firms that depend on cash transactions were hit particularly hard, with DLF Ltd (DLF.NS), India's biggest property developer, closing 17 percent lower.

But analysts said the move would prove beneficial to India in the longer term, by ushering in transparency and bringing transactions into the formal economy, and providing additional revenue for a country that has long struggled to contain its fiscal deficits.

It could also lead to easing inflation, raising the prospect of additional rate cuts from the central bank, which lowered the key repo rate by 25 basis points last month.

(Reporting by Mumbai, Delhi and Bengaluru newsrooms; Writing by Rafael Nam and Sanjeev Miglani; Editing by Mike Collett-White)