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Reasons India scrapped its two biggest bank notes
November 24, 2016, 9:31 am
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In a surprise televised address on the evening of November 8th, Narendra Modi, the prime minister of India, delivered a bombshell: most of the money in Indians’ wallets would cease to be accepted in shops at midnight.

The two most valuable notes, of 500 and 1000 rupees ($7.50 and $15), were to be “demonetised”, economist slang for taken out of circulation. Indians have until the end of the year to visit banks to either exchange their cash against newly printed notes or deposit it in their accounts.

After that, their notes will become mere pieces of printed paper with no value at all. Citizens and businesses face weeks or months of disruption as the new currency stock is deployed. So why bother?

The government justified the move in part due to concerns over a proliferation of counterfeit notes (not unusually, it pointed the finger at neighbouring Pakistan), which it claims is fuelling the drug trade and funding terrorism. But its main impact will be on “black money”, cash from undeclared sources which sits outside the financial system.

Perhaps 20% of India’s economy is informal. Some of that is poor farmers, who are largely exempt from tax anyway. But the rich are perceived to be sitting on a vast illicit loot. Though a large part of that sits in bank accounts in predictable foreign jurisdictions, a chunk of it is held in high-value Indian notes. Purchases of gold or high-end real estate have long been made at least in part with bundles (or suitcases) of illicit cash. 

The impact of the move is that everyone will have to disclose all their cash or face losing it. Those with mere bundles of 500 rupee notes clearly aren’t the target: the government has said tax authorities won’t be told about deposits of less than 250,000. But those who have stashed large piles of notes are in a bind. A recent amnesty programme for “black money” has just passed meaning the tax man is unlikely to look upon undeclared cash piles with sympathy.

The question is not whether the scheme will work but whether the cost of implementing it is worth it. The notes being nixed represent 86% of all cash in circulation: everyone is impacted.

Queues have snaked around banks for days as Indians have tried to convert their notes into new money. And the “black money” hoarders have ways to liquidate their loot, for example hiring lots of people to deposit their notes into their own accounts and then send it back, all for a fee.

The benefits are hard to gauge for now. The government is keen to be seen to be cracking down on tax-dodgers on behalf of the “common man”. But if the poor fellow then has to spend his days (like your correspondent) scouring the streets for an ATM that works, he may end up wondering if he is a beneficiary of the scheme or its victim.

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