India’s Prime minister Narendra. D. Modi, on the night of 8th Nov’ 2016, announced that denomination of 500 and 1000 will be invalid hereafter and general public has stipulated time to exchange that money for either 100 Rupee notes or newly minted 2000 Rupee notes. Media is lauding the PM and general public has termed this step as the master stroke. The step, according to me, is a audacious one as it will put many people against him especially the businessmen who deal only in cash and the people who live on the daily wages. It can even cost him the next election.
The purpose : Black money, stocked money that in general is in higher currency denominations will be brought to circulation and money can be moved from unorganized to organized sector. The issues of terror funding and fake currency will be dealt well by this step. The level of cash in the central banks will be raised; It will give better picture to data scientists of Govt. and better plans can be chalked out for small scale businesses. On a fundamental level, it will increase the lending power of the banks.
The timing of announcement : He had plans to unearth money from the homes of people and get it into circulation for a long time. He started it 2 years ago by making people open zero deposit and free accounts in banks. Then he asked people to deposit whatever money they have in the bank accounts. He extended the cutoff deposit dates too. Approx. 62,000 Crore ( 620 Billion Rupees) were deposited and 45 % tax rebate was given to people who deposited this amounts. But people are incorrigible and then PM used his master stroke and just before midnight he announced demonetization. All business gets closed by that time, stock markets, shops, and almost every business transaction gets done by that time. It came as a surprise to people and created a panic situation for the money hoarders.
What is targeted : Fake currency, black money that is stocked, funding to terror groups, people who keep large undocumented cash as the black assets and people who conceal the income e.g. Jewelers dealing in cash, real estate marketeers. Also, it attack the parallel economy that runs in the informal/grey sector (Untaxed sector)
What is not targeted : The big fish of the ocean who black the money in foreign bank accounts, stocks, gold bullion, tax evaders and corruption. All these processes generate a lot of black money but it doesn’t mean that it is stored somewhere in form of cash. Some part of that money comes into the cycle of economics.
Tax evasion in India : Only 1% population pays the tax and 25% of that population earns < 5 lakh Rupees per year. Around 3% population files the tax return but the 2% gets away by showing zero income. Also, 50% of the population is still employed in agriculture and allied activities and agriculture income is tax exempt.
The currency : 500 and 1000 rupee notes make up approx. 85% of the monetary chunk. Right now, they are nothing more than an exchange coupon. India is a cash based economy as over 90% transactions are done in cash
People’s reaction : Although people are frustrated for the long queues in front of ATMs and banks but people who understand how things work and why the step was necessary are happy with the step. People are coming up with an argument that it could have been planned in advance. NO! It couldn’t have been. If people had time and had prior knowledge they would have converted the money to some other asset. If more 100 Rupee notes were to be printed before the announcement then the news could have been leaked and would have shattered the whole plan. I have friends who work in banks and even though they are in office for longer periods and even on weekends, they are happy with the step. The panic will last few days as there is some cash crunch but things will be back to normal in a few days.
Market’s reaction : The sudden currency ban caused the markets to go down by 6% but both BSE and NIFTY resurged.
Positive impacts : 1. Brought 75 thousand crore rupees ( 750 billion) in one of the national bank of India within 3 days.
2. Counterfeit currency that was used to fund terror groups and other things will be curtailed.
3. Cash hoarders (> 2.5 lakh rupees) will have to explain to the tax department.
4. More data points for the data scientists of Govt. to chalk out better strategy.
Other impacts : 1. Approx. 100 billion Rupees spent in printing the new currency.
2. Hassle to people.
3. No impact on those who have foreign bank accounts and still no action by the Govt. when it is said that the list of account holders is available.
4. The informal sector e.g. the chit funds would be ruined and people employed in those sectors will be affected. This informal sector acted as a lending agency and it will be damaged permanently. Although, one can argue that lenders use to charge whatever interest rate they wished.
5. There is an opportunity of discounted currency business to grow i.e. You give me 500 Rupees and I will give less than 500 rupees to you in form of non demonetized currency. Discounting is illegal and Govt. is setting up measures to curb the same.
6. Tourists who had money in form of large currencies will have to face problems.
7. Collateral damage to housewives : UN reports say that 80% of Indian women didn’t have bank accounts till 2014. So, most of their possessions are in the form of cash and gold. They have been hoarding money for years but they are unintended victims of the process. Whatever they had saved over the years will come to the limelight of the family members. They should learn to invest and save, not hoard.
8. Around 26% of the population doesn’t have access to the banking system as they don’t have the valid ID cards with them and I wonder what will happen to those people’s money. This step might encourage people to get documented and be a part of the system.
Conclusion : Demonetization is not a sudden one-step action against graft but part of a bigger picture to control and curb corruption and the parallel economy that the tax evaders are running. If people can wait in queues for hours for getting latest phones, reality show auditions, some mega sale at a mall but whining while standing in a queue in a bank or outside an ATM then the interests of those people might not be concurrent with the national interests.