Show me the money

Ban on Rs 500, Rs 1000 notes deals with stocks of black money. But push to a cashless economy is premature.

Written by Ila Patnaik | Published:November 11, 2016 12:24 am
demonetisation, notes demonetised, currency demonetised, india currency, Goa, Goa tourism, demonetisation impact, impacts, india news, indian express While the ban may address the problem of the stock of black money in cash, the question is will it encourage people to disclose all income and start paying taxes on it? (Source: Reuters)

The sudden and dramatic announcement by the prime minister banning Rs 500 and Rs 1,000 notes issued by the Reserve Bank of India has a number of objectives. Among them are tackling counterfeit notes, curbing black money and restricting finance for subversive activities. While progress will be made by suddenly making the present high denomination currency illegal, we need many more steps before the desired objectives can be fully achieved.

One of the main objectives of replacing old currency notes by printing new notes is to tackle the problem of fake currency notes in circulation. In India, there is fear that counterfeit currency is being used for financing terror as well as other subversive activities. If security features of the present notes are weak and there is rampant counterfeiting, there is a need to replace these with new notes that have better security features. Usually, this is done gradually. So, for instance, the RBI could have started issuing new Rs 500 notes, allowed old notes to be exchanged for new ones and issued a deadline after which the old notes would not have been legal tender.

This is typically the strategy followed by most central banks, who are, in general, in a constant battle with counterfeiters. Curbing counterfeiting of internationally accepted currencies like the US dollar, which is used all over the world for legal and illegal activities is supposed to be a constant challenge.

In India, the problem of fake rupee notes has been noticed for many years. It has been difficult to estimate the size of the fake notes in circulation. It is not known whether the counterfeiting is done in India or across the border. Currency notes with better security features are certainly welcome, though it is not obvious that such a sudden move would make a big difference to this objective. It could have been done slowly with banks not giving out old notes until the last hour.

Then, the objective of curbing black money. Black money is money that has not been declared as income to the income tax authorities. It is not necessarily obtained from crime or corruption. It may be acquired by not showing the output of a factory and not paying excise on it. All black income is not held in cash. For instance, it may be in foreign bank accounts. Similarly, all cash is not black income. Legitimate businesses deal with large amounts of cash. Petrol pumps, white goods dealers, textile merchants and jewelers often have large cash holdings by the end of the day with many consumers paying in cash.

Cash will either have to be exchanged by the holder at a bank himself or through someone. For some days, it will be disruptive for business. It would not be surprising if, in some time, a black market pops up to exchange old notes for new notes, thereby converting black money into white. This could be in the 50-day period in which the old notes can be exchanged with new ones. There would, no doubt, be a discount, if this happens.

But the ban will certainly hit those who are holding black money in cash. Corrupt bureaucrats, politicians and many more with piles of cash must be wondering how to handle the situation and how long to wait before they try to solve it. Since the present high denomination notes are going to be replaced by new notes, it is not that cash will no longer be used for corruption and storing black money — though it is likely that dollars, gold or diamonds could become more popular for such illegal purposes due to the fear of such a ban recurring.

However, while the ban may address the problem of the stock of black money in cash, the question is: Will it encourage people to disclose all income and start paying taxes on it? Or does that require simplification and rationalisation of the tax system? As long as agricultural income can be used as a route to avoid taxes and indirect tax rates have multiple rates and exemptions, the problem of tax evasion is unlikely to go away.

On the negative side, the disruption in transactions could hit the emerging growth of consumer demand. In 1978, India denotified the 1,000 rupee note, and nothing much happened. A black market sprang up, people who had these notes took a loss while selling off these notes to people who could claim these as legitimate income. At the time, those notes were 0.6 per cent of the cash in circulation. Things are more daunting this time as 85 per cent of the cash in circulation is in the old Rs 500 and Rs1,000 notes.

A monetary economics perspective is useful. In India, there is one concept of money supply for the formal economy (the total money in all banks) and another concept of money supply for the informal economy (the cash in circulation). We will have an 85 per cent reduction in money supply for the informal economy for some days. Money is the means of transacting in the informal economy — payments will be held up and purchases will be postponed.

Some see this move as a way of pushing the country forward towards a cashless economy. There are two problems with this perspective. First, it is not that high denomination currency notes will go away. The existing notes will be replaced by new notes. Second, the cashless ecosystem is not ready to support a whole range of new users; this push is premature. Those who move from the denotification of the Rs 500/1,000 notes will not take to electronic payments. Their quest could instead take them to new notes, gold, US dollars and the bitcoin.

The writer is professor, National Institute of Public Finance and Policy, Delhi

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    Prashant
    Nov 11, 2016 at 6:42 am
    In delhi people r converting their old cash with Gold without any PAN proof,,,,,how is this possible???,,, definitely govt officials r involved,,,,govt took right decision but Now this 1 month is very crucial,,more strict vigil shd be kept on all gold dealers
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      Prashant
      Nov 11, 2016 at 6:29 am
      Who is responsible for all this Huge black money nd hawala nd fake rackets,,,,,, obviously 60 yrs of congress regime,,, atleast Modi took some initiative,,,what congress did in past 60 yrs???,,,
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      1. H
        Hemant Kumar
        Nov 11, 2016 at 8:32 am
        There must be a raid on her house.
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          Astha
          Nov 11, 2016 at 8:59 am
          Baba Ramdev declared in 2012 that if the government want to curb blackmoney, it only has to withdraw Rs 500 and Rs 1000 notes. Do you then think he will be holding his wealth in the form of these notes? And everyone knows, without giving any jobs, how much monay this man has been making by grabbing lands in Maharashtra! So will the prime minister take care of this? (which is of course one man out of the thousands corrupt) I guess not!
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            Harsh
            Nov 11, 2016 at 8:47 am
            Neither does this move stop corruption or tax evasion, nor counterfeiting currency, given that some countries get the ink, machines and silver thread from the same places as India. In the short run, the move will drastically affect the economy, causing huge inconvenience and an almost standstill in the economy. In the long run, the shceme serves no purpose. Besides there are also ethical issues involved: 1. How will the government prove that its party did not know of the move beforehand, especially after Nalini Maurya's picture holding stacks of the new notes. 2. What about the black money not held in the form of these notes. what about PM's own blackmoney. 3. It is as good as trading a monetary deficit for a trust deficit. Such moves will reduce the reliability of currency. And significantly impact the ease of doing business.
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              Junu
              Nov 11, 2016 at 8:12 pm
              She should be our finance minister. Jai ho . Since you're a professor i have no idea how many students brain you will destroy.
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              1. M
                Mugdha
                Nov 11, 2016 at 1:56 am
                The Pm modis move is laudable in sense that it will curb counterfeit, promote cashless society and may act as deterrence for illegitimate and legitimate cash holders and will ensure free flow of money to a large extent.The newly arriving saving will help bank to tackle NPAs and ensure investments.However, the sudden move has halted day-to-day business chiefly of traders and rural dwellers,which is unwarranted.
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                  Trun
                  Nov 11, 2016 at 4:41 am
                  Indians are buying foreign currency and stashing them as they lost trust in fear of rupee changing colour.
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                    Ramakrishnan
                    Nov 11, 2016 at 4:05 am
                    I effeminately agree with the policy but its hardly a move to stop black money its more a means to collect tax from people and eliminate compeion to the elections. lt;br/gt;A few years back the cm of Gujarat offered 2 crore from his pocket to the Mumbai police department in light of the Mumbai attacks, the now PM has less than Rs 30,000 in his bank account, its quite clear this is a planned move and more than a few politicians would have easily disposed of their money in land and gold like our beloved pm, an effective way to cripple the compeion and look like a clean despite being dirty.lt;br/gt;Bravo
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                      Nathan
                      Nov 11, 2016 at 1:15 am
                      WITH MY POOR KNOWLEDGE, I AM NOT ABLE TO CONCEPTUALIZE WHAT THE AUTHOR OF THE ARTICLE WANTS TO CONVEY TO THE PEOPLE. SHE IS EXPLAINING WHAT BLACK MONEY IS AND FAKE CURRENCY IN CIRCULATION. SHE IS TALKING ABOUT AMERICAN GREENS AND BIT COIN. WHAT IS THE RELEVANCE OF THE ARTICLE TO THE CAPTION OF THE ARTICLE. KNOWN THINGS ARE SIMPLY REPEATED. THE COGENCY IS LACKING.
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                      1. A
                        A
                        Nov 11, 2016 at 4:22 am
                        Would it surprise you to know Sweden is almost totally cashless? And the reason is related to ABBA?lt;br/gt;lt;br/gt;Björn Ulvaeus made his fortune as one of the four members of ABBA, but he’s now making history all over again by leading the cashless revolution.lt;br/gt;lt;br/gt;It began after Björn’s son’s Stockholm apartment was burgled twice in 2008. As Björn remembers, “There was such a feeling of insecurity. It made me think: What would happen if this was a cashless society, and the robbers couldn’t sell what they stole?”lt;br/gt;lt;br/gt;He began writing blogs and articles on how the entire criminal economy depended on untraceable cash. If there was a digital record of every transaction, robberies, fraud and financial crimes would end.lt;br/gt;lt;br/gt;Then, in 2011, Björn stopped using cash altogether (and he hasn’t touched it for the five years since).lt;br/gt;lt;br/gt;When he opened the ABBA Museum two years later, it didn’t accept cash, and he put this message outside the entrance:lt;br/gt;lt;br/gt;“I challenge anyone to come up with reasons to keep cash that outweigh the enormous benefits of getting rid of it. Imagine the worldwide suffering because of crime, from drug dealing to bicycle theft. Crime that requires cash. The Swedish krona is a small currency, used only in Sweden. This is the ideal place to start the biggest crime-preventing scheme ever. We could and should be the first cashless society in the world.—Björn Ulvaeus”lt;br/gt;lt;br/gt;Amazingly, people started to notice. More switched to cards and digital payments. The Swedish banks created a cashless app, ‘Swish’, and Swedes began Swishing.lt;br/gt;lt;br/gt;Today, just 3 years later, Sweden’s cashless revolution is almost complete. Bills and coins make up only 2% of Sweden’s economy. Only 20% of all consumer payments in Sweden this year will be in cash, compared to 75% in the rest of the world. lt;br/gt;lt;br/gt;The result? Crime is down. Bank robberies are down 70%. Muggings and burglaries have also plummeted. lt;br/gt;lt;br/gt;Sweden was the first European country to print a paper currency in 1661, and it’s likely to be the first country where paper and coin currencies will disappear altogether. Other countries will follow, with Norway and Denmark also down to just 6% cash transactions.lt;br/gt;lt;br/gt;Including the star of a ’70’s pop band, who is spearheading the cashless revolution after making his money singing “Money, money, money…”lt;br/gt;lt;br/gt;Björn started his movement by 'being the change'. (Just not the change in his pocket This message came to me in Whatsapp.Of course India can not be compared to Sweden considering the potion and educated level of the potion. By giving incentive for cashless transaction,slowly the % digital transactions can be increased.The rider is that effective safety features to be built in
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                          Archana Sinha
                          Nov 11, 2016 at 11:26 am
                          I hear that a black market for converting older notes to new ones is on the rise in nearly every city. How is the government going to combat this menace?
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                            Brave Heart
                            Nov 11, 2016 at 5:33 pm
                            With this move, every citizen is forced to use the card or online transactions for their daily needs which will make all the money accounted for.
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                              Dave
                              Nov 11, 2016 at 11:51 am
                              congratulations, this is a very clever way to catch all those criminals who earn cash money illegally. They now must declare the money via a bank or see the value disappear in 50 days.lt;br/gt; So do not worry about the 'white' money. Maybe that will be changed again in 2 years time!
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                                dd
                                Nov 11, 2016 at 2:31 am
                                Your article is also premature. You know only negative side....do you know each coin has 2side....you are thinking one way...
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                                  truth is
                                  Nov 11, 2016 at 7:11 pm
                                  How does it deal with stocks with black money smarty pants? Stock portfolios can be monitored and are linked with transfers from banks
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                                    truth is
                                    Nov 11, 2016 at 7:14 pm
                                    cashless economy? where get your terminology? Black money cashless economy you mean :-D If you have it in bank it is as liquid or cash. If you have in trash bag and don't know where it came from that cash is not accounted in economy anyways. So net effect "0"
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                                      Dr Noorul
                                      Nov 11, 2016 at 1:16 am
                                      Sudden announcement of ban on 500 and 1000 rupee notes has paralysed the daily life of commons men and the w system of business. Such announcement should have been made months before but the Modi government was bound to announce abruptly to turn the minds of public from worse condition of Kashmir and fake encounter of Bhopal.
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                                      1. S
                                        Sreenivasan
                                        Nov 11, 2016 at 10:02 am
                                        We are not pushing for a cashless economy. Instead we are providing convenience to those who wants to keep cash in their boxes, by introducing Rs.2000 notes.
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                                          gc
                                          Nov 11, 2016 at 9:41 am
                                          Even if a politician, rich man or corrupt official buys gold to make his money white, the jeweler who got the notes have to convert them into white, or even if he buys something else, then that person has to convert that money into white or at least bring to the bank. Kuch bhi karlo, paisa has to come into the banking sector.that is the genius of this.Then that money will be used for your country's welfare.If road is built, it is built for you.15 lakhs installment has reached you.This is not the first installment though, you the people have India have already received many installments, since this government came into ^power, in terms of coal allocation money etc.
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                                            gc
                                            Nov 11, 2016 at 7:50 am
                                            The higher value new notes are a necessity given the reality of economics in india at the moment, IT DOES NOT MEAN THEY CAN NOT BE ABOLISHED IN A FEW YEARS! who knows? Next YEAR WHAT WILL THEY DO?
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