1. Rs 500/Rs 1,000 Notes: Ban may not be able to stop creation of another black market in new notes

Rs 500/Rs 1,000 Notes: Ban may not be able to stop creation of another black market in new notes

Using demonetisation to attack black money is definitely a great idea; and the manner in which it has been executed by the government is praiseworthy.

By: | Published: November 10, 2016 6:22 AM
When it is believed that high denomination notes leads to generation of a parallel economy or black money, introducing new ones with higher denomination will be met with suspicion by the public. (Rupee) When it is believed that high denomination notes leads to generation of a parallel economy or black money, introducing new ones with higher denomination will be met with suspicion by the public. (Rupee)

Using demonetisation to attack black money is definitely a great idea; and the manner in which it has been executed by the government is praiseworthy. The opening of bank accounts through Jan-Dhan was a prelude to this exercise. This was followed up by the income disclosure scheme, which was a good success; and after this came this big step of simply banning the use of the R500 and R1000 currency notes. It has been done with clinical precision and with a great degree of secrecy.

However, when implementing this grand design care has to be taken to ensure that all the pieces are together, because if they are not, it would result in chaos. Let us see what has been done this time. High denomination notes have been immediately demonetised to be replaced by new R500 and R2000 notes. People can withdraw limited sums from their accounts while there are no limits for deposits—but the tax man will be watching. The attempt is to block black money and get rid of counterfeit currency. While this sounds reasonable, some issues need to be discussed.

When it is believed that high denomination notes leads to generation of a parallel economy or black money, introducing new ones with higher denomination will be met with suspicion by the public. There can always be a repetition of such an act in future, and no one would like to be left holding such notes. Further, terming R500 and R1000 notes as high value can be debated as a R500 note cannot really get one much from the market—a single can of edible oil for a family of four costs above this amount. Similarly, an R1000 note cannot pay for the milk bill for a month. Hence, the premise that these notes are high can be discussed further.

The second reason provided for this action is that there are counterfeit notes. But banning all notes because a small proportion is ‘fake’ may not be the right way out given that it involves the lives of 1.3 billion people. Also, there is no guarantee that the new notes will not be counterfeited again. In fact, it is hoped that the government has taken measures to ensure that such currency does not enter the stream as whenever new notes are introduced, the public could be fooled by counterfeit notes as it takes time to adjust before they can identify the right ones.

The other issue of demonetisation is the timing. There is compelling reason to do it immediately as this does not give time to anyone to dispose of these notes. The success of this scheme will hinge heavily on whether our systems are prepared to face this challenge, and this is where there could be some doubt. Our banks need to be geared up to making such provisions and in the past it has been observed that ATMs have tended to run out of money on long holiday weekends. With volumes increasing, the banks across the country need to ensure that all branches across the country are equipped for the same. Even prior to this move banks were never able to provide R100 notes to customers in sufficient quantities. Hopefully, this has been addressed appropriately otherwise it could lead to substantial unrest.

Households in particular will face the challenge of keeping money for emergencies. Normally, it is locked in R500 and R1000 notes which have to be deposited and then withdrawn as this need would not ebb though would be replaced by different notes of similar denominations. Hence, the next few months would be hectic as they strive to restore equilibrium.

The other part of the infrastructure which has not been put in place is a system of alternatives. For example globally plastic cards have been used for transactions for which every dealer has the swipe facility. This does not exist in the country which will create continuous disequilibrium in the demand-supply chain. Even government services like the Railways accept only cash at the counters. Further, the committee on black money had earlier suggested that all usage of cards would have to go without a charge which has not been implemented. Hence, cost of using non-cash has become more expensive. At any rate there have to be more facilities provided at every point of sale (PoS) to make the system work in future.

Is there a better way of doing the same? Probably not, because any extra time given for holding on to the existing currency would be self-defeating as black money would filter out of the system. However, if all bank branches and ATMs had been equipped with large amounts of currency from Day 0, it would have been reassuring. By putting limits on the withdrawals (which is mainly due to the logistics issue of quantities of currency involved) panic would set in till such time every household is able to reach equilibrium. Also, a longer time window for depositing such notes would have made it convenient as the December-end date appears too close given the systems that are in place today.

In terms of what has been intended there could be conjectures of how things could work out. While it will probably never be known how much such money has been blocked, it must be mentioned that often black money gets diverted into gold or property which will be hard to track. Also, often such money is converted into foreign currency and stored in different locations. It would probably be only at the fringe that large sums would be lying holed up.

Who then would be affected by this move? First, real estate prices could moderate with this move, but developers could just raise their prices by the tax amount in the medium run after forming a cartel—which cannot be ruled out. Rural households would have considerable amounts stashed away out of habit and may have some explaining to do to the tax authority. Most farm transactions are in currency notes and so is the storage if not invested in gold or jewelry. Political parties using cash for election purposes could be the other community affected, provided the notes are of high denomination. Last, there could be individuals who have been deep into corruption would find their funds blocked.

This attempt at curbing black money may not really be able to stop the creation of another such parallel economy with the new notes. But the harsh steps taken today could be a strong signal to such players that in future the government could just bring in similar measures. For sure households would remain uncertain of the future.

The author is chief economist, CARE Ratings. Views are personal

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