By Lindsey Mattila (CMC ’17)
India’s Prime Minister, Narendra Modi, announced a policy to reform India’s sizeable cash economy by voiding the two largest note denominations and enacting a plan to decrease the amount of notes in circulation, which will help to address India’s problems with “black money.” Modi’s plan was inspired by the European Bank’s recent decision to stop circulating the 500 euro note which was frequently being counterfeited.[i] Within hours of his announcement, the 500 and 1000 rupee notes were nearly void in basic transactions.[ii] This came as a shock since India’s economy is known for being relatively informal; few Indian businesses are legally registered under governmental tax codes and a large majority of transactions are through cash. This has led to a second problem of people not depositing cash into bank accounts, making their savings untaxable.
Due to counterfeiting problems, Modi announced that the 500 and 1,000 notes, currently the highest denomination, which are roughly $7.50 and $15 USD respectively, would no longer be legal tender after midnight on November 8th.[iii] .The government will be replacing these notes with new 500 and 2,000 notes in the next few months. This will not be an easy overhaul since 85 percent of notes in circulation were the 500 and 1,000 notes that were deemed void.[iv]
The fact that people rely so heavily on cash has posed a problem for the Indian government. It has led to a trend of fewer people depositing their cash into banks, which means less cash is verified for authenticity. It also means that there are large amounts of cash that are not taxable by the government. According to the Indian Finance Minister, only 2.89 percent of Indians paid income tax in 2013.[v] Additionally, rough estimates speculate that India’s cash economy is worth a fifth of its total GDP, which means the government is missing out on a huge source of tax revenue.
The government is hoping that if they are able to get more people to deposit their money, they will be able to eliminate the counterfeit cash in circulation, and they will also be able to tax more of the current cash-based economy. To get more people to deposit their money, credit for the old notes that are still in circulation will only be issued when citizens deposit the notes to a bank with state identification by December 30th. Additionally, to help prevent the economy from returning to its current state, Modi is setting ATM limits so that the highest note that can be withdrawn is the 100 rupee.[vi]
Although it is clear that the government needed to enact legislation to bring the “black money” back into the formal economy, many are concerned that the policy Modi announced was an impulsive decision that will affect the poor the most. Small traders, laborers, and vendors, for example, rely heavily on cash for both business and personal transactions. Using credit or debit cards linked to bank accounts requires state identification and banking fees that many poor people cannot afford. For these reasons, Modi’s proposed monetary reforms disproportionately burden the poor. This poses a challenge to the implementation of the policy, a key feature of which is the depositing of expired notes. To address this, the Indian government is giving cash subsidies to the poor who deposit their expired notes, but it is unclear whether or not this subsidy will cover the costs of acquiring formal identification and other related expenses.[vii]
The government is confident in its decision and believes that addressing black money and tax evasion is the only way to eradicate extreme poverty in India since the government would be collecting more revenue that can be spent on poverty alleviation programs. Modi’s policy is the first step in modernizing the Indian economy to rely more on electronic banking and transactions rather than just cash savings and transactions.[viii]
[i] Rajesh Kumar Singh and Iain Marlow. “India Abolishes 500 and 1,000 Rupee Notes to Fight Corruption.” Bloomberg. 8 November 2016. http://www.bloomberg.com/news/articles/2016-11-08/india-abolishes-inr500-1-000-rupee-notes-to-fight-corruption
[ii] Merrit Kennedy. “In Surprise Move, India Voids 500 and 1,000 Rupee Bills to Fight Corruption.” NPR.org. 8 November 2016. http://www.npr.org/sections/thetwo-way/2016/11/08/501199606/in-surprise-move-india-voids-500-and-1-000-rupee-bills-to-fight-corruption
[iii] “India Demonetization: Chaos as ATMs run dry.” Al Jazeera. 8 November 2016. http://www.aljazeera.com/news/2016/11/india-demonetisation-chaos-atms-run-dry-161109061403011.html
[v] “How Many People In India Pay Income Tax? Hardly Anyone.” International Business Times. 6 June 2013. http://www.ibtimes.com/how-many-people-india-pay-income-tax-hardly-anyone-1294887
[vi] “Shock as India scraps 500 and 200 rupee bank notes.” BBC News. 9 November 2016.
[vii] Rajesh Kumar Singh and Iain Marlow. “India Abolishes 500 and 1,000 Rupee Notes to Fight Corruption.” Bloomberg. 8 November 2016.
[viii] “Demonetisation decision was a logical step in journey towards cashless society: Arun Jaitley.” Economic Times. 10 November 2016. http://economictimes.indiatimes.com/markets/expert-view/demonetisation-decision-was-a-logical-step-in-journey-towards-cashless-society-arun-jaitley/articleshow/55352466.cms