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Impact of Modi’s Surgical Strike on Black Money – Detailed Analysis

Analysis : The Indian Iris Team- Narayan Singh Rao, Gaurav Sinha, Akash Ranjan

On the stroke of mid-night of November 8, 2016, 86.4% of Indian currency went out of circulation with a 72 hour exemption window for specific services. There were 1,650 crore Rs.500 and 670 crore Rs.1,000 notes which now have no tender value.

How black money is generated, in the first place

Black money is like moving worm in any economy. It puts a large part of currency out of institutional circulation and thus goes unaccounted for in a country’s GDP. Black money is generated through several means such as tax- evasion, under-invoicing, over-invoicing, land transactions, encroachments on land, payment of bribe, misuse of public property, misappropriation of public funds, illicit trades and in all cases where laws are violated during financial transactions.

A World Bank study of 2010 estimates that the black economy formed 23.7% of our GDP in the year 2007. It might have increased significantly since then.

Why government demonetized Rs 500 and Rs 1000 notes

Government had earlier come up with a Voluntarily Income Disclosure Scheme where citizens were allowed to deposit the cash beyond their declared income by paying 45% tax by September 30. No questions asked. Enough efforts were made to propagate this information to the citizens. Prime Minister Narendra Modi himself had warned of tougher action after the deadline in clear terms during several of his speeches.

Here are the primary reasons why government had to take this step –  

  1. To eliminate fake currency notes from the system, which are largely used for financing terrorism, espionage, arms smuggling, drugs and other contrabands in India. The majority of this was in the form or Rs 500 and Rs 1000 notes.
  2. To curb black money. While, voluntarily disclosure scheme has resulted in deposit of Rs 65,000 Cr, government anticipates that far greater amount of black money still remains undisclosed.

The two info-graphics below show the trail of fake currency notes and the magnitude of the same. A large amount of fake currency has crept into our system over a period of time.

tracing-the-fake-note-trail

pc: blog.arthakranti.org

counterfeit_currency_recoveries_and_seizures_2012-15

pc: indpaedia.com

What this action will lead to:-

Positives

  1. People with genuinely earned money will deposit the money in the accounts, and/or can exchange the notes.
  2. People with money above the exemption limits or more than they officially declared may not be in a position to approach banks as it will invite penal actions. Hence, that money will be of no value.
  3. Since the decision was sudden, black money hoarders did not get any time to convert it into other forms, e.g. purchase land, or gold, or shares etc
  4. More money will come into institutional circulation
  5. Fake currencies will be identified and filtered
  6. It will increase adoption of digital medium of payments paving way for a cashless economy in the longer term
  7. It will increase in people opening up more accounts, leading to better financial inclusion
  8. It may have an impact on the people’s behavior towards doing legitimate financial transactions, decreased evasion of taxes etc.
  9. It will reduce the circulation of black money during upcoming elections in UP early next year.
  10. Lead to increase in the value of Indian Rupees i.e. it will lead to deflation for some time.

Negatives

  1. It will create short term deficit of low denomination notes and people will have to face a lot of problems.
  2. People who work in informal sector such as drivers, maids, cooks, electricians, and plumbers etc who receive periodic payments in case will have to suffer for a short period of time. Their salaries may get delayed.
  3. Citizens who have cash but do not have any accounts or a valid ID proof, will have to get these first before they can deposit or exchange the money.
  4. Small businesses, both in urban and rural areas, will be impacted significantly in the short-term as they mostly run on cash. They receive payments for services in hard cash and make payments for inventory and goods in cash.
  5. People may face issues who are in immediate need of cash like those in private hospitals, or those with scheduled marriages in the next few weeks/months
  6. Cost of printing shall increase as printing cost per note is higher for low denominations.
  7. Property prices may go down significantly.

g-charticle-money-value2-web

pc: Livemint.com

What this action will not do –

  1. It will have no impact on the black money outside of the country
  2. It will not impact the black money in the form of land, gold, shares

Sector Wise impact of Demonetization

Here is a short summary of how some major sectors will get impacted due to this decision.

Real Estate

  • Housing prices are likely go down.
  • This might lead to more transparency in the real estate sector in future.
  • New building projects may halt for some months.

Gems and Jewelry

  • It will be good news to common people that for the next few months, prices of gems and jewelry may decrease.

Agriculture

  • With the invalidation of currency notes, the price of agriculture products may go down.
  • It may be difficult for farmers to sell their agricultural products in the market as people willing to buy will be less due to cash crunch.

Banking and Finance

  • Since India is cash transaction country, more people will deposit their money in the form of cash increasing bank’s deposits by huge margin.
  • It may lead to increase in lending activity, as banks have to maintain cash reserve ratio (CRR)

MSME

  • Majority of micro and small enterprises run on cash. With the invalidation of currency notes, these enterprises will face difficulty in receiving payments of their services and making payments for their inventory and goods.

Laborers & Daily Wage Earners

  • This will bring difficult times for laborers as they might not get their wages on time or even may have to remain unemployed for a short period of time.
  • Shutdown/halt of some projects in real estate, labor employment shall be impacted.

Consumers

  • For consumers, coming couple of months may be boon for them as deflation is expected for some time.
  • Due to deflation the prices of the several commodities shall go down including in real estate, jewelry, automobiles etc.

Along with this announcement rumors on the internet or social media too started circulating. We provide clarification on the same.

Rumor Fact
·         Your Rs.500 and Rs.1000 are Invalid and it will be of no use

 

No, it is not invalid it can be exchanged with new notes from a bank or a post office.

 

·         RBI’s new Rs.2000 note will have GPS tracking chip RBI’s new Rs.2000 note does not have any GPS tracking device.

 

This policy change will keep government, banks, and financial institutions busy for a few weeks. The success of this scheme shall depend on how well this is executed. Reaching deeper into the country will be a challenge. The Government should ensure that the people who have earned their livings through hard work should not be harassed.

To make such a major policy change successful, citizens will also need to come forward. We are expected to follow the guidelines without panicking and spreading rumors. We should not exchange Rs.500 or Rs.1000 with the people who may not be aware of these policy changes and who may not have access to a bank account. Rather, we can educate them to open a bank account. Also, with the introduction of new currency notes, we can pledge not to write anything on the currency notes.

The  Indian Iris -Op-ED

 

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