India grapples with the effects of withdrawing 86% of cash in circulation
A crackdown on India’s black economy makes life harder for everyone
A NEW strain of trickle-down economics has been spawned by the decision, on November 8th, to withdraw the bulk of India’s banknotes by the end of this year. As holders of now-useless 500-and 1,000-rupee ($15) notes rushed to deposit them or part-exchange them for new notes, an e-commerce site offered helpers, at 90 rupees an hour, to queue outside banks in order to save the well-off the bother.
Elsewhere, a chronic shortage of banknotes in a cash-dominated economy has left most trades depressed. Seven out of ten kiranas (family-owned grocers) have suffered a decline in business, according to a survey by Nielsen, a consultancy. Supply chains, in which wholesalers and truckers deal mostly in cash, have fractured. Some 20-40% less farm produce reached markets in the days after the reform. City folk admit to hoarding the 100-rupee note, the largest of the old notes to remain legal tender. Taxi drivers refuse to break the new 2,000-rupee note. Road-tolls have been suspended until at least November 24th, to prevent queues. Beggars have disappeared from parts of Delhi; no one has spare change.
India’s prime minister, Narendra Modi, is gambling that this temporary pain will be worth it. His goal is to flush out “black money”, stores of wealth that bypass the tax system, finance election campaigns and grease the wheels of high-level corruption. An enforced swap of high-value notes, say the reform’s boosters, acts as a tax on holders of illicit wealth. The element of surprise is disruptive but without it, there would be time for black-money holders to launder their funds by purchasing gold, foreign currency or property. A tight deadline makes it hard for holders of large stashes of notes to swap or deposit them without alerting the tax authorities.
This swiftness comes with a cost. Aside from cases where hyperinflation has rendered a currency worthless, such swaps generally take place over long periods to avoid disrupting commerce. GDP growth might be as much as two percentage points lower this quarter and next before returning to normal as the money stock is replenished, reckons Pranjul Bhandari of HSBC, a bank. Much depends on how quickly new cash can be swapped for old. It has not been a smooth process so far. The Reserve Bank of India (RBI), which issues notes, waited for six days before setting up a task force to ensure ATMs could dispense the new 2,000-rupee note. Only a quarter of ATMs in four big cities were full on November 21st, according to Goldman Sachs.
Yet there are signs that the reform is nudging Indians out of cash and into bank deposits and plastic, where money can be tracked. In the fortnight after the announcement, bank deposits were up by 5.1trn rupees, thanks to an influx of old notes and restrictions on withdrawals of new ones. PayTM, a provider of digital wallets, reported a surge in transactions.
Despite the distress, and the raucous protests, the reform seems to have widespread support. Bashing the rich is popular even if the poor are inconvenienced. Some may also hope it will bring new state benefits for the poor and make housing more affordable. Indian real estate is so expensive in part because it is a store of illicit funds. In theory, whatever black money cannot be laundered will be worthless, yielding a gain for government’s finances and perhaps ultimately for poorer Indians. But such a boost cannot be relied upon. The RBI has not yet formally said that old notes will be cancelled for good, says Ashish Gupta of Credit Suisse, and it may be loth to do so. No central bank likes to say it no longer stands behind the paper it issues.
This article appeared in the Finance and economics section of the print edition under the headline “Short-changed”