It has been a historic week, globally and otherwise. While the world stayed at the edge of their seats waiting for the verdict by the American people, closer home, in by far the boldest move by the current government, high denomination 500 and 1000 currency notes stopped being a legal tender in a matter of a few hours. The reaction inspired awe, shock and even a frenzied panic, quite inevitably.

As we read through a detailed press release by the Ministry of Finance, the term ‘shadow economy’ caught our eye. According to a World Bank report, the size of the said shadow economy rose from 20.7% of the national GDP in 1999 to 23.7% in 2007. To put that statistic into perspective, a whopping 250 billion USD in 2007. To elaborate more on what shadow economy exactly means and how does banning the High Denomination Notes helps- let’s take into account the following facts.

  1. High Denomination Notes in Legitimate and Shadow Economy:

In a legitimate economy, bigger transactions are generally carried out electronically, the reason being convenience and eliminating the risk of carrying the vast amounts of physical cash around.

However, the underground or ‘shadow economy’ thrives on cash. Cash offers anonymity, leaves no trails behind and is generally universally accepted. So, it becomes the mode of payment for the shady, anti-social elements in an economy, from money launderers and tax evaders to the drug traffickers and terrorist organizations. If you eliminate the high denomination notes, the volume of the equivalent money increases manifold, thus making it a lot harder to move around.

How does this Shadow Economy work?
FICN (Fake Indian Currency Notes): To picture the extent of the counterfeit money present in our economy, every 250 out of 10 lakh notes in India are fake. For a cash-based economy like ours, this is enormous. The consequences of the circulation of fake currency notes are incredibly harmful in the long term, the biggest being inflation. To put it into simple terms by breaking down the problem:
The fake currency circulates faster. If an individual is in the possession of counterfeit money with his knowledge, he will try get rid of it faster and in all likelihood, will not mind paying more  than the worth of his purchase because, anyway the money isn’t real. This leads to an illusion of increase in purchasing power of the individual and price of the commodity goes higher eventually leading to the price of the product going up. If you scale up this instance to a nation, the effect is exponential and eventually leads to a general rise in inflation.
Counterfeit notes reduce the credibility of the currency in the global markets and make it weaker.

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Terrorism Finance: Well, let’s face it. The nations around us rarely follow ‘Love Thy Neighbor’ policy with India. This is especially true in the time when the situation is particularly dire in the valley of Kashmir with cross-border terrorism and counter surgical strikes. The counterfeit money that has infiltrated in the Indian economy can almost range up to 1500 crore INR a year. The parallel economy that comes with the fake currency finances the operations of the anti-social, fear-mongering terrorist organizations

Financial Inclusion: There is a large section which isn’t financially literate in India and the running government’s earlier policy ‘Jan Dhan Yojna’ aimed to get rid of that. However, the demonetisation of 500 and 1000 will force this section to open bank accounts leading to financial inclusion on a larger scale.

The Drugs and Human Trade: The illegal trade involving drug trafficking and flesh trade prevalent in India, in fact the entirety of South-East Asia follows a very cash-based business model. It often involves moving the large volumes of cash across borders. The increased volume of the cash consignment entails a higher risk of detection and prosecution while traversing territories. In fact, even the credit card payments made to purchase legal vices like porn and prostitution (in certain areas) are generally turned to cash to enable money laundering.

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Tax Evasion: As the Prime Minister addressed late Tuesday evening, there were two very distinct emotions in the air, the jubilation among the honest working-class and a barely-disguised panic among the shady lot who were suddenly hit by a crisis that they did not see coming. The stacks of cash shoved in attics suddenly ran the risk of becoming no more worthy than paper. Tax Evasion hollows out the economy cutting down on the funding for public institutions and infrastructures. The staggering difference between the RBI-projected tax returns and the actual number is the biggest tell-tale sign of all the money that is unaccounted.

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Electoral Corruption: The elections in UP and Punjab are right around the corner, the states very notoriously famous for a stunningly corrupt political framework. The often discovered but mostly hidden accounts of bribing the poorest of poor with liquor but mostly cash to garner votes is a very sad truth plaguing elections in India. The argument here is of course they can obviously switch to a 100 rupee note instead of a 500 one but the risk of detection because of the sheer volume increases by a lot and there are a better chances of safe and sound elections.

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Like everything, there are two sides to every story:

  1. The times of military or natural calamities: In case the financial system of a country breaks down, the people would want to resort to cash. In case of warzones where refugees leave their houses in multitudes, the hard cash would come in handy instead of ways of electronic payments. However, this is a one-off scenario which does not counteract numerous benefits the discontinuation provides.
  1. The infamous Indian Jugaad: The 50-day limit to exchange the notes has prompted the black money hoarders to make it ‘white’ by trying to make a deal with people with accounted sources of income from commissions ranging from 10% to 50%. The night of November 8, the banks and the stores were kept open till late to increase their own profit where people could buy things and get rid of the cash they could not legitimately exchange. In a matter of two days, a whopping 250 crores rupees of gold was sold to legitimise and hoard the unaccounted money. This fact is disheartening as the people aren’t conscientious enough to let the change come about.
  1. The cost of printing money: As cited in Economic Times, the 1000 rupee note is the cheapest note to be produced in India which requires only 0.32 percent of its face value to print whereas the costlier money stays. The move led to 22 billion notes being junked out and the cost of printing the costlier money of lower denominations should also be taken into account.

It goes without saying that the policy and the intention behind it is commendable. However, it must be noted that it is a deterrent and not an eliminator of corruption. Increasing the risks of detection with more equipped scrutiny and easily accessible alternative modes of payment, it is a welcome change. With this move, the state stops to provide the tools of trade to the very people who pose a threat to its harmony and balance.

 

References

  • Making it Harder for the Bad Guys: The Case for Eliminating High Denomination Notes by Peter Sands- Harvard Kennedy School
  • Purushottam Goyal’s article.

    Author – Priyanshi Goyal

    Designer – Himali Tripathi