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Demonetization & the Fight Against Black Money! Will it work?

A few days back,PM Mr. Narendra Modi, in a televised address to the nation announced the demonetization of existing 500 & 1000 Re notes. If shock & awe were the intent, it was achieved very successfully. No one had a clue it seems, general people or be it banks, everyone was wondering what next! The intent is quite laudable. The demonetization will mean immediate stop of legal tender of existing 500 & 1000 Re notes and that possibly could mean death knell for thousands of crore of black money stored in cash by unscrupulous people. This has been hailed as the surgical attack against black money, using the term which had just got famous from the attack on Pakistan army near the border. Question is whether it will serve the purpose and will it match the hype it generated!

Logically it seems that this has the potential to kill existing black money to a large extent. These notes cannot be exchanged at banks etc, less because of operational night mare but more because of setting the system alarm on and attracting the eyes of Income Tax, Enforcement Directorate etc. A few press releases by the Finance secretary, Income Tax department highlighting need of ID proof, in camera exchange and auto reporting of high value cash transactions (> 2.5 lakh seems) seems to buttress these figures. Challenge is that it is going to create fear more on those fringe players, more likely commoner who kind of beat the system to just hoard a few lakh of Indian currency (small business class, professional services firms/ individuals etc) but the bigger fish would have never thought anyway, of going to the bank. So we are seeing varied impact in our daily lives. For common people,

  1. Cash strapped common people lining to the banks/ post offices to ensure they have minimal money to go about their daily chores of buying groceries & daily items
  2. Rush for petrol pump, medical shops etc to utilize whatever 500/1000 notes are there before Nov 11 mid night
  3. Empty malls while serpentine queues outside ATM/ bank branches etc

For the real black money hoarders, different impacts are being seen:

  1. Big rush to jeweler shop to covert cash to gold
  2. Big rush for hawala operators to exchange Indian currency with USD or other currency to be converted back to INR once new notes are released (at a hefty rate)
  3. A parallel economy of illegal tender market where older notes are being exchanged with 100 or other legal tenders at a hefty discount

A few sets of people are seemingly making the most, hawala operators & gold shops. Hence grey market gold price, forex exchange rates have sky rocketed, nearly 1.3-1.5 times the regular rates.

Obviously the GOI understands this effect and hence have started raiding big hawala operators, gold shops etc based on internal information. This is a move in right earnest and this will ensure that the big fish does not escape the brunt with minimal impact while common people suffer.

A proper implementation has many direct & indirect impacts:

  1. Supposedly this cleans off most of existing black money,
  2. Soothing impact on prices of items which sees more cash transactions in black, for e.g. real estate, agricultural land sales etc.
  3. Lower the inflation as parallel economy is crippled, at least momentarily
  4. Businesses who have been transacting more in cash currently, may likely switch to more cashless/ electronic transactions
  5. More customers will start switching to digital money

But at same time, black money hoarders may switch from keeping money in cash to more in gold or land/ real estate/ forex to prevent similar challenges in future.

The success of the current move will need to be judged in future. The Janata Party government had done something earlier as well a few decades back but obviously it did not have necessary impact as is evident now. So what would ensure that past does not repeat and the huge harassment borne by common people and the banker etc does not go futile?

  1. While current circulation is contained/ minimized, steps needs to be ensure that future such transactions in huge cash component are made nearly impossible by both proactive legislations and as well as aggressive monitoring of such transactions
  2. Corruption, which is at the heart of such black money, is addressed more effectively. Till now we have not seen much success. Be it government institutions (e.g. municipal bodies etc) or dealing with political parties or small businesses/ private practices of professionals (evading taxes) are monitored effectively and penalties/ punishments speedily given to ensure deterrence

GOI is going to reissue new 500, 1000 and introduce 2000 currency notes. So there is a high chance that the surgical strike may end up as a stop gap, short tenured redressal of black money unless there is a more holistic effort in rooting out the sources of such black money in the system. People/ institutions dealing with such cash heavy transactions to avoid taxes etc may not be proactive adopters of digital currency/ electronic transactions unless the rules & its implementations are not strong enough to force them to get into mainstream economy.

The current political party at power is already making noises on how they are going to leverage the apparent goodwill generated from the demonetization scheme for the upcoming elections in some of the major states. We can only sincerely hope that the people/ leader in the Government are not thinking in similar terms and actually ensure that common people pain does not go the drain. People may not forget & forgive this time.

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