In a new tryst with destiny, once again at the stroke of the midnight hour on November 8-9, Mr.Modi effectively demonetised large denomination notes in India. Of the Rs.16 lakh crore-plus in circulation, Rs.500 and Rs.1,000 notes account for about Rs.14 lakh crore and more than 85 per cent by value of all rupee bills in circulation, as per Reserve Bank of India data.
At the heart of it is the simple proposition that large currency notes are used more to conceal than to purchase. Mr. Modi has converted this one sentence into an economic boom in his true fight against black money and corruption, which is laudable.The U.S. stopped issuing $500 notes in 1969, the European Central Bank halted 500-euro notes early this year, and Singapore killed its $10,000 note and Canada its $1,000 note in 2000. India has one of the highest cash to GDP ratios at 12 per cent (excluding the parallel economy) and despite a well-publicised amnesty scheme, the fear of god had not sunk in. Now it will, with Mr. Modi’s big-bang step.
Indeed, there will be some contraction in money supply and thus a slight deflationary impact, which will cause some inconvenience in the very short term to the average citizen, which the Prime Minister has acknowledged repeatedly in his speech, but this will be compensated by significant benefits in the long term for all law-abiding citizens.
The deflationary impact could be felt in sectors where cash is the main instrument of transaction and perhaps in some asset prices as well, such as in real estate. In the longer term, it will lead to a greater proportion of the economy shifting from black to white. Those who hold large amounts of cash may, if they deposit it in banks and perhaps pay taxes on it, be forced to join the white economy. It may also raise permanently the cost of holding cash by adding a risk premium. This may encourage people to take the certainty of paying taxes in lieu of the uncertainty of holding black cash.The next big hit should be on purchase of benami property which is a national avocation, for that’s perhaps the other big outlet and repository of black money. When the Goods and Services Tax comes into force, the government should do away with stamp duty on land at any stage of the sale; moreover, the tax rates on purchase of property should be dramatically slashed. This apart, election funding reforms and online voting are all big steps in the continuum of reforms, of which this was just the first big step.
The incentives for honesty have been improved, dramatically, with this reform measure, much needed after it was last done in 1978. This will seriously affect the stock of black money but the effect on future flows is unpredictable. However, the flows will perhaps be reduced because of the increased risk perception in cash transactions. Further, the government should take steps to increase mobile penetration, pre-bundled with cash apps, which will make it easier for those who wish to go digital.
Cash is the new trash and the Prime Minister has acted decisively, ending reams of debates, declamations and declarations. Changing human behaviour is the hardest thing to do in the world — Mr. Modi is doing just that in one of the most difficult ecosystems in the world. As a small aside, he has also dealt a body blow to ‘terror money’, and electoral politics in India will never be the same again.