In­dia’s at­tack on dirty money

The Myanmar Times - - News - KAUSHIK BHATTACHARYA SUNNY KU­MAR SINGH news­room@mm­

RE­CENTLY, In­dia’s govern­ment de­cided to with­draw 500 ru­pee (US$7) and 1000 ru­pee cur­rency notes. The sud­den­ness of the de­ci­sion has taken In­dia by sur­prise. While many have se­verely crit­i­cised the de­ci­sion, some have hailed it as a bril­liant move to un­cover black money.

The close re­la­tion­ship be­tween large-de­nom­i­na­tion cur­rency notes and the black econ­omy is well es­tab­lished. For ex­am­ple, criminals – and more re­cently, ter­ror­ists – are known to be ma­jor users of large de­nom­i­na­tions like the US$100 bill or 500 euro note. Com­mon sense, there­fore, sug­gests that in­creas­ing the use of al­ter­na­tive modes of pay­ment like cheques, cards or in­ter­net bank­ing, re­duces cor­rup­tion and ush­ers more transparency into an econ­omy. Our re­search, us­ing an­nual panel data of 54 coun­tries for the pe­riod 2005-14, seems to sup­port this com­mon wis­dom. We found that greater re­liance on large de­nom­i­na­tion notes, in­ter alia, is pos­i­tively as­so­ci­ated with more cor­rup­tion in an econ­omy.

In In­dia’s case, there is an ad­di­tional prob­lem re­lat­ing to the forgery of large-value notes. In­dian in­tel­li­gence agen­cies sus­pect that th­ese forged notes are be­ing cir­cu­lated in In­dia with the help of a for­eign power. Thus, there ap­pears to be good merit in the de­ci­sion of the In­dian govern­ment.

The pol­icy, how­ever, could be crit­i­cised on sev­eral grounds. First, the In­dian govern­ment has de­cided to rein­tro­duce cur­rency notes of large de­nom­i­na­tions (in­clud­ing the 500 and 2000 ru­pees) with in­creased se­cu­rity fea­tures. Our study sug­gests that with their rein­tro­duc­tion, it is likely that black money will rear its head again. Fur­ther, we fear that the pos­si­bil­ity th­ese notes will be forged again can­not be ruled out – es­pe­cially if a for­eign power is in­volved.

Sec­ond, the cur­rency sys­tem in In­dia, as in other parts of the world, is un­der the purview of the cen­tral bank. While legally the govern­ment can in­ter­vene in the work­ing of the cen­tral bank, in­ter­ven­tions of this na­ture are gen­er­ally not con­sid­ered de­sir­able. At present, it is un­clear the ex­tent to which the Re­serve Bank of In­dia has been in­volved in this de­ci­sion. What is clear, how­ever, is that there was no de­bate in the In­dian par­lia­ment on this is­sue. Pro­ce­du­rally, if a “le­gal ten­der” is with­drawn, that should re­quire – if not legally, at least eth­i­cally – par­lia­ment’s sanc­tion.

Third, the sud­den­ness of the de­ci­sion had been a big sur­prise to all. A golden rule in pol­icy-mak­ing is that rad­i­cal de­ci­sions in­volve more risk. An al­ter­na­tive, and safer, ap­proach would have been to with­draw th­ese notes grad­u­ally with the help of the cen­tral bank. This ap­proach would have avoided the short-run prob­lems re­lat­ing to a paucity of cash and re­duced the trans­ac­tional costs of the pol­icy greatly.

One pos­si­bil­ity is that sur­prise was key to the pol­icy’s po­ten­tial suc­cess, as it gave the own­ers of black money no time to ad­just. How­ever, we ar­gue that be­ing rich, such peo­ple have the nec­es­sary money and man­power to re­act quickly. For ex­am­ple, news­pa­pers are re­port­ing that rail­way tick­ets are cur­rently be­ing booked in bulk with old notes of high de­nom­i­na­tion. To carry out this type of work on a large scale, one ob­vi­ously needs money and man­power. Those who have both can fol­low a sim­i­lar strat­egy of di­vid­ing big cash into many small chunks and con­vert­ing them ei­ther to de­posits or small de­nom­i­na­tions. Ob­vi­ously, the pol­icy of the In­dian govern­ment will in­crease the cost and risk as­so­ci­ated with such ac­tiv­i­ties now and in this way may lead to a re­duc­tion in cor­rup­tion. How­ever, the above ob­ser­va­tions also sug­gest that dra­matic changes are un­likely.

More im­por­tantly, our con­cern is that the very high trans­ac­tion cost the pol­icy has un­leashed could it­self lead to the cre­ation of a (black) mar­ket for con­vert­ing big notes into smaller ones. It could also lead to the hoard­ing of smaller-de­nom­i­na­tion notes and cash in gen­eral. The pos­si­bil­ity of hoard­ing im­plies that the de­mand for cash would ex­ceed the nor­mal trans­ac­tional need and sat­is­fy­ing it will not be easy in the short run. If the hoard­ing prob­lem is not ad­dressed quickly, then the cur­rent cri­sis may per­sist for a long time.

Fi­nally, while our re­search sug­gests that the re­moval of large notes helps a coun­try to re­duce cor­rup­tion, we do not sug­gest that cash as a whole should be re­moved to­tally. Cash trans­ac­tions are anony­mous, while all other trans­ac­tions leave a trace. To­day that trace may help us to re­duce cor­rup­tion, but the lack of anonymity in an eco­nomic trans­ac­tion al­ways helps the in­cum­bent po­lit­i­cal power. We fear that dic­ta­tors will love this power, as it will help them to an­tic­i­pate any po­lit­i­cal move by the op­po­si­tion. – Pol­icy Fo­rum

An al­ter­na­tive, and safe, ap­proach would have been to with­draw th­ese notes grad­u­ally with the help of the cen­tral bank.

Kaushik Bhattacharya is cur­rently a pro­fes­sor of eco­nomics at the In­dian In­sti­tute of Man­age­ment Lucknow. Sunny Ku­mar Singh is an as­sis­tant pro­fes­sor of eco­nomics at Narsee Mon­jee In­sti­tute of Man­age­ment Stud­ies, Hy­der­abad, In­dia.

Photo: EPA

In­dian Youth Congress ac­tivists show repli­cas of old In­dian ru­pee notes dur­ing a protest against the ru­pee note change in New Delhi, In­dia, on Novem­ber 18. In­dian Prime Min­is­ter Naren­dra Modi an­nounced the elim­i­na­tion of the 500 and 1000 ru­pee bills hours be­fore the mea­sure took ef­fect at mid­night Novem­ber 8.

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