Demonetisation In India: Everything You Need To Know

Two incidents shook the world on November 8, 2016. One was Donald Trump, but the other was perhaps more important for the people of India, where Narendra Modi outlawed five hundred and thousand rupee notes in a shock move aimed at fighting black money. We summarise the whole thing in this article.

On November 8, 2016, two rather shocking incidents happened that would surely be written into the history books of the future. One: Donald Trump became the forty-fifth President of the United States, after fighting the longest odds in living memory. Two: Narendra Modi, the Prime Minister of India, chose this night to outlaw all existing five hundred and thousand rupee notes in a bid to fight black money and corruption in the country.

Today, we will tell you everything you need to know about the second incident.

What actually happened?

The Prime Minister made every existing five hundred and thousand rupee note invalid from January 2017. Between now and the end of the year, people can deposit their notes and get hundred rupee notes in return for them. In cases where you turn up at a bank with a suspiciously large hoard of cash, the Income Tax guy will be waiting for you to ask questions.

The rationale behind this move is that a significant amount of black money in India exists in the form of cash. Modi wanted to bring all this ‘shadow money’ out into the open, under the ambit of the banking system so that it becomes ‘white’.

How did the people react?

The initial reaction of people was of pure shock because the plan was kept under wraps quite admirably. Unless you belonged to the top political brass or the banking sector, chances are that you were caught off guard. But once the initial shock has waned, the majority of people seemed to have come to terms with the idea, and they also appreciated the intention behind the move.

What are the results so far?

So far, the result has been a lot of inconvenience for the common man who used cash as a saving tool, which is much of the informal sector. Almost 86% of transactions in India happen via cash, and with shopkeepers and small businesses refusing to take five hundred and thousand notes, small businesses have ground to a halt.

Banks and ATMs have also felt the brunt of scaling up to exchange all the existing notes for small-denomination notes. Long lines at ATMs and banks have become the norm, and estimates are that they will only lengthen as we get closer to the end of the year.

Almost everyone in the country is talking about nothing else at the moment.

What do the naysayers say?

The counterpoint to the Prime Minister’s view is that there should have been a fair warning given before making such a drastic move. There are also some people who point out that the war on cash has begun, and this is how all totalitarian regimes aim to confiscate citizens’ wealth in broad daylight.

While these points have merit, it is too early to tell whether these doom-and-gloom scenarios will play out. So far, the vast majority of India’s citizens have taken on the extra inconvenience with typical good cheer, and are lauding Modi’s initiative to do ‘something’ as opposed to ‘nothing’ when it comes to black money.

Who are the people most hit?

Money launderers must have seen their business models evaporate in front of their eyes in one night. Hawala – a huge shadow money transfer trade in India with links in multiple countries – must have taken a hit, though understandably none of them have come out and voiced their concerns. Politicians, small-town mafia and small real estate developers all rely on cash for many of their dealings, so all of them are now feeling the pinch.

In addition, it must be said that people on the other end of the spectrum, the extremely poor who have not had the opportunity to convert their cash into assets, have also been inconvenienced. They have had to trek for long distances to find a bank or an ATM, often losing out a day’s pay (significant if you’re a laborer) or more to get their notes exchanged.

Rise of the ‘shadow depositor’

It is said that where there is a will, there is away. Two quick shadow businesses have come up ever since the Prime Minister’s announcement. One is that of a shadow depositor, who will deposit your money if it is under three lakhs, and he will do it for a commission of say 2%. He will keep the commission and return the cash to you in small notes. If you’re a person with a large amount of cash on hand, you can assemble thirty or forty of these shadow depositors and get back your cash invalid notes within a few days.

The other business model is that of a note buyer. These guys purchase your illegal notes and give you smaller notes, but they only give you a fraction of what they’re worth. For instance, a particular note buyer may be working at a 10% exchange rate, which means that if you give him your old thousand rupee note, he will give you only nine hundred rupees in return. The remaining hundred is his risk premium.

A few other birds

The demonetization drive has become the stone that killed multiple birds for the government. In short summary, here are a few more advantages besides fighting the black money menace.

• The country’s official currency reserves will go through the roof now. Already, 6 lakh crores have been deposited into India’s banking system. This means that the banks’ ability to give loans will be multiplied by many factors, giving a boost to the economy on paper.
• This will drive deposit rates and also lending rates down because of the overflow of deposits. Lowering of interest rates will add another shot in the arm for the economy.
• The higher deposits mean that the government has more avenues to tax them. The government’s tax income will increase significantly because of this.
• Politically, this was a masterstroke with the Uttar Pradesh elections looming. All the political parties who were getting ready for massive cash spending are now unable to do so, whereas the BJP, because of its access to information, would have positioned themselves accordingly in hundred rupee notes.

In closing

It is to be noted that this move has not created any wealth in India. All it has done is transfer it from under the table to over the table, which means that from now on, this area of the economy will also be measured and recorded. Therefore, in official numbers, we might see a huge boost when the next budget arrives, and the government’s ‘record’ will look good because they’ve managed to convert a shadow industry into a white industry in one fell swoop. The shadow cash industry should now once again rise, and that will take time.

All in all, the true implications of the move – and its unintended consequences – will only be apparent in time, in the coming months and years. But Narendra Modi might have just made the one significant move of his Prime Ministership that will almost certainly ensure his re-election in 2019.

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