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Shock Therapy
India’s Black Money Crackdown Backfires

Indian Prime Minister Narendra Modi’s surprise decision to ban the 500 and 1,000 rupee notes has sent shockwaves throughout the country, and some opposition forces are now taking to the streets to protest. The Associated Press: 

Thousands of people demonstrated across India on Monday to protest the government’s sudden decision to withdraw large-denomination currency from circulation, a move that has caused enormous hardship to millions of people in the country’s predominantly cash-based economy. […]

Nearly three weeks ago, Prime Minister Narendra Modi announced that 500- and 1,000-rupee notes, worth about $7.50 and $15, would become worthless overnight and would be replaced by new currency in a bid to stamp out corruption and tax evasion.

The surprise decision pulled 86 percent of the country’s money supply out of circulation, leading to serpentine lines at banks, which often ran short of currency, showing that the government was ill-prepared for the move.  

The details of Indian fiscal policy do not typically merit mention here, but the social upheaval caused by Modi’s sudden currency ban points to a wider phenomenon. India is undergoing a rapid process of modernization and transformation—a process that holds great promise for the livelihood of Indians in the long term, but that also brings short-term shocks, especially when the government seeks to accelerate the process.

Modi’s move is ostensibly targeted at large-scale tax evaders and hoarders of “black money.” But in a country where more than 90 percent of transactions are conducted in cash, the policy is having an outsized impact on India’s lower and middle classes. Almost half of Indians do not have bank accounts, and Modi has used the new policy to encourage citizens to embrace digital payments. In theory, that should help bring India into the modern world and let the government more efficiently collect taxes. In practice, however, the policy has so far provoked resentment while placing a disproportionate burden on India’s working class.

There is no doubt that India needs serious reform to transition away from cash, improve tax collection, and crack down on the illegal economy. Yet prominent economists from Larry Summers to Kaushik Basu are questioning whether Modi’s abrupt measure will achieve that effect. Most of India’s big fraudsters, after all, store their money in gold and silver or in offshore bank accounts. The new policy will inconvenience them much less than it will India’s middle class.

Modi’s policy is no doubt well-intentioned, and it may even pay off in the long term. But much like the global ban on heat-trapping hydrofluorocarbons that will price refrigerators and air conditioners out of reach for most Indians, the policy is likely to inflict short-term pain on the rising middle class it is supposed to help. In any case, the public response to India’s demonetization policy is worth watching. Expect more growing pains as India’s leadership and citizenry adjust to their growing role in the global economy.

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  • Andrew Allison

    I’m shocked, SHOCKED to learn that the tax evaders and corrupt are outraged! The problem faced by the-government-which-can-do-no-right (in the eyes of TAI) is that if it had taken the time to properly prepare word would inevitably have leaked out, allowing the miscreants to take evasive action.

    • Tom

      Given that the worst of the miscreants aren’t likely to be affected by this, your outrage is…misplaced.

  • Gene

    Something MUST BE DONE!

    THIS is something.

    This MUST BE DONE!

  • Fat_Man

    Modi is demonstrating the wisdom of another Asian culture:

    “Rule a large country in the same way that you would fry a small fish.”

    Chapter 60 of “Tao Te Ching” by Lao Tzu (`500 BCE)

    • CapitalHawk

      Low heat?

  • LarryD

    This won’t improve trust in India’s currency. Gold and silver looking even better.

  • jsdozcn9

    “There is no doubt that India needs serious reform to transition away from cash, improve tax collection, and crack down on the illegal economy.”

    There is no doubt the government should get out of the way of productive citizens that are responsible for economic growth and lifting the disadvantaged out of poverty. Corrupt and inefficient government is the illegal economy.

    • ljgude

      Yes, the real economy was all there was in the US until the IrS came along. Now India has an opportunity to find some other way to collect taxes like a VAT style tax on major manufactured goods and leave the cash economy free to operate relatively unhindered. I’m not saying a VAT would work, but squeezing cash out isn’t going to work in India. There is already talk of using other currencies like USD to keep business going and the forced move to digital increases the motivation to adopt Bitcoin to bypass the government. The Indians are nothing if not inventive.

  • CapitalHawk

    The attempt to eliminate cash is coming to a country near you.

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