Please Change Cash Here

Towards the end of 2016, India shocked their population by announcing the sudden withdrawal a majority of currency in circulation. On the 14th November, India announced they were scrapping their 500 and 1000 rupee notes – a move affecting +85% of all rupees in circulation.

This blog post will explain that the root for the move and will analyse whether the long run benefits of the moves will achieve their publicly proclaimed benefits.

The developing nation is highly dominated by cash transactions – 90% of the nation’s transactions are in cash. This method of transaction is so dominant because +52% of Indians do not have bank accounts. Therefore they are not able to engage electronic transfers and keep all their cash savings out of the banking system.

This therefore explains the root of India’s currency exercise – to bring as much of this cash into the banking system as possible and reduce the occurrence of “black money”. Black money is the local expression for money earned in black market transactions: transactions outside the legal system and therefore untaxed. Whilst this is a move that most publicly affects the poor Indians who do not have bank accounts – the exercise also forces rich Indians with money earned through illicit transactions to bring their currency into official channels. All Indians must bring their money to banks for deposit or conversion to alternative notes. Where any transaction breaches a given threshold, they must leave their name and ID to create an audit trail. Here lies the cleverness of the government’s move – holders of vast sums of black money must declare their funds or risk rendering their money useless.

The short run costs of this exercise has been immense. Everyday transactions with the equivalent of +85% of all cash in circulation have been rendered impossible. All the people without bank accounts need to queue at banks for hours to change their money. They are forced to do it in small batches for fear of causing official enquiry. Even worse – approximately 300 million Indians do not even have any form of government identification – so they are unable to engage the financial markets in any official sense. And thus could not even execute minimal transactions, even if they wanted to. Meanwhile, those with bank accounts are need to use ATMs to draw new funds – but ATM transactions are limited to 4000 rupees, to prevent “new” cash from being “too” available. So they too are forced to wait many days to accrue enough cash for larger cash payments – i.e. cash payments in excess of US$56 (4000 rupees).

The first economic impacts will be on demand – with cash in short supply, all Indian cash transactions will be curtailed. This will impact revenues for shops and have negative impacts on cash flows. Meanwhile, there will be systemic impacts on financial habits – it forces more Indians to engage with the official financial system and creates an incentive for individuals use non-cash transactions. In the longer term, this will increase money velocity: money will move around the system faster because electronic flows are considerably easier, especially for large transactions. However it is difficult to predict if this will be a positive move, because there will be a generational distinction – the older generations will find it more difficult to change their habits, and will therefore be at a disadvantage. Meanwhile, the holders of black money are likely to find long run methods to overcome this impact to their habits. Whilst it is true that they are negatively affected in the short-run, they will adapt and find new ways to accrue illicit funds. The greater impact is likely to be much more psychological in impact – the government’s standing against black money will be more public and those that engage in illicit funds will be less willing to take “traditional” pay off methods.

© Patrick Tsui and, 2016. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Patrick Tsui and with appropriate and specific direction to the original content.