Question

What is the usefulness of demonetisation as an instrument to check an underground economy?

Answer 1

There is avoidable confusion about the objectives of the recent demonetisation programme which at one stroke invalidated 86% of the currency in circulation, causing widespread disruption in economic activity and the life of the common man. The opposition has trained its guns squarely on its political objectives. The government has shifted ground, from national security to targeting black money to a cashless economy, and finally to ethical or moral cleansing. How does the silver bullet of demonetisation measure up to its three stated economic objectives, namely counterfeiting, black money and cashless economy?

Governments the world over replace old currency with new to neutralize counterfeiting. If there are pressing national security concerns, the new currency can have added security features and suspected denominations can be withdrawn. The latter can also be declared illegal tender after a critical mass of new currency is in circulation. It is, however, only a matter of time before the new currency is counterfeited. Counterfeited new currency surfaced within days of demonetisation. Government data shows that counterfeit notes comprise less than 1% of the currency in circulation. Demonetisation on this scale is a blunt instrument for this purpose.

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Targeting black money through demonetisation of high-currency notes is recommended by Kenneth Rogoff, a noted Harvard economist, in a recent book, The Curse of Cash. A substantial chunk of America’s illicit economy is conducted, and its assets parked, in $100 bills. According to Rogoff, demonetisation would have a similar impact in India, although long-term gains would be offset by the reintroduction of new high-denomination notes.

The US dollar is the de facto global reserve currency. It is a riskless, universal store of permanent value, a safe haven like gold. It makes eminent sense to stock illicit wealth in $100 bills within the US and outside. The Indian rupee on the other hand is a risky asset exposed to high rates of inflation, exchange fluctuation, loss of value beyond borders and political risk of the kind that has just fructified. High-value currency notes are therefore mostly used in black economy flows, the profits from which are ultimately converted into black money. The greater proportion of Indian black wealth is parked in assets like real estate, gold, stock markets, foreign accounts and $100 bills. Demonetising only Rs1,000 notes would have caused less disruption, as data from the Reserve Bank of India shows that their share of the total currency in circulation grew spectacularly over the last decade. The small portion of black wealth stocked in currency is likely to be recouped over time, especially since high-denomination notes are being re-introduced.

Answer 2

Answer:

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