Originally posted at Zero Hedge
Amid scenes of panic across India, following PM Modi’s shock decision to withdraw high-value bills in the middle of the sowing and wedding season, Reuters reports the move, aimed at cracking down on the shadow economy, has brought India’s cash economy to a virtual standstill. With over 90% of all transactions done in cash, money flows in and out of the black-and-white system… until now, as Devangshu Datta exclaims, “The system works because everybody believes that those pieces of paper will be accepted by everybody else… This move has shaken that trust.”
Farmers have been left stranded as traders have no cash to pay for their produce, while millions of Indians lined up outside banks and post offices for the ninth day to exchange old banknotes or withdraw rationed money from their accounts.
Many of India’s 260 million farmers have no bank accounts and depend on local money lenders to fund sowing, which means those that have to borrow to sow winter crops like wheat or rapeseed could face debt trouble without a good harvest.
And so India’s government on Thursday announced immediate steps to ease a cash crunch for farmers amid widespread criticism. In the latest in a series of ad hoc steps, Modi allowed farmers to withdraw up to 25,000 rupees ($368) a week against their crop loans to ensure that sowing of winter crops “takes place properly”, a senior finance ministry official said.
But, as Devangshu Datta explains, the demonetisation of Rs 500 and Rs 1,000 currency notes came as a surprise to almost everyone. The details of re-monetisation are still to become entirely clear. What follows is a set of personal opinions of likely outcomes arising from this move to demonetise. Each of those opinions could be entirely wrong but they are all centred on subjects that are worth thinking about.
But, first, some basic statistics.
About 85% of all currency in circulation has just been turned into coupons that can only be exchanged in specific places. These notes can be converted into currency again only with identity proofs (which hundreds of millions don’t have) and the additional hardship of standing in many queues for many hours.
Over half of India’s population doesn’t have any sort of bank account at the moment and about 300 million don’t have basic ID such as Aadhaar either and hence, cannot access the banking system at all. About 130 million Indians have mobile wallets (about 25 million have credit cards) and there are maybe 550 million-600 million debit cards in circulation. So access to cash is very, very important for average Indians.
Liquidity in the economic system will be sucked out for several weeks at the very least, due to the very stringent restrictions on cash withdrawals from ATMs, and bank accounts. Plus there’s the sheer logistics of getting that massive volume of new notes into circulation. In addition there will be a cost to printing and distributing the new notes and taking the old currency out of circulation.
India is a cash economy. Well over 90% of all transactions are done in cash. Most of these transactions are legal, consisting of relatively small amounts, and frequently done by people who don’t make enough money to pay income tax. Your domestic worker pays for her bus ticket. You pay her husband, the plumber, for fixing your flush. The security guard at the bank ATM buys cigarettes.
Money flows in and out of the black-and-white system. The paan-wallah pays the fast-moving consumer goods companies for the cigarettes and chewing gum he sells, and keeps the retail margin. That’s white. He ploughs the surplus cash into buying paan leaves in undocumented transactions: the farmer who grows the paan pays no tax; the trader who sells paan under-reports the transactions. That’s black. The mechanic (who is outside the tax net) receives an (undocumented) tip for changing a flat tyre and buys a metro token (putting cash back into government coffers), or goes to see a movie (paying service tax).
Industries like fashion, retail, interior decoration, furniture, laundry and dry-cleaning services, hospitality, medical services, gems and jewellery, et cetera., are large conduits for these flows. We could call them black and white industries. Construction and real estate are totally built around black and white. Land is always sold with part of the price being paid in cash. The real-estate developer buys in black and white and he sells in black and white. The construction process is also black and white (carrying ghost workers on the construction rolls is one easy way to generate black money for example).
These are the facts…