November 9, 2016
Almost everyone (from the common man on the street to business houses to politicians) was taken by surprise with regard to yesterday’s decision by the government to withdraw old Rs. 500 and 1000 notes from the market. The prime minister said that such notes will become "mere paper." While I have been writing on this subject for last 8 months, this one step is truly a master stroke. So let’s look at what it means for all of us.
Mere Paper: This means that you cannot transact with old Rs. 500/1000 currency (except for emergency use cases like railway, bus tickets, Airport, Petrol Pump, etc. for next 72 hours) and they need to be deposited back to the bank till December 30, 2016, or maximum up to March 31, 2017.
So all those who currently hold huge piles of cash will be stuck in tough situation if:
Our Responsibility: Those who hold legitimate sources of income need not worry. However, we have an even bigger responsibility to educate and help the vulnerable (domestic help, security guard, driver, old parents living in other cities, etc.).
The exercise to be undertaken by banks starting November 10 is mammoth in nature. We have approximately 16.5 billion 500-rupee notes and 6.7 billion 1000-rupee notes in circulation (72 billion notes in circulation in total), which means approximately 23.2 billion notes are to be taken out of circulation and replaced with new Rs. 500 and Rs. 2000 notes. In total, 14–15 lakh crore rupees worth of old currency will be moving out of the market. Overall, 500 and 1000-rupee note contribute to 88 % of the 17 lakh crore physical cash in circulation. In total, 180 lakh (250 notes per million) currency notes out of this are assumed to be counterfeit; therefore, the larger problem is not counterfeit but the cash economy and the resulting tax evasions.
To start with, black economy is a much wider term (it moves in various instruments within the economy) and involves real estate, gold/jewelry, agriculture land purchases and conversion to commercial entities, money in the form of currency notes, hoarding of consumables (wheat, pulses, etc.) etc. So while the immediate impact will be on cash, for the medium term, it will impact all black money purchases (for the long term, it can reduce the size of the black economy but won't eliminate it).
This is a difficult question to answer. During 2011–16, while the economy has grown by 30%, the circulation of the Rs. 500 note has grown by 76% and the Rs. 1000 note by 109%. While a part of it can be attributed to the increase in the cost of essential daily-use items, the larger remaining piece is still hard to explain (reflecting the huge growth in counterfeit notes). This differential can represent counterfeit cash.
5% of GDP is real estate: And if 20 % (market estimates) of the sale represents cash, then it’s around $22–25 billion.
703 tons of gold purchase: Large jewelers have acknowledged during TV debates that almost 80% of this is purchased in cash, i.e., 560 tons is cash (approx. $270 billion). Of course, there is no estimate to suggest how much of it is actually regular consumer purchases and how much is black. A 22% (based on the size of the black economy) estimate gives a figure of $54 billion.
The final impact will take a long time to understand; the journey is long. However, a lot of my friends in the business community are already talking about:
Impact to small business: The big trader will start offering credit till the dust settles, money rotates and comes back to the system. This will impact small traders who are not in a position to play.
It will activate the touts: In next few hours, the business community will suddenly find a number of usual suspects willing to convert black money to white. Last time I heard, the rate is 5%.
The cost of the 100-rupee note will suddenly shoot up: Already, the rate to procure the 100-rupee note in the business community has gone up to 3%. This essentially means that businessmen are paying Rs. 103 to procure Rs. 100 from the market for labor and other business-critical payments.
Funding to political parties: Local business houses known to support a favorite political party for poll funding will find it difficult to pay. So election spending in UP, Punjab, Uttarakhand, Goa and Manipur will be impacted.
Impact on business cycle: It’s not just one or two individuals that the business cycle gets impacted for; a friend based out of Raipur had the below take on it:
Short term to medium term impact on the price of:
Impact on the underground/black economy: As per the USAID Report Barriers to a Digital Economy, an overwhelming 97% of retail transactions in India are in cash. This move will positively impact the movement towards digital transactions and will push us to a less-cash society. Estimates of the size of black economy range from 30% to 75% of the GDP. Just think of the tax revenue and productive usage this money will generate if submitted. If even 25% ($550 B) of this is brought into the tax net, it has a potential (purely on account of blended tax income of $75–80 B) to bring millions above the poverty line. Large-scale government schemes like NREGA, NRHM can be funded for over next 10 years by just one year of tax revenue emanating from this initiative. Getting rid of the black economy will be one of the true manifestations of Swatch Bharat Abhiyan.
Impact of digitization and contribution to GDP and job growth: The latest Moodys Analytics Report estimates that the increased usage of electronic payment methods has added $6.08 billion to India's GDP during 2011–2015, adding 3.36 lakh jobs in the same period.
Cost of cash: With 76.5 billion (2012–13 RBI data) pieces of currency in circulation, the operational cost of managing currency operations (to RBI and banks) is $3.5 billion. Think of the need to reissue currency due to wear and tear. However, what’s even bigger is the loss on the account of dead cash lying in wallets rather than in income generating instruments. There is an additional cost in terms of time and effort submitted to withdraw cash. It further places the disproportionate burden on poor due to lack of places to keep and save it securely for their future.
Leakage in government subsidy and welfare schemes: As per the Economic Survey released in February 2016, the government provides approximately Rs. 3.7 lakh crore in subsidy via various programs like fertilizer, food, kerosene, diesel, etc. And the survey further suggests that a large percentage of this does not go to its destination. Just think of the savings (due to reduced leakage, lower administration cost and efficiency of service delivery) if all of this goes directly to the Aadhaar-linked bank account. A 2010 report, The Benefits of E-Payments to Indian Society by McKnisey predicted Rs. 97,000 crore in savings due to the electronic payments infrastructure.
Cost of liquidity management: Corporates spend large amounts in managing cash in their value chain (consumer-retailer-distributor). If a large portion of this goes digital, it has obvious liquidity management benefits to all participants of this value chain.
Think of the above benefits and the force of this decision – along with 20 new banks, mobile wallet players, FinTech players and PMJDY! This is clearly a once-in-a-lifetime opportunity impacting the black economy at large and to get a billion people under the financial inclusion umbrella sustainably and profitably.
Overall, it’s a huge positive in terms of the showcase of government intent and will put pressure on the black economy. It will directly impact counterfeit and corruption in the public domain. However, the real result will be seen more on a long-term basis and increase in digital payments will be a good proxy to check the impact.