Depth report

　　

On November 8, 2016, Indian Prime Minister Narendra Modi (Narendra Modi) announced that the banknotes of 500 rupees and 1,000 rupees (approximately US$7.5 and US$15 respectively) will be abolished immediately. This action resulted in an 86% reduction in cash in circulation. In addition, the discarded banknotes must be deposited in the bank before December 30, and withdrawals are restricted.

    The boldness of the democratically elected leader of such a huge country makes what US President Donald Trump has done so far seem trivial. Should we regard this as a decisive action in India's fight against tax evasion, the black economy and rampant corruption? Or should it be regarded as a very arbitrary practice by a paranoid democrat? It now appears that both are a bit similar. In the long run, the conclusion depends on future developments.

    It is unprecedented for a country with political and economic stability to suddenly take such an unexpected and radical abolition of banknotes. Why would an elected government cause such a shock-especially considering that India's economy is so dependent on cash transactions? As a low- and middle-income country, India still has a huge population outside the formal financial system. In addition, even in a country such as India, its dependence on cash is relatively high-it is estimated that cash payments still account for 78% of total consumption payments.

    The reasons for implementing this policy are also constantly changing. When announcing the "rejected banknotes" for the first time, Modi emphasized that the main purpose was to cut off the source of funds for terrorism. Later, he emphasized that the move was more to recover tax evasion black money, and later changed his slogan to encourage Indians to use digital payments more.

    Modi also said: "I want to urge Indian intellectuals to inform the world about the resilience shown by the Indians in supporting the decision to abolish banknotes." "History will remember this moment, not because of which prime minister made this decision, but because Because of the struggle against black money launched by ordinary people."

    According to the 2016-2017 Economic Survey of India’s Ministry of Finance, the banknote waste policy has four objectives: “to curb corruption, counterfeit banknotes, the use of high-denomination banknotes for terrorist activities, and “black money” (income not reported to the taxation department) The accumulation of these goals.” These goals are very popular among the Indians, who accepted the upheaval with extraordinary calm, hoping that the villains will get the punishment they deserve. These are also reasonable goals. Few people would deny that India is plagued by large-scale corruption and tax evasion. However, this approach may also sow long-term distrust of government promises. The disease may be serious, but the cost of this prescription is high. How much might it cost? How much benefit will it bring?

    The short-term cost is obvious. As summarized in the above economic survey, these costs are "inconvenience and hardship", especially for people in the "informal and cash-intensive sectors of the economy." Because hundreds of millions of Indians are poor, the impact is not trivial.

    What caused this short-term cost was a sharp drop in the supply of cash. According to the aforementioned economic survey, cash supply fell by 35% relative to demand by December. However, the survey also predicts that cash supply will pick up as early as April. Although the growth rate of currency in circulation has slowed sharply, the growth of demand deposits-which is part of the policy implementation process-has largely offset this consequence. As a result, interest rates have also fallen.

    When analyzing the short-term cost, the analysis emphasizes the impact on three aspects: for aggregate demand-the reason is the reduction in cash, and the permanent loss of wealth for those who choose not to declare cash holdings; for the aggregate supply-the reason is that cash is used as a The role of a production input (such as in agriculture); and the impact of increased uncertainty. The survey concluded that, in general, waste banknotes may temporarily reduce the growth rate of gross domestic product (GDP) by 0.25 to 0.5 percentage points relative to the base annual growth rate of about 7% through the impact on the money supply.

    However, even in the short term, there are benefits. Analysis shows that 2% of GDP is in the hands of banknotes that reflect black economic activity. Some of these illegally acquired wealth will disappear, and some will be taxed. This is because the holders of these banknotes have to declare the wealth of unknown origin, or pay penalty taxes, or lose their wealth, or wash them out. In general, given the increasing risk of holding cash, this policy allows the government to tax black money, at least a one-time tax, and perhaps a long-term tax. On the whole, wealth will be transferred from criminals to the government. It is difficult for people to feel sorry for these victims.

    In addition, in the long run, there should be significant benefits. First, this shock should accelerate the entry of liquid wealth into the financial system, thereby increasing the integrity, transparency, and efficiency of the economy.

    An important result may be an increase in the degree of financial “digitalization”, although this will require the implementation of complementary reforms, especially reforms that facilitate digital payments for Indians who do not have smartphones. Another result will be more efficient taxation. The prerequisite for all this is that actions must be determined. A government that dared to do so, what else would it dare not do?

    Whether the cost or the benefit is greater will ultimately depend on the current state of affairs. The important point is that the conversion between bank deposits and cash must be fully restored. In the long run, India may follow other economies and become an economy that uses almost no cash.

    However, trying to do so now, the time is very immature. In addition, the government must provide the required policy framework and support to ensure financial inclusion (including electronic payments) for the population. Equally important is the fight against corruption, which mainly includes the structure and management of taxation.

    In this regard, a recent achievement is the introduction of a value-added tax-goods and services tax. In addition, election fundraising reforms are also crucial. Politicians are not immune from corruption suspicion. In the end, repeated use of banknotes will have a devastating blow to confidence. Must not allow this to happen.

    It is often difficult to distinguish between courageous leaders who make unpopular decisions for the benefit of the entire country or leaders who make arbitrary decisions for their own benefit. Historians may determine that the abolition of banknotes was done by the former leader. The matter is still unknown. Let's see what Modi dares to do next.