India fighting corruption by replacing old 500 and 1000 rupee notes with new 500 and 2000 rupee notes
US was not the only country who experienced shocking news on Nov 8th. India the seventh largest economy in the world decided to fight corruption in a very drastic way — by banning large currency bills — 500 Rupees note and 1000 Rupees note. This effort was led by the new government under the Prime Minister, Narendra Modi, and new RBI Governor of the Reserve Bank of India, Urjit Patel.
On 28 October 2016, the total currency in circulation in India was ₹1,777,000 crore (US$260 billion). In terms of value, the annual report of Reserve Bank of India of 31 March 2016 stated that total bank notes in circulation valued to ₹1,642,000 crore (US$240 billion) of which nearly 86% (i.e. ₹1,418,000 crore (US$210 billion)) comprised of 500 and 1000 rupee notes. In terms of volume, the report stated that 24% (i.e. 2,203 crore) of the total 9026.6 crore banknotes were in circulation. (https://en.wikipedia.org/wiki/Indian_500_and_1000_rupee_currency_demonetization)
Based on what I know so far I wanted to write a quick Q&A on what it really means for Indians, others who own Indian currency, and people who do business in India.
How much is 500 Rupees and 1000 Rupees worth?
Depending on the day $1 is equal 66–67 Rupees. So 500 Rupees is around $8 and 1000 Rupees is around $15.
What happened?
After the news was announced on Tuesday, Mr. Modi said banks would be closed on Wednesday. After that, people can exchange the banned notes (500 and 1000 Rupee notes) through the end of the year for those of smaller denominations or new bills that are being created — the new 500 and 2000 Rupee notes.
Why does India think it will help against the tax corruption?
About 78 percent of transactions in India last year were made in cash, compared with 20 percent to 25 percent in the United States, Britain and other countries, according to a report by Google India and the Boston Consulting Group. (http://www.nytimes.com/2016/11/09/business/india-bans-largest-currency-bills-for-now-n-bid-to-cut-corruption.html)
For the common business owner in India this means they can report a different amount than what they earn thus reduce their taxable income. Very common practice in India. As you can see from recent tax data shared by the Indian government only 1% of the total Indian population paid tax for assessment year 2012–13 (http://indiatoday.intoday.in/education/story/income-tax-report-made-public-first-time-10-disclosures/1/656806.html)
This means business owners have a lot of unreported cash (black money) which they use to do things like buy real estate or gold. Infact, Indian politicians are supposed to have the most amount of black money from bribes (http://qz.com/831433/modis-crackdown-on-black-money-is-bad-news-for-political-parties-including-the-bjp/)
For people from non-cash economies, the scale of this black money cash reserve is unimaginable. Many people have storage rooms worth of money sitting there.
You can’t just exchange my old cash for new cash?
That’s where it gets tricky. In order for you to exchange the old cash for new. Indians will have to declare their cash pile reserves. This in turn triggers the accounting for how much taxes they have paid so far and there will be major crackdowns and tax triggers. If you don’t exchange then your bills will be worth nothing so Indians are really anxious and trying to figure out what to do with their piles of cash they have stored.
Also, for the next two weeks, people will be able to exchange only 4,000 rupees a day, or about $60.
So this is a taxation crackdown and more…
It’s also a fight against fueling terrorism. Mr. Modi said during his address that “Terrorism is a frightening threat. So many have lost their lives because of it. But have you ever thought about how these terrorists get their money? Enemies from across the border run their operations using fake currency notes. This has been going on for years. Many times, those using fake five hundred and thousand rupee notes have been caught and many such notes have been seized.” So this is also a crackdown on terrorism.
The new policy puts India at the “leading edge of countries restricting the use of high-denomination currency notes that are now seen as mostly fueling illegal activities rather than legitimate commerce,” said Eswar S. Prasad, a trade policy professor at Cornell. (http://www.nytimes.com/2016/11/09/business/india-bans-largest-currency-bills-for-now-n-bid-to-cut-corruption.html)
What does it mean for foreign travelers?
According to this article, The government intends to set up provisions for people arriving or departing from international airports to exchange their Rs500 and Rs1,000 notes for new notes or legal tender up to Rs5,000, prime minister Narendra Modi said in a speech on Nov. 8. The limit applies to citizens as well as foreign tourists, and the latter will face the same cap when exchanging foreign currency too. More here: (http://qz.com/831450/this-is-what-indias-ban-on-500-and-1000-rupee-notes-means-for-foreign-travelers/)
Will this really stop corruption moving forward?
The outcome is uncertain. This change is more backward looking over forward looking. This change doesn’t seem to have an impact on the actual cash economy and how business is done in the future. We will wait and see how it plays out.
All details on the announcements made can be found here. http://www.finmin.nic.in/press_room/2016/press_cancellation_high_denomination_notes.pdf
I want to thank my k12 friends (specifically — Jay Bhatia, Sajith Nair, Mukesh Patel, Ramesh Savani, and others) from India for educating me on this topic.
