While 8 November 2016 will be mostly remembered for the surprise election of Donald Trump as US president, another momentous event was taking place in India at the same time. Narenda Modi, the country’s prime minister, announced the withdrawal of every Rs500 ($7.5) and Rs1000 ($15) banknote nationwide – that’s 86% of all cash resources taken out of circulation in one sweep. Bold decision or political suicide? Several months after the event, I decided to judge for myself during a recent trip to India.
India is a country where the population is still largely dependent on cash – it is estimated that cash accounts for more than 90% of all transactions compared with just 45% in the UK. The intention of the government was undoubtedly laudable: aside from the desire to curb corruption, reduce counterfeiting and discourage the use of high denomination notes for terrorism, it seems their primary objective was to tax the black economy. India’s tax revenues as a percentage of GDP sit at 17% (versus the OECD average at 35%).
My first observation was the amazing resilience and a “get on with it” attitude displayed by most people on the street. There was little sign of frustration or anger, despite people having to queue for hours, sometimes days to get to a bank counter in the first few weeks. I discovered that one could even employ a personal “queuer” to stand in line on one’s behalf. Were they then paid in cash I wonder? Inevitably the waiting turned into a communal experience with people sharing cups of tea and coffee, as well as grumbles. The day I arrived in the capital, I was soon irritated after trekking around five cash machines before finding one open, containing money, and not suffering from a power cut!
Otherwise, everything appeared to be functioning as normal. The economy seemed to have adapted surprisingly well to this one-off purge. The majority of people I encountered confirmed that they were happy to bear the temporary inconvenience because they supported the government’s actions to rein in on tax evasion and push towards digitalisation. A taxi driver offered “why do we need to use cash. The rest of the world is advancing, why should we be left behind?” This hypothesis will be put to the test when the results of state elections, covering over 240 million people in five states, are announced on 11 March.
My business meetings also confirmed that corporates are not fazed either. They all reported lower demand for their products and services in the last two months of the year, but all see it as a temporary blip with the expectation of a return to normality within one or two quarters. The Rs1000 notes have been replaced by Rs2000 notes, and one of the speedbumps was the fact that the Rs2000 notes were larger than the old ones and required every cash machine to be recalibrated.
Demonetisation has clearly been a windfall for digital payment platforms. Wandering around the cities and large towns, you are able to use the PAYTM system for rickshaw rides, cups of garam chai, and even for donations to the many religious institutions. Unfortunately, with smartphone penetration hovering around 30% and skewed to urban areas, digital can only take up so much of the slack. Unfairly, as is often the case, the poorest within society are suffering the most.
However, the primary goal of the scheme is to tax the black economy, so has it succeeded? As far as I can gauge this remains largely unproven. According to news reports, 97% of the demonetised currency has returned into the banking system, suggesting that the vast bulk of the cash hidden as part of the black economy has so far been re-integrated into the economy. Ultimately this has been a failure within parts of the banking community to uphold standards of integrity. Bank employees have a variety of ‘creative’ methods – for a commission of course – to channel black money into the formal banking sector.
The onus is now on the tax authorities – and their IT systems – to spot, follow up and crack down on suspicious account activity. Taking the population over 20 years of age as a crude proxy for those affected equates to over 700 million people. I hope the tax authorities have been hiring more officers!
On balance, I applaud the intention of the operation but question the effectiveness of its implementation – which currently rests in the hands of the tax authorities. The prime minister continues with bold reforms, as the focus moves to the introduction of a global sales tax. Designed to simplify and homogenise taxes on goods and services across India, it is the single largest reform since the opening of the economy in 1991 – no easy feat! Watch this space.