The Global War on Cash - India's Demonetization Debacle

The basic problem stems from a failure to distinguish between "black money"-- money on which tax due has not been paid-- and the legitimate informal sector-- the cash-based economy. Estimates of the size of that sector range from about 50% to around 90% (depending on how it's measured, e.g., as a percentage of GDP, or in terms of the percentage of wages paid in cash and not paid into a bank account). Many people working in the informal sector don't pay any income tax-- not because they're corrupt or tax evaders, but because their income falls below the threshold upon which tax is due.

... It's a staple scene in many Bollywood films to see stacks of illicit cash secreted somewhere in the villain's lair. Demonetization was designed to flush out just such cash. Yet, unfortunately, mundane reality doesn't conform to these Bollywood cliches. As I first pointed out in this November 16 post: black assets are typically not held in the form of Indian bank notes-- but are either held off-shore, or if kept in India, are invested in real estate, gold, jewellery, art, antiques, or securities.

The latest figures show that much of the outstanding currency has been redeposited into bank accounts. The possibility that there would be a big demonetization windfall-- and an increase in income tax collected-- has not materialized. As reported this week by the Economic Times in 90 per cent of scrapped notes back in system, big dividend unlikely...

.... I should emphasize that a higher value of cash has been returned to the system, deposited into bank accounts, than the government anticipated, as reported in the Financial Times in Indians rush to exchange cash ahead of deadline. But the lack of sufficient quantities of new currency means that people cannot access that cash-- which is subject to strict withdrawal limits (24,000 INR per week-- but many banks lack sufficient currency to allow customers to withdraw up to the limit to which they are in theory entitled). The Financial Times also reported that "banks had replaced just 38 per cent of the Rs15.3tn in demonetised notes that was sucked out of the system by November's announcement, according to RBI data''....