Prime Minister Narendra Modi of India has declared war on corruption, a big factor in perpetuating poverty in that country. But his shocking decision on Nov. 8 to remove and replace large-denomination paper money was poorly thought out and executed.
Cash is king in India. It is used in an estimated 78 percent of transactions, compared with 20 percent to 25 percent in industrialized countries like Britain and the United States. Many people do not have bank accounts or credit cards, and even those who do often must use cash because many businesses don’t accept other forms of payment.
Paper currency makes it easy for people to avoid taxes and engage in corruption. For example, real estate sales are often split into two parts: a smaller portion, which is reported to the government, is paid by check, and a larger, undeclared sum is paid with stacks of cash, or “black money” as it is often referred to in India. Business people and criminals routinely buy off government officials and politicians with envelopes and briefcases of cash.
Mr. Modi’s solution to a systemic problem is an odd one. Last week, he announced that the government would get rid of the 500- and 1,000-rupee notes (worth about $7.50 and $15), which together make up about 80 percent of currency in circulation, and replace them with new 500,- and 2,000- rupee notes.
The move, which went into effect last Wednesday, is meant to force tax evaders and corrupt officials hoarding cash to deposit or exchange their old notes at banks by Dec. 30. Those with very large sums will be forced to explain how they amassed so much cash and pay taxes owed on the money.
At least, that was the plan. The change, however, has thrown the economy into turmoil, with many millions of people forced to line up at banks to deposit or exchange their old bills.
identification card, which is required to swap or deposit old bills. He was hoping a charity would feed him and his family while he waited to convert his stack of 500-rupee notes, worth about $148. Meanwhile, many traders have established lucrative money-laundering services to help the cash-rich get rid of their old bills.
Mr. Modi acknowledged that the currency swap would cause “temporary hardships” to “honest citizens.” But his government did not appreciate the extent of the pain it would inflict, for what may be only a short-term solution. The government has begun circulating new 500- and 2,000-rupee notes, which means that cash-based corruption and tax evasion are almost sure to return as people accumulate the new bills.
India’s current policy of replacing Rs 1,000 notes with Rs 2,000 notes undermines the long-term effectiveness of demonetisation, according to Harvard professor and economist Gita Gopinath.