Is Demonetizing 500 and 1000 Rupee Notes an Effective Strategy for Tackling Black Money in India?

This question wasn’t A2A to me but I saw it in my mailbox, so I feel like answering it. No, the Indian Government’s decision to demonetize 500 and 1000 rupee notes has essentially created chaos without addressing the core issue. Here’s why:

Understanding the Issue

Curbing black money is not a one-day job; it requires systematic and strategic steps rather than a sudden move. In essence, demonetization is aimed at finding out who used the 500 and 1000 rupee notes for illegal purposes. The Indian government hopes that individuals who hold such notes will either declare them or be caught in the act. However, this approach has many flaws and is not as effective as it is often portrayed. Let’s delve deeper.

Will the RBI Get All the Old 500 and 1000 Rupee Notes Back?

No, the Reserve Bank of India (RBI) will not get all the old 500 and 1000 rupee notes back, especially in their exact form. Here’s why:

The RBI has a sophisticated mechanism to distinguish between genuine and counterfeit notes, which is deeply rooted in the banking system. This means that fake notes will not go unnoticed. The real challenge lies in the mismatch between the number of old notes in circulation and the number returned to the RBI. Historically, the RBI only receives around 40% of the old notes that were in circulation.

This is due to the nature of cash flow in the market. Not everyone will participate in the exchange, especially those who are not overly concerned with the process or those who have hidden their money effectively.

What Exactly is Black Money?

The issue of black money is complex. It involves a mixture of family money, working money, and illegal money. Here’s a breakdown of each type:

Family Money

30% of the black money consists of family money. This includes:

Small and large transactions within families. Traditional or ritual money given by elders to kids or guests during weddings. Savings at home, which I argue can be considered grey rather than black money, as long as the original taxes were paid.

Working Money

50% of the black money is related to working money. This includes:

Construction workers and small traders who deal primarily in cash. Transporters, fruit and vegetable vendors, and small business owners who face financial risks daily. Private doctors who take cash payments without receipts. People who borrow cash for daily operations and find it difficult to pay taxes due to high expenditure.

Illegal Money

20% of the black money is related to illegal activities. This includes:

Builder-facilitated corruption. Underworld operations. Political funds. Media and entertainment industry.

Historically, Indian governments have taken steps to regulate illegal money, making it difficult for such entities to operate and earn profits.

Is the Government’s Move Really Effective?

The government’s move has created several issues:

Family Money:People who have deposited their money will likely withdraw it again, continuing the same cash-based transactional system. Working Money:Individuals in this category are either diverting funds due to panic or destroying them, which is detrimental to the banking system. This could lead to an appreciation of the rupee in the future, although not in a sustainable way. Illegal Money:With demonetization, the culprits will not be caught, which is crucial to effectively curb black money. In the long run, the system will revert to its previous state with new printed currency notes.

In essence, the solution is more imagined than real. While the government aims to organize working money and encourage tax compliance, the current strategy may have little effect.

Conclusion

The demonetization of 500 and 1000 rupee notes, while intended to combat black money, has not yielded the desired results. It has created more chaos than it has resolved. The real battle against black money requires a multifaceted approach that includes regulatory measures, digitalization, and improved tax compliance.