When legal tender becomes illegal

When legal tender becomes illegal

RAJIV KUMAR / PALAKH JAIN
Business line, 11th Nov 2016

Legitimate economic activity will finally be awarded. The aam aadmi will benefit

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The currency conundrum It may yet have its uses S ThanthoniYesterday, two colleagues in a multinational company were chatting about the recent move of the Narendra Modi government abolishing 500 – and 1000 – rupee notes. One of them said, “It really is a good move for curbing black money and ending circulation of fake money.” The other one responded saying, “I am already feeling at par with the rich. Our (salaried class) value proposition has increased now!” Indeed, this is true.

Good move

The surprise surgical strike will make the economy stronger in the years to come and reduce inequality to some extent.

Though the prime reasons for the demonetisation lie in the anomalous increase in fake currencies of higher denomination and the increasing incidence of black money in the system, the Reserve Bank of India’s move comes with some reassurance for the public.

The central bank has said: “You will get value for the entire volume of notes tendered at the bank branches/RBI offices.”

But there will be caps on the cash one can tender. This cap on the exchange will give rise to blackmarketing of currency. Further, the next 49 days will see how the markets of banned products function.

Will the experience be different from what happened when Morarji Desai demonetised currency or will it be the same?

The trajectory

How all this played out this time makes for interesting reading.

The Government first issued plenty of warnings and provided opportunities to the people holding black money to turn it in through the Income Declaration Scheme.

When it was found that the response to the scheme was not to its expectations, the Government decided to take this bold step.

In order to try and understand what happened when Morarji Desai demonetised certain denominations back in 1978, I interacted with a dealer based out of Kucha Mahajan (a market in Old Delhi).

He said, “This is not the first time this is happening. I have witnessed it myself many years back when I was young. People started trading the 1000-rupee note as a commodity. Traders would buy the note for 250 rupees and sell it for 260 rupees and so on till the money reached the person who knew how to convert it into white money. In the process, they made lot of money. Notes used to come in sacks, soiled in mud”

He then added, “I do not know what will happen now but one thing remains the same, that is, the underlying intention of the Government.” For all we know, equity will improve even if these notes are traded in this fashion.

Strong impact

Certainly, there will be an impact on real estate. Most of the black money used to be in the real estate market. Now, when people do not have money to buy, transactions in real estate will be badly affected. Prices will be slashed. What that means is that a dream home will be well within the reach of a typical, middle-class, salaried .

A very important development will be in terms of cashless payments. Cashless payments will pick up. Companies such as Paytm will flourish further. In developed nations, cashless payments are the norm. This will be an important signal to the world in India’s journey from the developing to the developed world.

WAssuming that the income levels of people will be constant, interest rates will reduce as money supply increases in the short run. There will be capital outflow from the economy due to decreased interest rates and the currency will depreciate. This will boost the export sector and enhance the competitiveness of the economy.

Having said all this, it will be ideal to see people earning money from legitimate sources. It will be good if the Government can rationalise the tax slabs in the coming Budget. As corruption reduces, India’s position in various global rankings will improve. Hence, the value proposition of the Indian economy as a whole will be enhanced.

Kumar is a senior fellow, CPR, and founding director of PahleIndia Foundation where Jain is also a senior fellow
(This article was published in the Business Line print edition dated November 11, 2016)

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