Banking

The Danger of a Bigger Black Economy Based on Invalid Currency is Emerging

After waiting for new currency notes for a few days, many small businesses have already started accepting old currency notes of 500 and 1000. This trend may increase in the coming days

Knowingly or unknowingly the Modi government has pushed the country into something resembling the Soviet era.  The whole country is queuing up for hours in front of banks or ATMs in search of few thousand rupees.  The unpreparedness of the whole demonetisation scheme has exposed the gross inefficiencies of the Indian banking system.  With $217 billion (86% of total currency value in circulation) currency out of the system, markets are deserted and economic activities are at a bare minimum.  If the present chaos continues for some more time, there is a danger of a parallel black economy emerging based on banned currency. This could be a much serious phenomenon than existing black economy.

Most people waited patiently for two-three days for things to settle down. Now it seems it is going to be much longer than just a quick transformation to a new system based on new currency notes.  Finance minister Arun Jaitley has admitted that it will take at least couple of weeks for the system to become normal. After waiting for new currency notes for a few days, many small businesses have already started accepting old currency notes of 500 and 1000.  This trend may increase in the coming days. At the moment this is based on the hope that these old notes will be deposited in savings accounts which has acceptable limit of Rs 2,50,000. Apart from their current accounts, most small businesses will also have a few savings accounts per family member. So transactions up to couple of days of business and trade could be accommodated. Instead of closing their shops for the next few weeks, these are desperate measures adopted by some small shopkeepers.  In the absence of valid currency, these informal measures are providing a cushion to small traders and ordinary people who have limited or no access to electronic money transfers.

However, if the present situation continues for a longer time, the non-legal tenders may also find some permanent acceptability (perhaps at a permanently lower value) within the black economy. Two major functions of money include medium of exchange and store of value. If people continue to exchange in old currency notes with the faith that it will be accepted at least within the black economy, it may become a permanent feature of Indian monetary system. It may be used for many transactions which are illegal any way and will never show up in the formal banking system. It is expected that at the end of the demonetisation period of March 2017, a significant amount of money may still be in the hands of people who will not be able to deposit or convert it with new currency. The chaotic situation in the next few weeks will provide an opportunity for this kind of black economy based on banned currency to emerge.  So it is very important that the whole transformation to new currency notes is completed as quickly as possible.

Overall, the economic benefits of this demonetisation scheme were always questionable. This was broadly seen as a political move by the government to show that it can take bold decisions and is serious about black money. The immediate euphoria created by sudden announcement has already been wiped out. Emerging anger in the streets will benefit political opposition more than the ruling party. The only option for the government is to activate all its administrative capacities to deliver transformation as quickly as possible. Slow and chaotic transformation will harm the Indian economy seriously. Any rollback now will be very expansive for the government, politically and economically.

Gulshan Sachdeva is Professor at the School of International Studies, Jawaharlal Nehru University.

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