On 8 Nov. 2016, India demonetized Rs. 500 and Rs. 1,000 notes with immediate effect. It has been widely proclaimed as a great step in curbing black money in the country. Now, while the move is bold and brave no doubt, I invite you to consider a possibility that the impact may not be as big as it is thought out to be.
Estimating cost of printing new notes At its press conference, the RBI said that it estimates 16.5 billion Rs. 500 notes, and 6.7 billion Rs. 1000 notes to be in circulation. This doesn’t add up according to my calculations.
As mentioned in an article by the RBI, the currency in circulation in recent years is roughly 10% of GDP. Thus, based on the IMF estimate of USD 2.25 trillion for India’s 2016 GDP, and exchange rate of Rs. 66.5 to a dollar, the currency in circulation would be Rs. 14,963 trillion in 2016.
Again, according to the same RBI article, Rs. 500 and Rs. 1,000 are total 47% and 32% of value of money respectively in circulation. Then, total no. of currency notes to be replaced will be:
Anyway, let’s go with the RBI-quoted figure of 16.5 billion and 6.7 billion notes respectively.
In one day, roughly 23.2 billion currency notes stopped being legal tender! Take some time to process that number.
For cost of printing, a Mint analysis (which is brilliant, by the way!) quotes RBI information that cost of printing new currency notes are Rs. 2.5 for a 50-rupee note and Rs. 3.17 for a 1,000-rupee note. The new notes will be more expensive to print due to costs of designing and adding new security features. But since the volume to be printed would be large too, let’s go only a little higher for pegging the cost of printing –Rs. 2.6 for a 50-rupee note and Rs. 3.5 for a 2,000-rupee note.
Let’s say we replace all old Rs. 50 notes with new Rs. 50 notes, and all Rs. 1,000 notes with Rs. 2,000 in equivalent value. The cost of printing these many notes will be:
We would spend Rs. 54.63 billion to print the new currency notes only for replacing old currency!
Before we look at other costs of this massive decision, let’s look at the benefits arising from this. The two big benefits expected from this move are curbing black money and curbing funding of terrorist activities.
Estimating impact on Black Money: The press release of the announcement puts the value of the black economy in India at 23.2% of GDP in 2007. Considering that same ratio for 2016, while highly unlikely, gives us a figure of Rs. 34,713 Trillion. However, not all of it is cash. In fact, a huge proportion of it will be in the form of real estate, gold jewellery and investments. Replacing currency notes doesn’t affect this at all.
So how much of black economy does it affect?
The black economy would have limited financial services as its disposal, but it would also have fewer participants, hence, fewer hands to exchange. Therefore, purely as a guess, let’s say the currency required for the black economy to operate is half of what is required for the white economy. Thus, 5% or Rs. 1,736 trillion will have to be replaced by black marketers in the event of replacement of currency notes.
Note that this Rs. 1,736 trillion turns out to be only 15% of the total currency in circulation in 2016 – Rs. 14,963 trillion. Doesn’t feel good, right? Ok, let’s push our original guess of 5% to 10%, so that this ratio goes up to 30%.
So does all of this cash become “white money”?
Not really, since black marketers can continue exploiting all existing loopholes to plough this same cash back into the black economy. But let’s still consider that this becomes white.
Reversing the Currency-to-GDP ratio, this will grow India’s GDP by Rs. 34,720 trillion in the first year. Converting black money to white by itself doesn’t matter much, what really matters to the government and to us, is the tax income generated from it.
Estimating incremental tax income Last year, the income from Central Taxes to the government was about 0.01% of GDP (Rs. 14.6 trillion on Rs. 1,37,855 trillion), thus, this new white money will give the govt. Rs. 3.47 Trillion more money.
Note that we will spend only 2% of that amount in printing new currency! Cool!!
Estimating impact on Black Money: The press release of the announcement puts the value of the black economy in India at 23.2% of GDP in 2007. Considering that same ratio for 2016, while highly unlikely, gives us a figure of Rs. 34,713 Trillion. However, not all of it is cash. In fact, a huge proportion of it will be in the form of real estate, gold jewellery and investments. Replacing currency notes doesn’t affect this at all.
So how much of black economy does it affect?
The black economy would have limited financial services as its disposal, but it would also have fewer participants, hence, fewer hands to exchange. Therefore, purely as a guess, let’s say the currency required for the black economy to operate is half of what is required for the white economy. Thus, 5% or Rs. 1,736 trillion will have to be replaced by black marketers in the event of replacement of currency notes.
Note that this Rs. 1,736 trillion turns out to be only 15% of the total currency in circulation in 2016 – Rs. 14,963 trillion. Doesn’t feel good, right? Ok, let’s push our original guess of 5% to 10%, so that this ratio goes up to 30%.
So does all of this cash become “white money”?
Not really, since black marketers can continue exploiting all existing loopholes to plough this same cash back into the black economy. But let’s still consider that this becomes white.
Reversing the Currency-to-GDP ratio, this will grow India’s GDP by Rs. 34,720 trillion in the first year. Converting black money to white by itself doesn’t matter much, what really matters to the government and to us, is the tax income generated from it.
Estimating incremental tax income Last year, the income from Central Taxes to the government was about 0.01% of GDP (Rs. 14.6 trillion on Rs. 1,37,855 trillion), thus, this new white money will give the govt. Rs. 3.47 Trillion more money.
Note that we will spend only 2% of that amount in printing new currency! Cool!!
But then, we have calculated only first year tax income, that too, only for Central Taxes. What about additional tax income to states, and also the multiplier effect of tax income spent as government's capital expenditure over the years? That will increase the benefit. But, for sake of ease, I assume that this impact gets balanced off by the fact that this tax income to government also takes it away from the hands of people who would have spent it, and that the original amount spent by the government on printing new currency would also have a similar multiplier effect over the years.
Let’s look at the second big benefit – lesser fake money for terrorists.
Fake money estimates An Indiatimes article says that ISI makes a profit of Rs. 500 crore a year by printing fake money and smuggling it into India. Cancelling old notes makes all that money worth nothing, but ISI has already made its profit on that money, so it hardly makes a difference.
Let’s say it takes ISI or its partners a full year to figure out how to make counterfeit new currency notes. Then, it loses Rs. 500 crore in this one year. Now what matters is... how much of ISI’s income comes from printing fake money. We wouldn’t know this.
Let’s look at the second big benefit – lesser fake money for terrorists.
Fake money estimates An Indiatimes article says that ISI makes a profit of Rs. 500 crore a year by printing fake money and smuggling it into India. Cancelling old notes makes all that money worth nothing, but ISI has already made its profit on that money, so it hardly makes a difference.
Let’s say it takes ISI or its partners a full year to figure out how to make counterfeit new currency notes. Then, it loses Rs. 500 crore in this one year. Now what matters is... how much of ISI’s income comes from printing fake money. We wouldn’t know this.
But what we can estimate is that ISI will earn higher profits right from the moment it figures out how to print fake currency notes of Rs. 2,000.
Makes the whole step seem pointless, no?
Let’s assess the third factor now – removing corruption We keep forgetting that the black economy is an economy – meaning it already has figured out the loopholes of the official system, and has been exploiting it for years, perhaps decades! A change in currency notes is nothing more than a speed breaker in the journey.
Will replacing currency notes stop people from asking for dowry, paying ‘donation’ for school admissions and college degrees, escaping tax assessments, asking for undue promotions in government jobs, etc.? No way!
Let’s now come back to the additional costs involved in replacing currency notes in a knee-jerk manner like this.
The biggest cost is of transporting this money all over the country to bank branches and ATMs. It’s difficult to put a number to it.
The next cost is a nominal one – Business lost during this time. A recent nationwide strike of trade unions estimated losses to be in the range of Rs. 180 billion. That’s for a single day, for a section of the entire economy.
In our present case, nearly 80% of all currency notes, Rs. 14,950 billion in value, are rendered useless overnight, and are replaced over 50 days. This is in an economy where 2/3rd of transactions are in cash as per a Hindustan Times article.
During this 50-day period, even if we consider that the impact is equivalent of lost business of only 5 days, it totals to a massive Rs. 0.9 Trillion loss.
Let’s assess the third factor now – removing corruption We keep forgetting that the black economy is an economy – meaning it already has figured out the loopholes of the official system, and has been exploiting it for years, perhaps decades! A change in currency notes is nothing more than a speed breaker in the journey.
Will replacing currency notes stop people from asking for dowry, paying ‘donation’ for school admissions and college degrees, escaping tax assessments, asking for undue promotions in government jobs, etc.? No way!
Let’s now come back to the additional costs involved in replacing currency notes in a knee-jerk manner like this.
The biggest cost is of transporting this money all over the country to bank branches and ATMs. It’s difficult to put a number to it.
The next cost is a nominal one – Business lost during this time. A recent nationwide strike of trade unions estimated losses to be in the range of Rs. 180 billion. That’s for a single day, for a section of the entire economy.
In our present case, nearly 80% of all currency notes, Rs. 14,950 billion in value, are rendered useless overnight, and are replaced over 50 days. This is in an economy where 2/3rd of transactions are in cash as per a Hindustan Times article.
During this 50-day period, even if we consider that the impact is equivalent of lost business of only 5 days, it totals to a massive Rs. 0.9 Trillion loss.
In other words, we would have lost 26% of our incremental tax income expected over the next one year, at the beginning of the exercise itself.
Impact on poor This cost, while not nominal, will be hidden and difficult to estimate too.
According to a 2015 study, while 53% of Indian population has a bank account, it is with a 43% dormancy rate – no deposits or withdrawals in a 12-month period. Again, go back to the previous mentioned cash becoming illegal overnight.
The timing makes it worse too - first week of the month, and just a week after Diwali, when quite a lot of them receive their festival bonus.
Theoretically, it should affect only black money. But we already know black money in cash is only 15-30% of all cash in the economy. Be my guest in estimating the losses Indians will occur!
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Disclaimer: This analysis has been done using all openly available figures and study reports. This massive move will undoubtedly have far-reaching effects in terms of scale and time. I have made an attempt at calculating a short-term impact using my skills from another field. It does not reflect the views of my present or past employers.
According to a 2015 study, while 53% of Indian population has a bank account, it is with a 43% dormancy rate – no deposits or withdrawals in a 12-month period. Again, go back to the previous mentioned cash becoming illegal overnight.
The timing makes it worse too - first week of the month, and just a week after Diwali, when quite a lot of them receive their festival bonus.
Now imagine 125 crore Indians, only 10% of them with an active bank account, scrambling to replace 80% of their cash.
Theoretically, it should affect only black money. But we already know black money in cash is only 15-30% of all cash in the economy. Be my guest in estimating the losses Indians will occur!
---
Disclaimer: This analysis has been done using all openly available figures and study reports. This massive move will undoubtedly have far-reaching effects in terms of scale and time. I have made an attempt at calculating a short-term impact using my skills from another field. It does not reflect the views of my present or past employers.
