Why this is important to Wisconsin businesses: With an ultimate goal of reducing corruption and tax evasion, the policy change is triggering short-term disruption in an economy that is largely cash-based.
On Nov. 8, 2016, India’s Prime Minister, Narendra Modi, announced the withdrawal of high-denomination notes (₹500, or $7.40, and ₹1,000, equal to $15) from circulation. He also announced the issuance of new ₹500 and ₹2,000 banknotes in exchange for the old ones. However, the banknote denominations of ₹100, ₹50, ₹20, ₹10 and ₹5 will remain legal and were unaffected by the policy.
The government also announced that the old notes could be deposited or exchanged at banks until the Dec. 30. The government claimed that the demonetization was an effort to stop counterfeiting of the current banknotes allegedly used for funding terrorism, as well as a crackdown on black money tied to drugs, smuggling, etc.
In the process, the government demonetized 86 percent of the total value of currency in circulation in a country that is heavily reliant on cash, bringing daily life to a halt. Long queues were seen at bank and ATMs for money withdrawal, but the government believes that this is temporary and that conditions will slowly return to normal.
The economic consequences of the Modi government’s decision on demonetization have been debated extensively, with experts divided in their opinions. Lawrence Summers, a former chief economist of the World Bank and ex-economic advisor to the U.S. President, said, Modi's demonetization move is “unlikely to have lasting benefits.” However, some economists believe that while it is causing short-term disruption to the economy, it will prove positive in the longer term, and that India will rejoin the ranks of the fastest-growing major economies in the world next fiscal year, even as a massive cash crunch is expected to drag growth lower in the current year.
India's economy is forecast to grow 7.5 percent in the financial year through March 2018, according to Deutsche Bank. Goldman Sachs pegged expected growth higher, at 8.6 percent.
U.S. State Department spokesman Mark Toner also supported India's move of demonetizing ₹500 and ₹1,000 notes, saying it was an "important" and "necessary" step to address corruption.
Meanwhile, India’s government is working to reduce the country’s dependence on cash. Opening bank accounts for the unbanked and adopting direct benefit transfers is part of the overall push to reduce the usage of cash and increase transparency. The government’s larger crackdown on black money and its resolve to deter tax evasion will yield two distinct sets of benefits: a lower cost of capital and higher flows into the financial services sector.
India’s import and export business is hugely affected by the recent announcement of demonetization. The foreign trade industry is suffering in the aftershocks, and this is expected to continue, at least for a limited time. While the ongoing changes are likely to engender painful side effects in the short term, long-term benefits of reduced tax evasion and black money may validate the policy change.