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Economic Rationale of Demonetisation

Scrutiny of the Governments Claims

The governments claims about the fruits of demonetisation of 500 and 1,000 notes are analysed. The
ve claimsghting terrorism, black money, gaining scal space, reducing interest rates, formalising
informal economyare scrutinised from an economics perspective.

Vineet Kohli (vineet.kohli@tiss.edu) and R Ramakumar (rr@tiss.edu) teach at the School of Development
Studies, Tata Institute of Social Sciences, Mumbai

On 8 November 2016, Prime Minister Narendra Modi announced the demonetisation of `500 and `1,000
notes with eect from the next day. Through the 50 days after 8 November, the government has made a
set of claims with regard to the objectives and outcomes of the demonetisation scheme. In this note, we
wish to examine the economic rationale and logic behind a few of these claims.

The rst claim is that demonetisation would plug terror nancing. The Prime Minister asked:

have you ever thought about how these terrorists get their money? Enemies from across the
border run their operations using fake currency notesMany times, those using fake ve
hundred and thousand rupee notes have been caught and many such notes have been
seized (PMO 2016).

The second claim is that demonetisation would help unearth black money. Clearly, the Prime Minister
was referring to black money hoarded in cash; he asked: which honest citizen would not be pained by
reports of crore worth of currency notes stashed under the beds of government ocers? Or by reports of
cash found in gunny bags? (PMO 2016). There are two ways in which this is supposed to happen: one,
unaccounted cash is not returned to the banking system due to fear of detection; and two, when
unaccounted cash that enters the banking system is either detected by tax authorities or voluntarily
disclosed by the depositors.

The third claim is that the unearthed black money would expand the scal space of the government. One,
when unaccounted cash is not returned to the banking system, the Reserve Bank of India (RBI) can use the
savings to pay the government a dividend. Two, unaccounted cash that is voluntarily disclosed would be
subjected to a 50% tax as per the Taxation Laws (Second Amendment) Bill, 2016. Unaccounted cash not
voluntarily disclosed but detected by tax authorities would be subjected to a 75% tax. Further, the
declarant would have to deposit 25% of the undisclosed income into the Pradhan Mantri Garib Kalyan
Deposit Scheme (PMGKDS) 2016, which would be used to nance programmes of irrigation, housing,
toilets, infrastructure, primary education, primary health, livelihood, etc.[i]
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The fourth claim is that demonetisation would help reduce interest rates in the banking system. According
to Arun Jaitley, Minister of Finance and Corporate Aairs, banks are now ushed with funds and
these low-cost funds are going to be lent at a much lower rate.[ii] In his address to the nation on 31
December 2016, the Prime Minister further claimed that demonetisation would reduce ination in the
economy.

The fth claim is that demonetisation would help formalise Indias informal economy, reduce the extent of
transactions in cash and help create a less-cash economy. In fact, between November 2016 and
December 2016, the slogan of demonetisation has shifted from being an attack on black money into a
facilitator of transformation into digital transactions. A number of incentives have been oered to induce
people to use digital transactions.

Counterfeit Currency

The circulation of counterfeit currency in the economy is a fact. However, there is no accurate estimate of
the quantum of circulation of counterfeit notes. There are two major sources of data on Fake Indian
Currency Notes (FICN): one, the data released by the RBI on FICN detected by the banking system; and
two, the data released by the National Crime Records Bureau (NCRB) on FICN seized by the police.

The share of FICN detected by banks in the total number of `500 notes in circulation was
0.000022% in 201314, 0.00002% in 201415 and 0.000016% in 201516. The share of FICN in the
total number of `1,000 notes in circulation was 0.000021% in 201314, 0.00002% in 201415 and
0.00002% in 201516 (RBI 2016: ch 8).[iii]

The share of FICN seized by police in the total number of `500 notes in circulation was 0.0037% in
2013, 0.0025% in 2014 and 0.0019% in 2015. The share of FICN seized in the total number of `1,000
notes in circulation was 0.0038% in 2013, 0.0031% in 2014 and 0.0028% in 2015.[iv]

In 2012, the government had entrusted the Indian Statistical Institute (ISI), Kolkata with a study on
counterfeit notes. The results of the study were reported in the written answer to a question in the Rajya
Sabha in August 2015.[v] According to the answer, the face value of FICN in circulation was found to be
about `400 crore and the value remained constant for the last 4 years. Media reports also quoted the
ISI study as concluding that the existing systems of seizure and detection are enough to ush out the
quantum of FICN being infused.[vi]
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Thus, it is unclear if the quantum of FICN is signicant to warrant overarching measures like
demonetisation.

Black Money

A crucial assumption in the demonetisation exercise is that black money is hoarded as cash. Such a view
is not just narrow, but also serves to defeat the larger purpose of preventing illegal creation and storage of
unaccounted money. To begin with, it is necessary to distinguish between three concepts: black
economy, black money, and what we may refer to as black cash.

The term black economy may simply refer to a broad set of economic activities that generate production
and income ows that are under-reported or unreported or result from economic illegality. A portion of
incomes generated in the black economy, when saved, adds to the stock of black wealth or, what we may
call, black money. Because savings that nanced the acquisition of black money were themselves
undisclosed, black money has been dened ocially as assets or resources that have neither been
reported to the public authorities at the time of their generation nor disclosed at any point of time during
their possession (GoI 2012a).

A part of the black money is held as black cash. According to estimates in the National Institute of Public
Finance and Policy (NIPFP) (1985), cash was a very signicant form of holding black money in only less
than 7% of the cases. The prominent forms of holding black money were: (a) under-valued commercial and
residential real estate; (b) under-valued stocks in business; (c) benami nancial investment; (d) gold,
silver, diamonds and other precious metals; and (e) undisclosed holdings of foreign assets. More recently,
open economy policies, free-trade arrangements and nancial liberalisation policies have expanded the
scope for holding black money in newer forms.

However, the very concept of black money is nebulous (NIPFP 1985). This is because the same person who
earns black income also typically generates income in white. He may choose to declare his savings by
claiming them to be a portion of his legitimate income. There may, in other words, be black incomes but
little or no black savings! No wonder then that economists are not very fond of estimating the size of black
money. In fact, we are not sure if there could be any realistic estimate of black money in India. A
commonly cited estimate puts the size of the black economy between 19% and 21% of the gross
domestic product (GDP) (NIPFP 1985). Some other estimates note higher shares. According to Kumar
(2016), the size of the black economy amounted to about 62% of GDP in 2012.

In fact, the idea that only illegal holdings of cash lubricate the black economy is itself misplaced. This
presumption has not only inltrated the public discourse but has also seeped into some of the academic
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work on the subject. In his much-quoted work on the subterranean economy of the United States (US),
Gutmann (1977) chose a base period in which he considered the size of the black economy to be
negligible. The currency-to-deposit ratio of the base period was then applied to the deposits in 1976. Such
a method gave him an estimate of the legitimate currency requirement in 1976. The ratio of GDP-to-
legitimate money (legitimate currency plus deposits) multiplied by the currency stock in excess of its
legitimate requirement, then, gave Gutmann his measure of black income in the US.

The problem, however, is that transaction balances used for generating black income need not be
undeclared or illegal. For example, a rm can declare cash in its balance sheet and then use it to procure
inputs at inated prices from an associated rm that operates from a low tax jurisdiction. The prots can
then be ploughed back into the rm, say, via the foreign investment route. The expansion of liabilities that
results may, at least temporarily, cause the rm to hold even larger amounts of cash. In this case, there is
nothing illegal about the original holdings of cash or their subsequent augmentation. In fact, since
transaction balances are held legally as cash, they could well be held as deposits. The example, therefore,
shows that bank deposits can also nance black activities. This, of course, goes against the very grain of
what Gutmann suggests and what the current Indian government would have us believe.

In the example we constructed above, black incomes are generated in the country but received in a
foreign land. But are not incomes from corruption (and many other forms of illegalities) received as cash
within the country. Would not demonetisation reduce these to worthless pieces of paper? It would, but only
to the extent that the recipients of such incomes were foolish enough to continue to hold them as illicit
cash. They could, in the rst place, choose to consume these incomes. But even when such incomes are
saved, they need not be held as cash. The savings can take the form of land, gold/bullions or nancial
shares. Besides, there are ways to launder illicit cash. For example, bill masters may be engaged to sell
fake bills to those rms that wish to inate their expenses (GoI 2012b). Illicit cash can then be shown as a
receipt for sales that never took place and, in this manner, made perfectly legitimate.

Thus, only a small section, which stores cash in large amounts either for future use or as revolving cash in
business/trade transactions, is adversely aected by demonetisation. As we explained above, even here, a
big portion of cash might actually be legal or made legal through myriad innovative ways. The assessment
by I G Patel, the then Governor of the RBI, of the demonetisation scheme of 1978 is as true for 2016 as it
was for 1978:

such an exercise seldom produces striking results. Most people who accept illegal gratication or are
otherwise the recipients of black money do not keep their ill-gotten earnings in the form of currency
for long. The idea that black money or wealth is held in the form of notes tucked away in suit cases
or pillow cases is nave. And in any case, even those who are caught napping or waiting will have
the chance to convert the notes through paid agents as some provision has to be made to convert at
par notes tendered in small amounts for which explanations cannot be reasonably sought (Patel
2002: 159).
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In sum, no signicant unearthing of illegal cash may be expected by demonetisation, even if it might halt
or slow down illegal cash-based operations for a while.

Fiscal Space

In the days soon after 8 November, the buzz in policy circles was that demonetisation would extinguish
close to `3 lakh crore of RBIs currency liabilities. The enlarged net worth of the RBI, it was hoped, could
then be transferred to the government in the form of a special dividend. The legal permissibility of such a
transfer was a matter of speculation for almost a month after the announcement. However, two points
may be noted in this context. First, the transfer of extinguished currency as dividend to the government
was ruled out by the RBI itself. Urjit Patel, the RBI Governor, claried on 7 December that the withdrawal
of legal tender characteristic status does not extinguish any of the RBI balance sheets ... They are still the
liability of the RBI. Secondly, as on 10 December, an amount of `12.44 lakh crore in the old series of
notes had already entered the banking system. The public had time till 30 December to deposit old notes
with banks, and they could continue to submit old notes to the RBI until around March 2017. In other
words, there is likely to be very little money left with the RBI to extinguish.

Given that the dividend route is closed, the government would bank on the second version of the Income
Disclosure Scheme (IDS) to improve tax collections and enlarge the kitty of the PMGKDS 2016. However,
one wonders why such a scheme could not have been announced without demonetisation. Perhaps,
demonetisation has armed the government with evidence on big ticket deposits that it can use to confront
tax evaders. Yet, why would anyone deposit a large sum into a bank after 8 November and invite scrutiny
from tax authorities? According to news reports, people may have split their large hoard of cash into
smaller parcels before converting them into deposits. The tax authorities now have the unenviable task of
establishing the trail from the original hoard of cash to multiple small-ticket deposits in the millions of
accounts spread across tens of thousands of bank branches.

What is likely to be the net revenue gain from demonetisation? As an illustration, let us assume that `1.6
lakh crore are voluntarily disclosed (which is more than two and a half times the amount disclosed in the
rst income disclosure scheme). A 50% tax on this amount would result in an addition of `80,000 crore to
governments tax kitty. Besides, declarants are supposed to provide an interest-free loan equal to one-
fourth of the disclosed amount to the government for a period of four years. Assuming a 6% interest rate
on borrowings, the government would then save `2,400 crore in each of the next four years. The present
discounted value of this income stream comes to `8,430 crore. The total revenue gain is then `88,430
crore.

However, the government would also lose money. It will end up spending about `17,000 crore on printing
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and distributing currency, and conservatively, another `6,000 crore as the interest cost (explained later) of
managing the excess liquidity with banks. Let us assume that 2% of the nominal GDP is shaved o due to
demand contraction; instead of growing at, say, 11.5% per annum, the nominal GDP would grow at 9.5%
per annum. Taking the nominal GDP (at market prices) of `135 lakh crore in 201516 and a tax-to-GDP
ratio of 17%, the combined loss of tax revenue to the centre and the states due to economic contraction
would amount to `45,900 crore.[vii] The total loss of revenues due to demonetisation would then be about
`68,900 crore. This does not include the compensation that government may have to provide for toll
operators (about `922 crore, as per estimates in the media) and the loss of revenue from the sops
announced on digital payments. The net revenue gain to the government would then be `19,530 crore.
Even if we are generous and assume that the government actually gains `40,000 crore from the entire
exercise, it would still work out to just 1.3% of the combined revenue receipts of central and state
governments in 201516.

In other words, it is hard to think of demonetisation as a game changer for government nances.

Interest Rates and Ination

According to Arun Jaitley, and a few media commentators, demonetisation would expand credit supply and
reduce interest rates in the economy. Such a claim betrays an incorrect understanding, not only of Indias
credit markets, but even more worryingly, of the process of demonetisation itself.

Before dealing with this issue in detail, we need to, right at the outset, dispel a claim made by the Prime
Minister in his 31 December 2016 address. He had said: the excess of cash was fuelling ination and
black-marketing. It was denying the poor, their due. Lack of cash causes diculty, but excess of cash is
even more troublesome.[viii] What may drive ination, besides a sustained escalation of costs, is an
excess of demand over supply. Demand, of course, is backed by access to a means of payment, which
may be held as cash or deposits. It is thus conceptually erroneous to claim that a mere conversion of cash
into deposits will deprive economic agents of the means of payments to demand commodities. As a matter
of fact, after 8 November 2016, the poor, who are underserved by banks and mostly receive and make
payments in cash, were forced to spend less due to the denial of their rightful cash. The success in
controlling prices, in other words, was achieved by squeezing the consumption budget of the poor.[ix]

The claim that demonetisation would result in lower interest rates can be rationalised through a simple
money multiplier process. Suppose `10 of cash in the hands of the public is converted into deposits. Let us
further assume that out of every `10 that banks issue as deposits, they are required to hold `1 as cash
reserve. As a result, banks will now have `9 worth of excess cash, which they lend to public and, which,
assuming that the public is discouraged from holding cash, returns as deposits. The cycle would then start
afresh: deposits will increase by `9, cash reserves by `0.90 and loans by `8.10. When all is said and done,
deposits, reserves and loans would have increased by `100, `10 and `90 respectively. Another way to
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understand this process is to simply assume that the banks hold no more than their required reserves by
crediting `90 to the deposit account of their borrowers. Of course, such an expansion of credit cannot
come without a reduction in its price and demonetisation has raised hopes that the interest rate on loans
may fall in the near future.

There is, however, a y in the ointment. What we are witnessing in India today is not a permanent
conversion of currency into deposits but a temporary measure that would last only till the limits on
withdrawals exist. Once the convertibility of deposits into cash is restored, the multiplier process sketched
above would start working in the reverse direction. As deposits worth `10 are converted into cash, the
banks, now holding less cash than they are required to, would be compelled to extinguish loans worth `90
(and the corresponding sums in the deposit accounts of their borrowers) from their balance sheets. Any
increase in credit on account of demonetisation would therefore be completely temporary.

There is more. The textbook money multiplier mechanism assumes that banks x the overall quantity of
credit and its price is determined in the marketplace. In the real world, just the opposite happens: banks
x the price of credit and its quantity is determined in the marketplace by the activities of borrowers. To
borrow terminology developed by Polish economist Michal Kalecki, the quantity of bank credit is demand-
determined whereas its price is cost-determined. Commercial banks can always expand their lendable
resources by borrowing funds from the RBI at the repo rate xed by the latter. The repo rate, in turn, sets
the oor for lending rates to various bank borrowers.[x] It is only when the stock of eligible securities with
banks, which the RBI requires as collateral in repo transactions, begins to run thin that one can realistically
talk in terms of a quantity constraint on their credit-creating capacity.

Surely, there was no quantity constraint for Indian banks before demonetisation. As on 28 October 2016,
the stock of government and other approved securities with banks stood at `28,956 billion; this was about
29% of the demand and time liabilities issued to the non-bank public, a gure well in excess of the 20.75%
Statutory Liquidity Ratio (SLR) that the banks are required to maintain.[xi] There was no constraint on the
credit-creating capacity of banks to begin with, and the nance ministers claim that demonetisation would
result in an expansion of credit appears grossly exaggerated.

Since the RBI acts as a price xer in money markets, it seeks to mop up the enlarged cash reserves of
banks either by activating its reverse repo window or through the outright sale of government
securities.[xii] Between 30 November 2016 and 6 December 2016 alone, the RBI had mopped up more
than `4 lakh crore from the commercial banking system.[xiii] The impact of expanded deposit base would,
therefore, be not so much to enlarge credit to private borrowers as to shift the ownership of Government
securities (G-Secs) and Tresury bills (T-Bills) from the RBIs balance sheet to that of the banks.

It is hard, then, to see how interest rates in the banking system would fall due to demonetisation; any
decline in interest rates would only be transient.
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On the other hand, excess liquidity situation, while doing little to improve credit supply, will actually have
adverse scal implications. This is because the RBI, a public institution whose prots are transferred to the
central government budget, will lose its income earning assets to commercial banks. Moreover, to the
extent that market stabilisation bonds are used to mop up excess reserves from the banking system,
interest payments will have to be made directly from the central government budget. The exact
magnitude of these costs is anybodys guess at the moment. But if `12 lakh crore is mopped up by the RBI
for a period of just one month, assuming an annual interest rate of 6% paid over 12 equal monthly
instalments, the total interest outgo of the central government would be about `6,000 crore.[xiv]

Less-cash Economy

Given the inordinate delay in the printing of new currency, the government has begun a campaign for less-
cash banking. It is argued that less-cash banking would formalise a large share of Indias informal economy
by bringing more rms into the tax net.

To begin with, there is no clear relationship between the currency-to-GDP ratio and what we call as the
shadow economy, which is a more appropriate concept to use than informal economy.[xv] India had a
currency-to-GDP ratio of 12.5% in 2015 (Rogo 2016). The size of Indias shadow economyusing one
denitionis estimated at about 21% of its GDP (Schneider et al 2010). Let us take three countries where
the currency-to-GDP ratio was either higher or comparable to Indias: Japan at 18.6%, Hong Kong at 14.7%
and Switzerland at 11.1%. The size of the shadow economy relative to GDP in 2012 was only 8.8% in
Japan, 15% in Hong Kong and 7.6% in Switzerland (Schneider et al 2010; Schneider 2011). Now, let us take
ve countries that had lower currency-to-GDP ratios than India in 2015: South Africa and Brazil at 3.4%,
Chile at 3.6%, Indonesia at 4.1% and Mexico at 5.7%. All these countries had a large-sized shadow
economy relative to GDP in the second half of the 2000s: 26.8% in South Africa, 38.5% in Brazil, 18.5% in
Chile, 19.1% in Indonesia and 28.5% in Mexico.

A higher share of cash in total payments does not necessarily indicate a larger shadow economy.
According to a Deutsche Banks study in 2016,

surveys and estimations for dierent countries show that a high share of cash in total payments does
not always indicate a large shadow sector: Germany and Austria are cash-intensive countries with
relatively small shadow economies. In Sweden, cash payments have become rare but the country
still has a mid-sized shadow economy. However, in many cases the degree of cash usage and the
size of the shadow economy do seem to be related: Spain, Italy and Greece are characterized by
intense cash usage and large shadow economies while countries with relatively low cash usage tend
to show low levels of shadow activity (Anglo-Saxon countries as well as Switzerland, the Netherlands
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or France). Given these diverse ndings, it becomes clear that cash is scarcely the reason for
conducting shadow activities (Mai 2016: 78, emphasis added).

Similar, again, is the relationship between corruption and cash. There are cash-intensive countries with
lower perceived corruption and less cash-intensive countries with higher perceived corruption. The
corruption perception index of Transparency International represents the perceived level of public sector
corruption on a scale of 0 (highly corrupt) to 100 (very clean). In 2015, the index was higher for many
economies with higher currencyGDP ratios (75 for Japan and Hong Kong; 86 for Switzerland; 81 for
Germany; 76 for Austria) and lower for many economies with lower currencyGDP ratios (44 for South
Africa; 38 for Brazil; 35 for Mexico; 36 for Indonesia).[xvi]

There are also many reasons why cash is preferred by rms, particularly small and micro-enterprises.
Transaction costs in cash transactions are low; in particular, costs of book-keeping are minimised by
relying on cash. The use of digital transactions is expensive as each transaction invites a 2%3% tax. Cash
transactions may also be convenient because of the immediacy of realisation without delays of bank
transfers. In many cases, informal credit is available to small and microenterprises only as cash, and needs
to be repaid too as cash. In other words, forcefully formalising a fragile informal sector may actually end
up eliminating the minuscule margins on which these rms survive.[xvii]

Finally, cash leaves no trail, while digital payments leave a trail. For this reason, the potential for state
surveillance, violation of privacy and abuse of civil liberties rise signicantly with the replacement of cash
payments with digital payments. New sources of metadata on everyday transactions of citizens are
emerging; big data analytics is increasingly becoming big business. Such personal data of citizens turn into
commodities in the grey markets, resulting in a breakdown of trust between the state and its citizens.
While strong laws on privacy and cyber-security exist in many Western economies, Indian legal system is
marked by the absence of such legal safeguards. The introduction of Aadhaar, and its expansion into the
Orwellian idea of India Stack and the JAM (Jan DhanAadhaarMobile) trinity, present new threats to the
freedoms of Indian people that have not been adequately appreciated in the public discourse on cashless
transactions.

Conclusions

In this brief note, we tried to examine the governments claims on the benets of demonetisation. We
argued that (i) the extent of circulation of counterfeit notes in the Indian economy is exaggerated;
(ii) the claims of unearthing large amounts of black money is unfounded and based on a poorly informed
view of what constitutes black money; (iii) no improvement in government nances may be expected due
to demonetisation; (iv) it is unlikely that interest rates in the economy may fall as a consequence of
demonetisation; and (v) the movement into a less-cash economy may neither lead to the shrinkage of the
shadow economy nor reduce corruption, and, instead, may open up new spaces of surveillance and
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assaults on the personal freedoms of citizens.

Thus, one nds it extremely dicult to locate any economic logic in the conception and implementation of
the demonetisation scheme.

REFERENCES

GoI (2012a): Black Money: White Paper, Ministry of Finance, Government of India, New Dehi, May.

(2012b): Measures to Tackle Black Money in India and Abroad, Report of the Committee headed by
Chairman, Central Board of Direct Taxes (CBDT), Ministry of Finance, Government of India, New Dehi.

GoK (2016): Interim Report of the Committee to Study the Impact of Demonetisation on the State
Economy of Kerala, Kerala State Planning Board, Government of Kerala, Thiruvananthapuram, December.

Gutmann, P (1977): The Subterranean Economy, Financial Analysts Journal, Vol 33, No 6, pp 2634.

Kumar, Arun (2016): Estimation of the Size of the Black Economy in India, 19962012, Economic &
Political Weekly, Vol 51, No 48, pp 3642.

Mai, Heike (2016): Cash, Freedom and Crime, EU Monitor, Deutsche Bank AG, Deutsche Bank Research,
Frankfurt, November.

NIPFP (1985): Aspects of the Black Economy in India, Report submitted to the Ministry of Finance,
Government of India, National Institute of Public Finance and Policy, New Delhi.

Patel, I G (2002): Glimpses of Indian Economic Policy: An Insider's View, Delhi: Oxford University Press.

PMO (2016): PMs Address to the Nation, viewed on 17 December 2016,

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http://www.pmindia.gov.in/en/news_updates/prime-ministers-address-to-the-nation.

RBI (2016): Annual Report 201516, Reserve Bank of India, Mumbai.

Rogo, Kenneth S (2016): The Curse of Cash, Princeton and Oxford: Princeton University Press.

Schneider, F, A Buehn and C E Montenegro (2010): Shadow Economies All Over the World: New Estimates
for 162 Countries from 1999 to 2007, Policy Research Working Paper 5356, Development Research Group,
World Bank, Washington.

Schneider, F (2011): Size and Development of the Shadow Economy of 31 European and 5 Other OECD
Countries from 2003 to 2012: Some New Facts, unpublished Note,
http://www.econ.jku.at/members/Schneider/les/publications/2012/ShadEcEurope31.pdf.

[i] The text of the Taxation Laws (Second Amendment) Bill 2016,
http://www.prsindia.org/uploads/media/Taxation%20Laws/Taxation%20Laws%20(Second%20Amendment)
%20Bill,%202016.pdf.

[ii] See Demonetisation will redene new normal for Indian economy: Arun Jaitley, Economic Times, 18
November 2016,
http://economictimes.indiatimes.com/news/politics-and-nation/demonetisation-will-redene-new-normal-for
-indian-economy-arun-jaitley/articleshow/55499881.cms.

[iii] As regards earlier years, a reply to the Rajya Sabha by the then Finance Minister in 2009 had stated:
the Reserve Bank of India has informed that they have received very few complaints of counterfeit
currency notes found in the notes issued by banks during the period 200607 to 200809 (answer to
Avtar Singh Karimpuri, by Pranab Mukherjee, Finance Minister, Starred question no: 379, answered on 15
December 2009, Issue of Counterfeit Currency by Banks).

[iv] answer to P C Mohan, by Arjun Ram Meghwal, Minister of State for Finance, Unstarred question No
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3285, Loksabha, 5 August 2016, http://164.100.47.190/loksabhaquestions/annex/9/AU3285.pdf.

[v] See reference in note number 4.

[vi] See Fake Notes Worth `400 crore in Circulation, Times of India, 11 May 2016,
https://timesondia.indiatimes.com/india/Fake-notes-with-face-value-of-Rs-400-crore-in-circulation/articles
how/52214965.cms.

[vii] Data till November 2016 published by the Central Board of Excise and Customs (CBEC) show that if
the decline in overall indirect tax collection between October 2015 and November 2015 was `3,914 crore,
it was much greater between October 2016 and November 2016, when indirect tax collections fell by
`10,513 crore. The corresponding gures in 2016 for central excise collections was `2,661 crore and for
service tax collection was `9,258 crore; the only component that showed a rise was customs collection,
where the corresponding gure was `1,406 crore. State governments are also likely to record a fall of
revenues. For instance, though Arun Jaitley has claimed that international tourism had grown after
demonetisation, tourism-intensive states like Kerala have reported a fall in tourist arrivals (GoK 2016).
While 11.93 lakh domestic tourists visited Kerala in November 2015, only 9.82 lakh domestic tourists
visited the state in November 2016 (a fall of 17.7%). Over the same period, the number of foreign tourists
fell from 89,883 to 82,079 (a fall of 8.7%).

[viii] See Prime Ministers Address to the Nation on the Eve of New Year 2017, 31 December 2016,
http://www.pmindia.gov.in/en/news_updates/pms-address-to-the-nation-on-the-eve-of-new-year-2017/?co
mment=disable.

[ix] According to available estimates, on a year-on-year basis, consumer prices in India increased by 4.2%
in October 2016 and 3.6% in November 2016, which was the lowest ination rate since November 2014
(see http://www.tradingeconomics.com/india/ination-cpi). In the Monetary Policy Statement released on 7
December 2016, the RBI had also noted the possibility of abrupt compression of demand in November
due to the withdrawal of SBNs. See https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=38818.

[x]The mark-up added by banks on the oor xed by the RBI varies with the risk proles of borrowers.
Typically, smaller borrowers pay higher rates than larger borrowers. The mark-up may also depend on the
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quantum of excess reserves held by banks. However, since the current surge in reserves is purely
temporary, any reduction in the rate of interest due to demonetisation would be short-lived. In any case,
the RBI can directly use the repo rate to inuence interest rate structure in the economy. Demonetisation
of 86% of the countrys currency stock is indeed a curious way of reducing interest rate.

[xi] The calculations were made using the data provided by the RBIs Weekly Statistical Supplement.

[xii] Otherwise, short-term money market rate would fall below the reverse repo rate and undermine RBIs
policy stance.

[xiii] The calculations were made using information from the RBIs press releases.

[xiv] `12.44 lakh crore is roughly the amount that returned to the banking system in the form of old notes,
as on 10 December 2016. The nal amount would, in all probability, be close to `14 or `15 lakh crore. From
this, we should deduct the amount of new currency that is withdrawn by public. About `4.61 lakh crore was
issued in new notes to the public as on 10 December 2016. But the process of releasing new currency has
been painfully slow and may continue for many months forcing the banks to hold excessive cash on their
balance sheets. Moreover, if demonetisation induces an economic slowdown and a decline in credit
otake, the RBI may well end up mopping up an even higher amount of cash reserves from the banking
system.

[xv] Schneider, Buehn and Montenegro (2010: 5) dene the shadow economy as all market-based legal
production of goods and services that are deliberately concealed from public authorities to avoid payment
of taxes and social security contributions, to avoid meeting labour market standards and regulations and
to avoid complying with administrative requirements of governments, such as lling up of forms.

[xvi] See Transparency International website at https://www.transparency.org/cpi2015/.

[xvii] This is a point also made by Rogo (2016), who notes that for emerging markets and developing
economies, it is far from clear that measures to reduce the size of the informal economy by reducing the
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use of cash will be a net benet. A great deal of informal employment makes use of workers with low
human capital who could not clear the threshold for employment in the formal sector and could not be
easily absorbed by rms required to bear the costs of dealing with weak government institutions.