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Indian Government’s Crackdown on Black Market Rupees Fails Miserably

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India’s experiment with “demonetization” has failed according to figures from the country’s central bank.

In a shocking decision on November 8th of last year, India’s government demonetized all 500 and 1000 rupee notes (worth USD 7.78 and USD 15.56 respectively), rendering 86% of currency in circulation worthless. Indians were given just four hours’ notice by way of a live, unscheduled television broadcast that only sub-500 rupee notes could be used as legal tender.

Per the decree, Indians were allowed to deposit the higher denomination notes into their bank accounts and withdraw notes of a lower denomination, thereby preserving their personal wealth, but most Indians would later find out that they faced restrictions on withdrawals amid cash shortages.

Further to cash shortages, which led to large police-controlled queues at banks, demonetization’s effects included a slump in Indian manufacturing output and industrial production in the months that followed and protests against Prime Minister Modi’s government in numerous Indian cities. According to the BBC’s Soutik Biswas, “many low-income Indians, traders and ordinary savers who rely on the cash economy were badly hit [by demonetization].” A man in Chennai told Biswas in November that he was “carrying all this cash, but can’t have lunch.” Others showed BBC cameras signs saying: “What am I supposed to eat? ATM Cards?”

In financial markets, India’s SENSEX equity index fell more than 6% on the morning following the announcement and the rupee fell sharply over a ten-day period, from 66.15 against the US dollar to 68.40 – a fall which, to be put into perspective, is equivalent to 93% of the entire 2016 trading range in USD/INR.

 

Why Demonetization?

The targets of demonetization were counterfeit currency, undeclared wealth (on which no tax is paid), and legitimate currency used to fund illegal activity or terrorism. The large majority of such currency is held in higher denomination notes.


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INR/USD 3 Month Chart

It was believed by the Modi government that individuals in possession of illegal rupees would not deposit them into bank accounts in order to avoid being identified. With 500 and 1000 rupee notes no longer accepted as currency anywhere in the country, India’s government expected to quickly wipe out much of the illegal money, together with criminal gangs and corrupt individuals or agencies whose activities depended on it.

 

A Spectacular Failure

Disproving the supporting theories presented by the Indian government when demonetization was announced is the latest report from the Reserve Bank of India (RBI). The report states that 99% of 500 and 1000 rupee notes in circulation prior to demonetization were deposited into bank accounts, and since virtually all money re-entered the banking system, it follows that virtually all illegal money also re-entered.

The Financial Times’ Simon Mundy offers one explanation for this outcome:

“Complex money laundering networks sprang up in the wake of demonetization to help wealthy Indians deposit huge volumes of previously undeclared currency without exposing themselves to authorities. Such people allegedly sold their old notes at a discount to brokers who then dispatched low-income Indians to deposit or exchange them at banks.”

As for detecting and eliminating counterfeit currency, the RBI’s report suggests little was achieved.

According to RBI data, between April 2016 and March 2017, a little more than 570,000 counterfeit notes of the 500 or 1000 denomination were identified. While this may sound like a respectable amount, it represents only 0.00002% of the twenty-four billion notes that were withdrawn within the same period. Policymakers would have hoped to detect a great deal more counterfeit currency considering that 400,000 fake notes were discovered in the year to March 2016, before demonetization.

Political and economic commentators have been scathing in their assessment of demonetization following this week’s publication of the RBI’s report.

“Modi’s biggest move was a total bust,” said Bloomberg’s Mihi Sharma.

“A colossal failure which…ruined the economy,” tweeted vice president of the opposition Congress party, Rahul Gandhi.

“Demonetization has been a failure of epic proportions,” said an unnamed BBC reporter.

 

As always, readers in need of foreign currency, including Indian rupees, can find the best value providers using BER’s exchange rate comparison calculators for travel cash and foreign currency transfers

 

Further Reading

 

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Posted to: News

 
 
Please note that the opinions of our authors are their own and do not reflect the opinion of Best Exchange Rates and should not be taken as a reference to buy or sell any financial product.
 

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