How Narendra Modi's Cash Recall Gambit in India Backfired; Modi's Plan to Root out Corruption and Tax Evasion Could End in a Terrible Recession

By Overdorf, Jason | Newsweek, December 9, 2016 | Go to article overview

How Narendra Modi's Cash Recall Gambit in India Backfired; Modi's Plan to Root out Corruption and Tax Evasion Could End in a Terrible Recession


Overdorf, Jason, Newsweek


Byline: Jason Overdorf

On November 8, when Indian Prime Minister Narendra Modi announced a surprise recall of more than 80 percent of the country's cash in circulation, his supporters hailed the measure as an ingenious "surgical strike" against corruption and tax evasion. Everyone else was too busy running to the ATM.

Before the move, Modi had made little progress in fulfilling his campaign promise to bring back billions in untaxed "black money" stashed abroad so he could deposit it in the bank accounts of India's poor. Washington, D.C.-based corruption watchdog Global Financial Integrity recently estimated that an average of $50 billion a year in illicit funds flowed out of India from 2004 to 2013, while bureaucrats, politicians and business tycoons amassed huge fortunes from influence peddling, backroom deals and outright graft.

Some Indians were so disgusted by this corruption that, much like Donald Trump's supporters in the U.S. or Britain's Brexiteers, they applauded Modi's radical gambit--believing any action would be better than continuing to do nothing. But as it becomes more and more clear that replacing old notes with new ones will, at best, result in a small loss for the biggest crooks and only a short hiccup in the bribery business, the scheme is rapidly looking less like a clever economic maneuver than a brilliant but potentially disastrous piece of political theater.

The idea behind the recall was simple. Overnight, India announced that anyone holding 500- and 1,000-rupee notes had to exchange them for new bills before December 31. After that date, the old money will become worthless. The catch: The government is allowing people to swap only 4,500 rupees (about $65) in the old notes for cash. Anything more than that has to be deposited, thus creating a paper trail. Theoretically, this would either force those hoarding cash to come forward and pay taxes or their money would be worthless. Plus, anyone caught with more than 250,000 rupees in canceled notes--about $3,500--is now subject to investigation.

Related: A train crash and black money trip India's "post-truth" moment

To prevent word of the plan from getting out, which might have allowed the biggest violators to exchange their big notes in advance, Modi reportedly opted to make the radical move in secret. He apparently relied on the advice of a few top advisers.

He would have done well to seek further counsel, because his plan has now thrown India's economy into chaos. The secrecy meant the country's mint couldn't print or distribute new notes until the announcement--so banks are struggling to meet demand. Even worse: Indians are standing in long lines to exchange or deposit their old notes, or withdraw cash just to buy groceries.

Black money--cash hidden to avoid taxes--is pervasive in India. Yet it's not only that police officers, tax collectors and politicians demand bribes to do their jobs or look the other way, says Surjit Bhalla, senior India analyst at the New York-based Observatory Group, an advisory company specializing in monetary and fiscal policy. Virtually anyone who buys real estate in India pays for it at least partly under the table, and even the poorest Indians routinely forgo receipts to avoid paying sales tax. "Everybody," says Bhalla, "has been made to commit this crime."

Black money can also represent proceeds from legitimate business, while illegal income from bribes or conflicts of interest can be "white"--as long as someone has paid taxes on it. So the politicians in Parliament or various state assemblies, many of whom have somehow earned tens of millions, if not more, after taking office, can pay taxes on their bribes and still get away with it. Recalling and replacing big bills won't do much to stop this malfeasance, Bhalla says. As long as bribery continues, the new clean notes will swiftly turn into dirty ones. Corruption, it seems, has little to do with the denominations of the bills--except that large notes take up less storage space. …

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