Currency revocation seems unlikely to generate windfall for Indian government

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Indians Rush to Exchange Cash Ahead of Deadline

Demonetisation Has Seen More Money Returned to the System than Originally Expected

By Kiran Stacey
Financial Times, London
Friday, December 30, 2016

https://www.ft.com/content/699c0d30-ce56-11e6-864f-20dcb35cede2

Indians rushed to exchange the last of their expired currency notes ahead of a deadline on Friday, amid initial signs that the country's controversial demonetisation policy will fail to generate the windfall expected by the government.

New Delhi has claimed its decision, announced last month, to scrap 86 per cent of India's currency and replace it with a smaller quantity of new banknotes would eliminate illicitly earned or unaccounted for income that has been beyond the reach of tax authorities.

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But figures show that as Indians queued to deposit the last of their old Rs500 and Rs1,000 notes, almost all of the old currency had been returned. Economists said this suggested the move had not eliminated as much illicit cash as expected, and would derail the government's hope of a windfall gain from the scheme.

Narendra Modi, India's prime minister, defended his experimental demonetisation policy on Friday evening, saying it had been necessary to root out India's well-established black economy.

"Some politicians criticised the demonetisation exercise saying the government broke a mountain only to catch rats," he said during the final hours of a 50-day transition period. "They are right. We want to catch the rats who are stealing the poor people's hard-earned money."

The Reserve Bank of India has not said when it will publish the final figures on how much has been returned. However their latest data show that over Rs14tn out of the Rs15.5tn that was scrapped has now successfully been deposited despite stringent checks for untaxed income -- far more than the Rs10 trillion that the government initially predicted.

According to some experts, this means the RBI will not be given a sudden windfall for the government to disperse in the new year.

"The government thought that trillions of rupees wouldn't come back, and those liabilities could then be written off by the Reserve Bank of India," said Sanjeev Ahluwalia, an adviser at the Observer Research Foundation think-tank.

"They thought they would be able to pull out that money as a windfall in what would have been a neat accounting trick, but at best, they were only ever going to get 5-10 per cent remaining outside the system."

However, "people have been clever at finding ways round the rules", he said.

Mr Modi first announced his decision to scrap 86 per cent of the country's currency on November 8, in what amounted to the biggest economic experiment since Japan's trial of negative interest rates.

With banks overwhelmed by customers looking to change money in the immediate aftermath of that announcement, Mr Modi pleaded with Indians to give him 50 days for normality to return.

By Friday -- the end of that 50-day period -- some sense of calm had returned to the banking system, albeit in the middle of holiday season and with most ATMs still shut for lack of new notes.

But as economists processed the initial results of the policy, many warned that the early signals show that it has significantly slowed growth.

"Growth will definitely have been lower because of demonetisation," said Kunal Kundu, India economist at Societe Generale. "Inflation data looks weak, as do early figures on consumer durables." Reports on Friday suggested spending on durable consumer goods fell by up to 38 per cent in November on the previous year.

India's army of small traders have reported a similar effect, with customers staying away either to stand in bank queues or simply to conserve their supplies of cash.

Kailash Ashtakwani, a hardware store owner from Delhi, said he had lost 70 per cent of his business as a result of demonetisation. Standing in line to deposit cash at his bank in New Delhi, Mr Ashtakwani said: "Putting the [old] money in is easy but to take anything out is impossible when queues are eight or nine hours."

India's finance minister, Arun Jaitley, has announced a jump in tax revenue in the period from April until mid-December, which he said showed that the move had not damaged growth. Economists warned, however, that the increase was also caused by multiple tax rises in that period.

Mr Modi will give another speech on Saturday during which he is expected to announce a sweetener to win over voters ahead of regional elections next year.

He may also say when the curbs on withdrawals from ATMs will be lifted. Bank customers can currently only take out Rs24,000 per week over the counter from banks, and some had predicted this limit would be lifted on Friday. With banks lobbying for the limits to be extended, neither the government nor the RBI has said when they will finally end.

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