India: How Consumers Outsmarted the Demonetisation
Chair, CashEssentials
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On November 8, 2016, India’s Prime Minister Narendra Modi announced that all 500 and 1,000 rupee notes – 86% of the cashMoney in physical form such as banknotes and coins. More value in circulation – would lose legal tenderMoney that is legally valid for the payment of debts and must be accepted for that purpose when offered. Each jurisdiction determines what is legal tender, but essentially it is anything which when offered (“tendered”) in payment of a debt extinguishes the debt. There is no obligation on the creditor to accept the tendered payment, but the act of tendering the payment in legal tender discharges the debt. More at midnight. This sudden move led the economy to a complete standstill as people spent days lining up at banks and ATMs, scrambling to exchangeThe Eurosystem comprises the European Central Bank and the national central banks of those countries that have adopted the euro. More their old “worthless” notes and deposit them in a bank account.
The policy’s primary objectives were to target unaccounted moneyFrom the Latin word moneta, nickname that was given by Romans to the goddess Juno because there was a minting workshop next to her temple. Money is any item that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular region, country or socio-economic context. Its onset dates back to the origins of humanity and its physical representation has taken on very varied forms until the appearance of metal coins. The banknote, a typical representati... More and bring it into the formal economy and counterfeitThe reproduction or alteration of a document or security element with the intent to deceive the public. A counterfeit banknote looks authentic and has been manufactured or altered fraudulently. In most countries, currency counterfeiting is a criminal offence under the criminal code. More notes. However, the Reserve BankSee Central bank. More of India reported in its 2016-2017 annual report that 98.8% of the worthless notes were diligently returned to the bank, placing a serious question mark over the efficacy of the demonetisationSee Demonetised banknote. More to clear unaccounted money.
Using transaction-level data from a large retail chain selling oversized ticket items, the authors of the report – Yewon Kim, Stanford Graduate School for Business; Pradeep Chintagujta, University of Chicago Booth School of Business and Bhavesh Pareek, Indian Institute of Management Bangalore – empirically document how households as consumers avoided or minimised policy-induced costs via strategic transactions at retail stores.
The researchers analysed over 7 million transactions before and after demonetisation. They observed that, following the demonetisation announcement, many consumers made “strategic returns,” buying items with soon-to-be discontinued banknotes to return them in exchange for new notes. This allowed them to exchange their banknotes without visiting a bank, where they would have been required to prove they had paid income tax over a certain amount. Some of the retailer’s stores saw returns increase by nearly 300% in the days following demonetisation.
The researchers also found that shoppers bought items they wouldn’t usually have purchased. Some stores had a 40% sales bump on the day demonetisation was announced. Other consumers made planned purchases earlier or switched their paymentA transfer of funds which discharges an obligation on the part of a payer vis-à-vis a payee. More to cash to spend their 500- and 1,000-rupee notes.
They extrapolated their estimates to the entire retail market. Using conservative methods, they concluded that Indian consumers had managed to shield an estimated $1.5 billion from the tax system by using retail transactions to their advantage. In the end, the retail chain came out ahead, too. The benefits of the surge in sales outweighed the costs of processing the returns and exchanging old currencyThe money used in a particular country at a particular time, like dollar, yen, euro, etc., consisting of banknotes and coins, that does not require endorsement as a medium of exchange. More for new.
“In the context of demonetization in India, such strategic consumer behaviors resulted in a significant impact that ran counterAutomatic device for the counting of banknotes or coins. More to the policy aim while benefiting both households the retail chain. Our finding underscores the importance of careful policy design that incorporates the possibility of unintended consequences due to the behavior of consumers at the retail level. We observe that, under the currency reform, retailers (partly) take on the function of financial institutions by accepting soon-to-be demonetized bills as well as distributing legal notes in their local economies.” conclude the authors.
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