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Will demonitisation truly catch the big fish?

Categories : Cash is a public good, Cash is trust
December 1, 2016
Tags : Asia, Demonitisation, India, inequality, Unbanked
Every day there are stories about the negative consequences of India's radical demonitisation scheme. And more are certainly to be written.
Communication Team / Equipo de Comunicación

India’s demonetisation of the Rs500 and the Rs1,000 is resulting in a number of side effects that Prime Minister Modi probably hasn’t thought of. Not only has this radical move forced many housewives to lose most, if not all, of the money they saved but is has caused endless lines at banks, pushed small businesses to struggle and resulted in numerous suicides. But the list doesn’t end here.

In the case of the Indian Parliament’s canteen, many regulars have been finding it difficult to pay for their lunch due to the scarcity of low denomination notes. To respond to this problem, a card machine was installed. Not everybody has been very happy about the move. Numerous canteen users have never before used a debit card. Worse, they are not very pleased with the idea that they must pay a transaction cost when using a card, which increases the price of their subsidised lunch.

Commercial banks are also suffering from the move. If the rush to deposit cash might have originally sounded like a jackpot for banks, today it’s actually hurting them. Deutsche Bank estimates that Indian banks could lose as much as 0.15 percentage points in net interest margin due to the recent chain of events. The surge in cash deposits resulted in a slump in short-term interest rates. “In response, the RBI temporarily raised the cash reserve ratio to 100% of excess deposits from a mere 4%. The effect was to suck $50 billion from the banking system. It was a costly move, depriving India’s already-struggling banks of $75 million to $90 million in foregone profits a week” (The Wall Street Journal).

Many economists are doubtful of the effectiveness of the measure to reduce corruption and curb tax evasion. According to Foreign Policy, serious racketeers and criminals rarely keep large cash holdings, instead parking it in real estate or stashing it in banks abroad. “The minor entrepreneur, the shopkeeper, the farmer will be hurt by this,” says Pranjul Bhandari, an economist at HSBC in Mumbai. “And even among the bad guys, the risk is you catch the minnows, but the big fish escape. ”