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Fight Against “Black Money” in India

For many residents of India, building a stash of banknotes has been a way of life. Large amounts of cash finance an underground economy that avoids government scrutiny, with many Indians sitting on huge amounts of 500- and 1,000-rupee notes. (A 1,000 rupee note is worth about $15 U.S. dollars.)

Unreported cash, called black money, is a huge problem, as prices on taxable transactions are routinely underreported, with the balance being delivered in cash. By one account, real estate deals are often reported at just 40% of the actual amount, with the other 60% changing hands under the table. (It would be like selling a property for $200,000, but paying taxes on just $80,000 while accepting $120,000 in banknotes.) Cash is also used to deliver kickbacks, bribes and store the results of criminal activity, plus hidden wages and other legal, but unreported, payments.

Prime Minister Narendra Modi, who is anxious to purge corruption from the Indian economy, has come up with an innovative solution. On November 8, he announced that he is outlawing India’s existing 500- and 1,000 rupee bills, which are the preferred denominations for tax-avoiding transactions. Those who hold these bills have until December 31 to exchange them for new bills, which the government is printing as fast as it can.

The catch is that anyone who is exchanging more than 250,000 rupees (about $3,700) must show proof that they have paid taxes on the money. There are reports of bizarre behavior on the part of people who have literal bags, suitcases and mattresses full of “black money.” Some are giving money to poor people, paying them a fee to deposit the money and return it later. Others are making a bee-line for luxury goods stores who are willing to sell gold, jewelry or other high-ticket goods and backdate the sales receipt.

Some families who have accumulated large sums to finance lavish weddings—traditionally a cash business—are scaling back their celebrations during the wedding season (which starts in December) to avoid having to exchange the horded cash. Five-star hotels, often the focus of big wedding parties, as well as caterers, musicians, decorators and makers of fancy saris, have been hit by a wave of cancellations.

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The exchange program is causing plenty of collateral inconvenience. Indian ATMs will only dispense 2,500 rupees per day, which puts a crimp in the day-to-day spending power of those who don’t have credit cards. There have even been reports of people just giving up and accepting that their piles of untaxed assets are going to be worthless.

But the program also seems to be working pretty much as designed, rooting out assets that have circulated only in the underground economy. And even if the corrupt and the tax-avoiders find ways to work around the currency exchange program, this clever program will be a demonstration that Prime Minister Modi is serious about reducing corruption, enforcing tax laws and moving India toward a more law-abiding stance.

The Indian economy has long been hobbled by its enormous bureaucracy (and the corruption that naturally results), and by the size of its underground economy. If Modi’s bold stroke can move the needle on the modernization of the economy, the entire country will benefit.
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Paul Goodwin is a news writer for Cabot’s free e-newsletter, Wall Street’s Best Daily.