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pic110 Demon-etisation: India opens with a fanfare the ball of the fiscal QEs

Since November 8, 2016, India has created a monetary revolution of a magnitude never seen, both by the size of the population concerned and the depth of the transformation induced. By demonetising the biggest notes of 500 and 1000 Rs (rupees), the Indian government is trying to reintegrate into the official economy the state’s gigantic parallel (or black or more simply the archaic) economy. In a nation where 90% of the transactions are made in cash, a huge part of the financial activity escapes the knowledge of the central government, and therefore statistics, taxes and infrastructure financing.

fig-1Blue: volume; red: value. Source: Bloomberg.

Warning signs

There is nothing new in the fact that the central government tries to force its population to declare their wealth. For example, between 1951 and 1997, no less than ten amnesty projects had been launched, encouraging citizens to declare their unofficial income in exchange for a simple payment of some increased tax[1].

When Narendra Modi came to power on May 26, 2014, his programme spoke of modernisation of the country according to the neoliberal principles of privatisation and deregulation. But the tone, in that respect, has changed around the world. In India, as elsewhere, investment in infrastructure, Keynesianism and taxation have become much more important than monetary easing and indebtedness. Thus, in November 2015, Modi began to put in perspective a new form of modernisation, based on a very ambitious tax reform (JAM[2]).

On June 1, 2016, he launched his own amnesty scheme, or rather his income tax declaration scheme, asking Indians to take advantage of this period to declare their unofficial liquidity imposing a tax of 45% instead of the usual 30%[3], lasting for three months.

The detail of the demonetisation process

But the operation of demonetising the 500 and 1000 Rs banknotes on November 8 (in the middle of the US election) over a period of 50 days (until December 30) was not expected. This produced a real shock, especially knowing that these notes account for 86% of the liquid circulating in India; meaning an amount of Rs 14 lakh crore (or 14 trillion rupees[4]) being withdrawn from the cash in circulation.

From 8 to 24 November it was foreseen that any person exchanging or depositing amounts of more than 250,000 rupees (Rs 2.5 lakh) without being able to justify them would pay double the normal (30%) tax on these sums, as well as a fine of 200%. During this first period of the measure, masses of notes were thus purely and simply burnt.

But on November 29 the Lok Sabha (Chamber of Representatives) judged this rule as legally unfounded and voted an amnesty decree allowing people to declare amounts above 250,000 rupees on a payment of a tax of 50%. The remaining 50% are thus reintegrated into the white economy. But that is not all, half of this laundered sum (25% of the total) is blocked in a bank account in the form of lock-ins, or bonds, for four years … at the end of which the money will be recoverable with interest (unlike the ... Read