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But What About the Rs 2,000 Note?

Apr 18, 2017

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In the Diary dated December 13, 2016, I had tried to answer a question: The question was what portion of black money is held in the form of cash.

In order to answer the question I had reproduced some data out of the White Paper on Black Money published by the Manmohan Singh government in May 2012. This data was reproduced in the form of two tables. The tables had data from the search and seizure operations carried out by the income tax department. They are reproduced below:

Table 1: Value of assets seized (in Rs. Crore)
Year Cash Jewellery Other assets Total Undisclosed Income
Admitted (in Rs Crore)
2006-07 187.48 99.19 77.96 3,612.89
2007-08 206.35 128.07 93.39 4,160.58
2008-09 339.86 122.18 88.19 4,613.06
2009-10 300.97 132.20 530.33 8,101.35
2010-11 440.28 184.15 150.55 10,649.16
2011-12 499.91 271.40 134.30 9,289.43
Source: White Paper on Black Money

The cash seized at the time the search and seizure operations were carried out by the income tax department, was a small portion of the total undisclosed income. This becomes clear from Table 2.

Table 2:
Year Cash Total Undisclosed Income
Admitted (in Rs Crore)
Proportion of cash in total
undisclosed wealth
2006-07 187.48 3,612.89 5.2%
2007-08 206.35 4,160.58 5.0%
2008-09 339.86 4,613.06 7.4%
2009-10 300.97 8,101.35 3.7%
2010-11 440.28 10,649.16 4.1%
2011-12 499.91 9,289.43 5.4%
Total 1,974.85 40,426.47 4.9%
Source: Author calculations based on White Paper on Black Money

So what do the tables tell us? They tell us that a very small portion of black money is held in the form of cash. People tend to hold their black money in the form of assets other than cash. And given this, what was the point of carrying out the demonetisation exercise which tried to tackle black money held in the form of cash, is a question worth asking.

As the ministry of finance press release on demonetisation said: "Use of high denomination notes for storage of unaccounted wealth has been evident from cash recoveries made by law enforcement agencies from time to time. High denomination notes are known to facilitate generation of black money." By demonetising the notes of Rs 500 and Rs 1,000, the idea perhaps was to ensure that a lot of black money is deposited into banks. And after that the government would find ways of recovering it.

So far so good. By now, you must be wondering dear reader, as to why am I repeating things which I have already pointed out earlier, perhaps multiple times. What is the current context? Well, over the weekend I happened to read a recently published book titled Demonetisation and Black Money written by C Rammanohar Reddy.

On Page 61 of the book Reddy has a table which is more or less similar to the Table 1 earlier in the Diary. The point he is trying to make is the same as the point I made earlier, i.e., very little of black money is held in the form of cash. Hence, Reddy goes on to say: "Thus, prima facie, cash is not a dominant component of the aggregate stock of black money or of the total value of transactions in the black economy."

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If cash is not a dominant component of the black money i.e. people don't hold a significant portion of their black money in the form of cash, then attacking it through demonetisation does not seem to make any sense. But Reddy does not totally agree with this and offers two reasons on why attacking the cash component of the economy through demonetisation can be justified. As he writes: "First, because cash is one instrument which is used for both transactions and investment-more for the former than for the latter---an attack on 'black cash', as it were, could have a disruptive effect on the market value of the stocks in the black economy."

Honestly, this is the first well argued point that I have come across in support of demonetisation. What does it mean in simple English? People who have black money do not hoard it in the form of cash, that is a given. Despite that transactions in the black economy are carried out in the form of cash.

Take the case of a home that has been bought using both white money and black money. When it is sold, the payment will be sought both in white money in the form of a cheque, and black money in the form of cash. Hence, as Reddy puts it: "The availability of a buyer with cash becomes critical for effecting the transaction... Cash, is not a dominant part of the black economy, [but] it lends liquidity to the transactions in the black economy". If you take cash out of the system, you make it difficult for those who transact in the black economy to continue transacting. And to that extent, there was some justification for demonetisation.

As I said earlier Reddy had offered two reasons in favour of attacking the cash component. Here is the second reason. As he writes: "Second, attacking cash may be the most effective way of communicating the government's determination to deal with the black economy. So any attempts to disable its use may send the appropriate signals to the holders of unaccounted wealth and to people at large." This is also a relevant point. It is easier for a government to attack cash than it attack hoards of black wealth held in the form of gold and real estate. That would be significantly tougher.

These are two very good reasons offered in favour of demonetisation carried out by the Narendra Modi government on November 8, 2016. Having said that along with demonetisation the government did something which has entirely opposite of what it was trying to achieve. It introduced a Rs 2,000 note replacing the Rs 1,000 note.

As mentioned earlier, while cash is not used to store black money, it is used to carry out transactions in the black economy. Also, higher the denomination of the paper money, easier it is carry out transactions in the black economy. It also makes it easier to store black money in the form of cash.

As Reddy writes: "It may have been a strange decision to take to introduce a new currency of even higher denomination, given that one of the objectives of the entire exercise was to remove high denomination notes from circulation."

One reason for introducing a Rs 2,000, a note of higher denomination than Rs 500 and Rs 1,000 notes which were demonetised, lies in the fact that it accelerated the process of remonetisation i.e. the process of printing notes and pumping them into the financial system. It takes one Rs 2,000 note to replace two Rs 1,000 notes or four Rs 500 notes. Hence, the process of remonetisation works faster.

Having said that, it goes against the entire idea of demonetising in the first place. A Rs 2,000 note makes it even more easier to carry out transactions in black than a Rs 1,000 note, given that fewer notes are needed. It also makes it easier to store black money in the form of cash due to the same reason.

Hence, it is important that the government withdraw the Rs 2,000 note. It needs to do this gradually over a period of time. The Rs 1,000 note needs to be re-introduced. The moment a Rs 2,000 note comes back to a bank, it needs to be replaced by two Rs 1,000 notes. A date also needs to be set by which the Rs 2,000 notes need to deposited back into the banks.

Again, it is important that the mess that was created in the aftermath of demonetisation be avoided. This can be done by having a last date which is a couple of years down the line. The RBI has carried out phased withdrawal of currency in the past, which is precisely what can be done in this case as well.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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13 Responses to "But What About the Rs 2,000 Note?"

avinash bhalchandra ketkar

Apr 19, 2017

Rs.2000/- note arrival may be treated as stop gap arrangement. now all real estate transactions msut be regulated by linking to adhar card no. pan card no. bank account account linking election i. card linking along with rathion card and gas no linking. One cannot expect now that he has got right for unlimited cash holding and transactions as well. If all gold ,real estate, cash transactons are made compalsary through bank account only black money can be curbed effectively. Our politisions do not have any shame to admit in parliament that 97% cash transactions are effected in day to day life. Now we are clearing backlog for last 70 years and present government must be given apportunity to function effectively for next two years afterwards we can expect better days and results.

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Parimal Shah

Apr 18, 2017

I say even 2000 and 500 denomination notes need to be phased out gradually - mind you, NOT demonetize.
Who needs 2000 value note? Mostly those who make big deals in cash. Make it impossible to carry large amount of cash by phasing out of the notes of 500 and 2000. Why bring 1000 notes?

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SHIVKUMAR D ISRANI

Apr 18, 2017

According to me the primary reason for Demon was to hit the Opposition very hard where it hurts so that their cash chest became almost worthless. Ruling party always has the advantage to manage a situation created by them.

I dont know whether 2000 rupee note has anything to do with political donations where the limit for anonymous donations has been reduced from Rs. 20000/- to 2000/. Easy keep only 2000 rupee notes and claim all donations from well wishers.

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Ullas Sharma

Apr 18, 2017

In my mind, introduction of Rs 2000 was perhaps done with an understanding that it would be withdrawn in the future, though not gradually but suddenly like Rs 1000 and Rs 500 notes were withdrawn. I think government should withdraw Rs 2000 note (ONLY) after a couple of years. It should take learnings from the earlier exercise to plug the loopholes as much as possible and minimize pain to poor people. It should not reintroduce Rs 1000 notes but should print more Rs 500 notes leading to withdrawal. Since poor are not likely to have many Rs 2000 notes, impact on them would be minimal. At the same time, those who hoard black money in the form of cash or keep transaction for black assets are likely to have it primarily as Rs 2000 notes. It should also ensure that all payments to workers are done through cheque payments before doing this an also limit the amount of money a person can keep in the form of cash to a relatively small amount. Also, all such money should be allowed to be deposited only in an account and exchanged. Doing it again will unsettle those who deal in black economy and a second jolt will act as a further damner against cash transactions.

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V.Janakiraman

Apr 18, 2017

The author seems to have forgotten/overlooked the reason given for issuing Rs. 2000/- notes in the first instance.
With the depreciation of the currency, the 1000/= rupee note had come down in value to about Rs. 500/=
So the new Rs. 2000/= note will have the same value as the 'original Rs. 1000/- note, when issued first.

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Bruce Kuriakose

Apr 18, 2017

As said earlier also the ratio between the small denomination and high denomination should be maximum 1:500. If it is practically possible to reduce the ratio below to this,then it is very much appreciable.This will definitely reduce/minimise the black money transactions due to difficulties of handling the small denominations.

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Chandrakant Modi

Apr 18, 2017

Hi,
Thanks for conveying two good reasons favoring demonetization from Mr. Reddy.

I liked your suggestion of withdrawing notes of 2000. But why to replace by 2 notes of 1000?? It will be better to replace by 4 notes of 500.
Since 15-20 days, I am observing that circulation of notes of 2000 is reducing. May be black marketers have started hoarding them for real estate transactions of black money portion.

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Pokri

Apr 18, 2017

You are assuming that Modi had any intention to hurt the black money holders ( bureaucrats and businessmen) who are his main sponsors. His intention was to hurt the non Sanghi parties in various states, in which he has succeeded ! He has also made contribution to political parties opaque so that the sangh parivar can benefit the maximum. So he will introduce 5000 or 10,000 rupee notes to further the activities of his black moneyed sponsors.

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vin

Apr 18, 2017

Are you really so naive ! Any way that is a problem with number crunchers far removed from
real ugly world of Politicians .
It is laughing matter that you are depending on numbers given by MM government. Most of the cash
money is held by politicians to be used during election times . How otherwise enormous amount of money
becomes available during elections . Definitely not from thin air !
Does one really believes that cash confisticated during MM regime, even 1 ruppee was from politicians !

Be real !

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Murali

Apr 18, 2017

2000 notes have increased the value of votes. Recently cancelled RK Nagar, Chennai, voters were given Rs.4000 (2000 note x 2) per vote. Effectively, it will increase corruption costs and also cost of living. It should be removed and we should have only 200 and 500 as higher notes.

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