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News analysis

'Black money' will be put out of circulation, tax coffers will rise

Prime Minister Narendra Modi's move to demonetise India's biggest banknotes should put a lot of "black money" out of circulation, boost tax collection and push India towards a cashless society, analysts say.

But they also warn of chaos in the short term as many people grapple with the sudden change. This is especially so in the rural areas and among small traders where business is done using cash only, with the 500-rupee and 1,000-rupee notes being the most popularly used.

Mr Modi on Tuesday announced that the two notes were being demonetised in an effort to put counterfeit currency, used for terror-financing, out of circulation and to curtail corruption.

The move will force "black money", or unaccounted wealth, to be brought into the mainstream by those hoarding them, as 500-rupee and 1,000-rupee notes lost their value on Tuesday at midnight, but they can be deposited in banks and post offices or exchanged for new currency. The banks and post offices have been told to carefully monitor these deposits.

Black money - wealth derived from corruption or by individuals and companies that avoid paying taxes - is often used to buy gold or real estate. "This one-time clean-up was required. It's a brilliant move. But we will suffer in the short term. GDP will plunge, traders will suffer and prices of real estate, where there is a lot of circulation of black money, will come down in the short term," said Mr Rishi Sahai, managing director of investment bank Cogence Advisors.

The smaller businesses which are key drivers of growth run mostly on cash, as does the rural economy where access to banking is limited. The economy is thus expected to be hit by slower spending until people have adjusted to carry on without the use of the two big notes.

On corruption, analysts say the government needs to aggressively target the source of black money. "You need a highly coordinated build-up in terms of curbing further generation of black money. That involves coordination between the tax department, state and central governments and municipalities," said Professor Sebastian Morris from the Indian Institute of Management in Ahmedabad.

There is also concern over how effectively the government will implement the phasing out of the old notes. Banks and post offices, where people can exchange their old notes for new ones, are bracing themselves for a massive rush.

"Demonetising high-denomination notes can be an effective means of checking accumulation of wealth in cash... Not only is the measure important but also it requires extensive preparation for effective execution," said Mr Naushad Forbes, president of the Confederation of Indian Industry.

Opposition parties have criticised the government's move, saying it will cause confusion and impact the poor who do not have access to banks.

Former finance minister P. Chidrambaram said at a press conference yesterday that an attempt in the late 1970s to withdraw currency from circulation had little impact on the black economy.

Still, to people like Mr Ashutosh Kumar Mishra, an anti-corruption activist, the government's move will make many people think twice about hoarding loads of money. And the flow of black money into the upcoming elections in Uttar Pradesh and Punjab states would be curtailed.

A version of this article appeared in the print edition of The Straits Times on November 10, 2016, with the headline ''Black money' will be put out of circulation, tax coffers will rise'. Print Edition | Subscribe