ISAS Working Papers

On November 8, 2016, the Indian Prime Minister, Mr Narendra Modi, announced the demonetisation of the Rs 500 and Rs, 1,000 currency notes from that midnight. This was arguably the most radical monetary policy initiative since 1947, leaving no part of the population unaffected. The main objective was to curb the black economy. This paper contends that demonetisation has proven to be a blunt policy instrument for checking the parallel economy. Data shows that a small proportion of black money is held as cash, with an overwhelming majority of illegally generated funds held in other asset classes such as precious metals, property, other financial instruments and offshore accounts. Of the funds unaccounted for by the tax authorities, a significant proportion has been returned to the banking system. Though precise estimates are difficult to obtain, collateral damage on the informal sector and those on the economic margin seem to have been severe, while the return of a large proportion of invalidated cash to the banking system, may have negated the original objective of seizing black money. There are likely to be benefits for public finance and progress in the quest for digitalising payments. However, without structural reforms and reforms in tax administration, a sustainable impact on the parallel economy is doubtful. From that perspective, the rationale for demonetisation is open to question.