India Abolishes 500 and 1,000 Rupee Notes to Fight Corruption

  • Chaos reigns as 500 rupee, 1,000 rupee notes are banned
  • The central bank will issue 2,000 rupee notes, Modi says

India Pulls Big Bank Bills in Corruption Crackdown

India will withdraw high-denomination banknotes in the nation’s biggest crackdown against corruption in almost four decades.

Five hundred rupee ($7.5) and 1,000 rupee notes will cease to be legal tender from Wednesday, Prime Minister Narendra Modi said in an unscheduled address to the nation. The notes in circulation will have to be deposited in banks by the end of December, he said in a late evening speech. 

QuickTake Corruption

Chaos prevailed across major cities as people lined up outside cash dispensing machines late on Tuesday following the announcement, while the S&P BSE Sensex tumbled as much as 6.1 percent before trading 2.6 percent lower at 9:54 a.m. in Mumbai.

The step by Modi, who is approaching the half-way mark of his term, is an attempt to fulfill his election promise of curbing tax evasion and recovering illegal income, locally known as black money, stashed overseas. Modi’s unprecedented move follows similar action taken by the European Central Bank, which is discontinuing the use of 500-euro ($575) notes to stop their use in “illicit activities.”

Modi is “changing the narrative at a time when everyone was saying this government’s moves on black money were mainly hype,” said Milan Vaishnav, a senior associate with the Carnegie Endowment for International Peace in Washington. At the same time “the average Indian waking up to this is going to think ‘what is going on’,” he said.

Read more: Modi put a target on tax evaders on his first day in office.

New Delhi and Mumbai, the nation’s commercial hub, witnessed massive rush outside fuel stations which are exempted from the curbs until Nov. 11. This is the first time since 1978 the government has withdrawn money from circulation, according to the central bank’s website.

Retrieve Overseas Funds

"I had difficulty to take out my car from parking because the attendant would not accept 500 rupee currency notes," said small business owner Shreet Agarwal, 21, as he parked his car at a fuel station in central Delhi packed with close to three dozen vehicles.

Banks are set to see a jump in deposits, boosting liquidity in the financial system even as cash in circulation sees an immediate contraction, economists said. Depending on how those funds get deployed, there could be an impact on growth and inflation, though it may not last. "This is a short-term risk for the economy which we would be tracking closely," Citigroup Inc. analysts including Samiran Chakraborty wrote in a note.

Struck Chord

The Indian premier struck a chord with 1.3 billion Indians in the 2014 national polls by promising at a political rally to retrieve funds stashed overseas and give the impoverished as much as 2 million rupees each from the money recovered. A one-time chance to come clean on unaccounted wealth led to declarations of only about 25 billion rupees in tax last year, while an income declaration program this year had met with a mixed response.

There are about 16.5 billion of 500 rupee currency notes and 6.7 billion of 1,000 rupee bank bills in circulation, according to central bank Deputy Governor R. Gandhi, amounting to 15 trillion rupees or $224 billion.

“On one hand, we are number one in economic growth and on the other we are ranked 100 in global corruption rankings,” Modi said, referring to India’s growth rate. “Despite various steps, we have improved only to 76.”

The timing of the move is critical. It comes just before key state elections. Money for votes is a common practice, as is handing out gifts, according to N. Bhaskara Rao, chairman of the New Delhi-based Centre for Media Studies, which published a report in 2014 on the topic.

For a story on the use of cash in elections, click here

Carnegie Endowment’s Vaishnav, who studies corruption and election finance issues in India, said the move is likely to impact smaller, less sophisticated regional political parties who deal in cash corruption. Larger and more established political parties, he said, often distribute political favors to businesses, who then pay campaign expenses directly -- without using cash.

The Reserve Bank of India will issue new currency notes of 2,000 rupees and 500 rupees.

"It is a very powerful measure to curb black money,” said Nirmal Jain, chairman of IIFL Holdings Ltd. "It will have a deflationary impact in general and more specifically on real estate prices and make homes affordable.”

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