China Research

What a surprise to the Indian people when Prime Minister Modi two weeks ago without notice banned people from using the most popular 500- and 1000-rupee notes, making these notes worthless on the spot in retail trade, services etc. Some GDP damage – probably short-term – cannot be ruled out. A distorting shortage of cash showed up immediately in this gigantic cash-using country. The total enforced withdrawing of 84 percent of India’s cash currency created directly a severe chaos, despite the still existing possibility of changing the old notes into new ones by year-end and/or of opening deposit accounts, based on the currently commercially invalid bank notes.

Two – on the paper plausible – reasons led to this drastic decision by the Indian government. First, it is regarded as an important step against India’s enormous corruption. Second, the attempt to move more and more financial transactions to credit cards and bank accounts is aiming at improving tax-paying honesty which really is extremely low in India (i.e. in a country where only 3 percent of the population prepare tax bills and just 1 percent is paying taxes in reality). The institutional shortcomings of corruption and the black economy are really severe.

The main question, however, remains: to what extent can the recently taken measures contribute to fundamental institutional improvements? I see these note eliminations rather as symptomatic steps. History from the 1970s reminds us that similar steps at the time definitely were not successful.

However, the world has received a reminder by the Modi government of the major need to improve India’s fundamental institutional conditions – one of the major assumptions for sustained high growth rates. The globalized world is changing continuously in many respects. But many or most principles of economics are still in place – institutional economics most certainly included.

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

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