India retires rupee notes: the effect on the urban poor

Stephan Siegel

Stephan Siegel

In a surprise announcement on November 8, 2016, the government of India retired all banknotes of 500 and 1000 rupees from circulation, effective immediately.

The intent of this sudden and sweeping act was to cut off the preferred currency of illegal commerce, corruption, crime, tax evasion and terror.

But how did it effect the nation’s enormous population of working poor?

According to a study co-authored by Stephan Siegel of the University of Washington Foster School of Business, working poor families in Mumbai’s urban slums lost income, cut spending and increased savings, on average, during the month following the government’s demonetization. The self-employed were hardest hit financially.

Despite the uncertainty it caused, most of the families surveyed expressed support for the demonetization policy—even a small majority of those who had lost income as a result.

“It is important to keep in mind that our survey is not representative of India’s population as a whole, nor is it necessarily representative of those of low socio-economic status in rural India,” says Siegel, an associate professor of finance and Evert McCabe Faculty Fellow at Foster. “Nevertheless, the results provide some initial understanding of the immediate and possibly long-term effects of the demonetization policy on the working poor.”

Removing temptation

This is not the first time a government has removed currency in an effort to combat corruption and crime. Demonetization policies have been used in the Soviet Union, North Korea, Ghana, Myanmar, even Great Britain and the United States, which began phasing out notes of $500 and higher in the 1940s.

India has a history of discontinuing problematic currency notes (in 1946 and 1978).

In this most recent act of demonetization, Prime Minister Narendra Modi banned the nation’s largest currency notes in a “surgical strike” to stem India’s rampant tax evasion and corruption. The 500 and 1000 rupee notes were seen as the favored form of “black money” that financed bribes, crime and terrorism. People stockpiled the notes to avoid paying taxes. And they were the denominations most often counterfeited.

When the rupees were pulled from circulation in early November, Indians holding legitimate and reasonable quantities of the decommissioned notes were allowed to deposit them into bank accounts or exchange for cash equivalents in other denominations.

On the other hand, the government intended that those who had amassed cash for or from illegal activities would find themselves sitting on worthless stacks of paper.

But banning India’s busiest two notes of currency, worth about $8 and $15 respectively, effectively flushed 80 percent of the nation’s cash from circulation. This change was always going to be felt most acutely by the enormous population of urban working poor. For them, cash has been the main currency of compensation, consumption and savings.

Siegel-IndiaSurvey says…

When the unexpected announcement came down, it happened that Siegel was on sabbatical at the Reserve Bank of India. As the nation was plunged into temporary economic chaos, he decided to examine the toll of this policy on the urban poor.

He partnered with Deepa Krishnan of the SP Jain Institute of Management and Research. In early December, Siegel and Krishnan sent MBA students from the Jain Institute to 28 Mumbai slums in order to interview the parents of kids they had mentored.

The 179 families surveyed have limited education and a modest monthly income (in the range of Rs 7000-17000 or $105-254) from work as street vendors, shopkeepers, sales clerks, taxi drivers, personal drivers, tradesmen, laborers, tailors, embroiderers and maids.

The survey revealed that, in the month after demonetization:

  • The urban poor households experienced, on average, a 10 percent loss in income compared with typical months.
  • Service workers fared best, with only 15 percent of those working as cooks, personal drivers and maids reporting income loss.
  • The self-employed fared worst, with 59 percent of shopkeepers and street vendors, and 41 percent of taxi drivers, laborers and tradesmen reporting significant income loss—of up to 44 percent of their normal monthly income, on average.
  • More than half of the households reported purchasing fewer groceries than usual, and 39 percent postponed purchase decisions in November.
  • Households expressed a much greater expectation that they would keep their savings in a bank account rather than cash in the future, especially those headed by laborers and the self-employed.
  • Despite the turmoil and uncertainty it created, 56 percent of the working poor households supported the demonetization policy overall. Even 51 percent of those who lost money reported that they approved of the policy.

“The biggest surprise for us,” says Siegel, “was that even people who lost income still supported the measure as they saw it as action against tax evasion and corruption.”

He adds that the policy moves India toward a cashless economy, a migration being discussed in the US and across the European Union.

Siegel stresses that this preliminary survey of the Indian demonetization provides only a snapshot of its short-term fallout in low-income urban communities. He and Krishnan are working on a follow-up study that measures the financial impact on urban working poor families over a longer time period.

Survey of the Effects of Demonetisation on 28 Slum Neighborhoods of Mumbai” is published in the January 21 issue of Economic and Political Weekly, an Indian policy journal.