Note Scrapping: Indian Economy Running on Cash Hinders Evolution

The cash-dependent Indian economy has created ‘Parallel’ and ‘Shadow’ economies.

(Photo: Reuters)

India runs on cash and that comes with its own set of problems. The most pronounced among them is the black money that the cash economy generates, which fuels the country’s shadow economy used to evade taxes and scrutiny.

It is that shadow economy that the government is targeting through its decision to withdraw high denomination currency notes of Rs 500 and Rs 1,000.

According to a 2015 report from PwC, 98 percent of all transactions by volume happen in cash. 68 percent of the total value of transactions are conducted in cash.

The most recent estimate of the shadow economy, that is a byproduct of this cash economy, came from consulting firm McKinsey & Company in 2013. Based on that analysis, India’s shadow economy is as large as 26 percent of the country’s gross domestic product.

This implies that almost one-fourth of the Indian economy goes untaxed and unaccounted. Noting that India also has a very high proportion of cash-based transactions, McKinsey in its report said that “high cash usage perpetuates a shadow economy and hinders the evolution of a digital economy.”

‘High-End Product Sales To Fall’

“A prevalence of cash often allows an ‘informal’ or ‘shadow’ economy — one that is not taxed, monitored by government, or included in the GDP — to grow or dominate. International comparisons show a clear correlation between cash usage in the economy and the size of the shadow economy,” said the report.

While the government’s move to discontinue high denomination notes is expected to make it difficult for hoarders to amass large sums of wealth, the suddenness of the move is likely to impact businesses of all sizes in the short term, experts said.

“Though clarity is unfolding on this, commodity transactions and general cash market transactions are likely to feel an immediate impact. Unorganised sector proceedings including small trade market activities will remain volatile in the short term,” Anis Chakravarty, Lead Economist, Deloitte told BloombergQuint.

People are likely to only shop for necessities and hold back on other cash purchases till the situation improves or eases so there will be a big impact on the erstwhile informal economy which was running on cash.

Chakravarty added that luxury commodities like gems and jewellery, automobiles and high-end branded products will see a drop in sales. Some of these products and sectors are places where black money was used.

(Read the full report on BloombergQuint.)