India's Cash Ban

I mentioned in a previous article Bitcoin could reach $1,000 in early 2017. This wasn’t a prediction. It was a comment on the momentum of the digital currency. It looks ready to challenge its all-time high. Since that article, it has reached over $950. If you are looking to buy some for long term wealth preservation, it makes sense to scale back your purchases because you’re getting less ‘bang for your buck’ with it this high. The last time it rallied this fast, it had a big correction which was a buying opportunity. I expect it to pass the all-time high and correct again. This volatility isn’t great for adoption, but you won’t hear any complaints now; they’ll only come when it falls. If you’re using it for day-to-day purchases price, declines can limit your transactions.

One of the reasons why Bitcoin has been rallying is because of the cash ban of 1,000 and 500 rupee notes by Prime Minister Modi in India. It’s a misnomer that government bans work to stem crime. Imagine if the government banned voice calls because criminals use them. It’s a bad precedent to set. India does have a problem with tax collection, but it should have improved this through legislation instead of banning high bills outright. I think it’s similar to Obamacare because it created problems for Americans who liked the healthcare to cover a relatively small amount of people who were uninsured. Modi disrupted the entire economy to get rid of tax cheats. Anyone trying to promote Bitcoin can use this as an example of the types of coercive actions governments take.

The chart below shows the declines in GDP growth estimates due to this change where Modi eliminated the cash dominations used for 86% of transactions. 98% of transactions use cash which means about 84% of total transactions were impacted. Modi’s next plan is to eliminate properties purchased which are not registered in the owner’s name. The government is using crime as an excuse to grow its power. India’s government has the goal of broadening the base of tax payers. It also is considering replacing taxes with a 2% banking transaction tax.


There wasn’t a warning about the cash ban which causes uncertainty which is the worst thing for business. The goal of widening the tax base is important, but Modi should take a page from Mitt Romney who had the goal of raising people out of poverty to get them into the higher tax brackets or paying taxes in the first place. Decreasing the size of government and lowering regulations is what drives growth. Banning cash is an example of an onerous regulation, so it is a step in the wrong direction.

It’s a difficult concept for a country which doesn’t have a population base who uses the mobile internet regularly. It’s quite amazing that India snubbed Facebook’s program which aimed to get Indians on the internet only to impose a regulation which had online banking at its core. 287 million Indians are illiterate. In a country of 1.2 billion, there are only 350 million internet subscribers. Modi may use this new policy as an excuse to try to drive the country forward technologically, but this is backwards logic. This would be the equivalent of wanting to ban fossil fuel usage to curb carbon dioxide emittance. The first step should be to develop new technology to serve as a solution. Indians should have been given a better chance to get on the internet before this policy was put in place. Facebook was trying to help (for its selfish benefit) and was rejected.

A 2% transaction tax would drive Indians outside the banking system which would counteract the goal to get them in the banking system with the cash ban. The income tax collectors are corrupt, but the solution to this isn’t to change the form of taxation; it is to reform the government and shrink it. Small government has less chance of being corrupt. The notion that Indians want to pay taxes and they just don’t like the method it is collected in misjudges human nature. I think, no matter where you live, there will be people motivated to evade taxes because they want to keep their earned money. It’s not a complex concept to understand. This simple idea comes with the conclusion that broadening the tax base with a lower rate is tougher than it sounds. India needs a middle class like America to truly broaden its tax base. Now it has a middle class who are the equivalent of the upper class in America. The worst part is these are real classes because of the caste system. Upper mobility is impossible for most poor Indians.

The greater effect on the global economy will be determined in a few months after we get some more data points. With China slowing and Brazil in a tough situation, India was one of the top developing economies in 2016. It’s a ding to the global economy to see one of the fastest growth countries have headwinds which were self-inflicted. As you can see from the chart below, the services economy has collapsed since the cash ban and is now contracting. Car purchases grew at the slowest rate in 9 months and motor cycle and scooter sales declined for the first time in nearly a year.


It appears Modi has benefited politically from the move to ban cash which means he has the momentum to get more of his policies enacted. He claims to support small businesses and help the poor gain electricity, but I view this as empty rhetoric. The cash ban was unexpected, so I wouldn’t venture to guess what his next move will be. It may be time to expect the unexpected.


With such a radical economic action taken, I think it’s worth mentioning that my own radical proposals of towards promoting capitalism can be achieved. They’re less likely to be achieved because autocrats always want more power, not less. At the same time, it is encouraging that radical change can occur. I’m interested to see what Trump’s policy with India is. Trump seems to want to limit China’s influence. This is part of why he’s had a positive tone when dealing with Russia. I expect him to have a similar positive relationship with India’s leaders.

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1 Comment

  • Mohan Karapundi

    December 28, 2016

    This move should be seen in the grand scheme of things and not about GDP numbers YOY. Along with this GOI is also educating people to move to a "less cash" (not the same as cash less) society. More emphasis on e-comm/e-banking to eliminate "under the table" deals which prevail in Indian Businesses today. People see this as a short term pain long term benefit. Why bother about a temporary dip in GDP ?