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Why India’s Demonetization Didn’t Work as Expected

Summary:
On his blog, JP Koning offers two explanations for the surprisingly high rupee notes redemption rate—nearly 99%—after last year’s demonetization experiment: Money laundering, and a partial amnesty. Indians who had large quantities of illicit cash were able to contract with those who had room below their ceiling to convert illicit rupees on their behalf … Two weeks after the initial … announcement, the government introduced a formal amnesty for demonetized banknote holders. Any deposit of cash above the ceiling would only be taxed at 50%, assuming it was declared. If not declared, the funds might still get through the note blockade undetected, although if apprehended an 85% penalty was to be levied. These new options were better than throwing away one’s stash altogether and suffering a

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On his blog, JP Koning offers two explanations for the surprisingly high rupee notes redemption rate—nearly 99%—after last year’s demonetization experiment: Money laundering, and a partial amnesty.

Indians who had large quantities of illicit cash were able to contract with those who had room below their ceiling to convert illicit rupees on their behalf …

Two weeks after the initial … announcement, the government introduced a formal amnesty for demonetized banknote holders. Any deposit of cash above the ceiling would only be taxed at 50%, assuming it was declared. If not declared, the funds might still get through the note blockade undetected, although if apprehended an 85% penalty was to be levied. These new options were better than throwing away one’s stash altogether and suffering a sure 100% loss …

As a consequence, the windfall for the government likely was smaller than expected. But poorer Indians may still have benefited, by selling their services in the money laundering scheme.

Dirk Niepelt
Dirk Niepelt is Director of the Study Center Gerzensee and Professor at the University of Bern. A research fellow at the Centre for Economic Policy Research (CEPR, London), CESifo (Munich) research network member and member of the macroeconomic committee of the Verein für Socialpolitik, he served on the board of the Swiss Society of Economics and Statistics and was an invited professor at the University of Lausanne as well as a visiting professor at the Institute for International Economic Studies (IIES) at Stockholm University.

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