By eliminating some high-denomination currency notes, India has joined a parade of countries seeking to put a crimp on illicit activities by eliminating a medium of exchange that is seen as playing an important role in facilitating corruption and the shadow economy.
The Modi government’s drastic action seems a well-intentioned move to choke off the life-blood of corruption, although it remains an open question if a less abrupt and aggressive implementation could have achieved similar goals without a public backlash. In an emerging market economy, some amount of short-term disruption in the pursuit of an important long-term goal might well be worthwhile.
The large share of the value of all currency in circulation accounted for by the high-denomination notes that were extinguished in one fell swoop suggests that a more phased approach could have been less disruptive while accomplishing similar objectives.
By putting a limit on the exchange of old for new notes and by forcing the exchange to take place through the formal banking system, a considerable amount of black money would have been flushed out without causing disruptions to legal commercial transactions.
There would no doubt have been some “leakage” of black money into laundered currency if there was a phase-in, but this may have been a modest price for avoiding any turmoil.
This bold strike has put corrupt public officials on notice and will crimp the shadow economy, but a lot of follow-through will be needed to alter the broad reach and incentives of the public sector that continue to create a fertile ground for corruption to flourish.
(Prof Prasad is the author of the bestsellers The Dollar Trap and The Rise of the Renminbi)