India's withdrawal of bank notes

At what was in effect no notice, on 8th November, India announced that all 500 and 1000 rupee notes would cease to be legal tender. That is 86% of the cash in the Indian economy.

This is quite a shock to the system, after all 90% of India's transactions take place in cash. Yet the bulk of the Indian population apparently support the move, despite having to queue for hours to deposit their now otherwise worthless notes into bank accounts.

The reason the government took this radical step is to reduce tax evasion. India has a massive corruption problem where only 1% of people pay income tax, largely because transactions go unrecorded because they take place in cash.

The move is designed to make people deposit their cash in banks and to make more future transactions through the banking system.

Those who deposit large amounts will be asked to prove they paid tax, or be taxed on it. From then on transactions will largely have to be transparent through the banking system as people can only obtain a limited amount of cash in new notes. Therefore in the future they can be taxed fairly.

This is a bold attempt to deal with the informal or black economy. Developing countries lack the tax base to raise the money governments need to fund infrastructure and other development projects. Of course it is unclear whether the Indian governments bold (reckless?) plan will work.

The BBC explain the motives here

This is an article that is relevant to Development Economics, the last topic in the IB syllabus. However it is well worth looking at now for use later.