Why Mumbaikars bought gold all night long on a weekday

goldGold is money.

It has always been money.

Nobody knows this better than us Indians. Our love for the yellow metal comes out in the way we hoard it. And this faith in gold was at display all night long yesterday in Mumbai.

The question is what brought out Mumbaikars to buy gold on a non-festive day? The answer is Narendra Modi.

In a late evening TV address to the nation prime minister Narendra Modi banned the use of Rs 500 and Rs 1,000 as legal tender. This essentially made a little more than 86 per cent of notes practically useless overnight.

Anyone who has Rs 500 and Rs 1,000 notes can deposit them in his or her bank account or post office account, up until December 30, 2016. This money will be
credited into the bank or post office account.

Nevertheless, these notes can be exchanged only up to a total of Rs 4,000 as cash. This limit has been set for a period of 15 days and it will be reviewed after that. People who have always declared their income and paid taxes on time, have nothing to worry about. All they need to do is just go to a bank or post office and deposit the Rs 500 and Rs 1000 notes they have. The money will be credited into their accounts, which they can later withdraw through ATMs/cheques.

Nevertheless, this move of the Modi government, has created trouble for those who have black money in the form of cash or notes. Black money is essentially unaccounted money which has been earned but on which tax has not been paid. If the holders of black money were to deposit it in their bank account, it would probably lead to questions from the income tax department regarding the origin of the money.

If they were to continue to keep it under their mattresses, the money would become useless overnight. Hence, the next best thing to do was to convert that money into a physical asset, which would continue to hold value. Of course, physical assets like land or flats or paintings cannot be bought overnight.

But there are no such problems in buying gold. It is practically available everywhere in the city. All one needs to do is to step out and buy it. And this precisely what Mumbaikars who had black money in the form of cash did late last night.

They exchanged their Rs 500 and Rs 1,000 notes for gold and ensured that their black money continued to hold value. Also, no identification documents need to be shown for gold purchases of up to Rs 2 lakh. This makes converting black money into gold an easy proposition. Further, those with black money always have the option of buying gold from multiple jewellers in order to avoid showing identification documents. Hence, people were essentially busy converting their black money into gold.

As per the government notification Rs 500 and Rs 1,000 were not supposed to be a legal tender post-midnight. But the city jewellers seemed to have overlooked this technicality and carried on with brisk business late into the night. This was a good opportunity for them to earn some money, in what has been an otherwise slow year for them.

Of course, the money that they earned during the night and all the Rs 500 and Rs 1,000 notes that they managed to accumulate, must be deposited into their bank accounts, to make sure that it continues to hold value. If they don’t do that they will essentially end up holding worthless pieces of paper.

And once the money is deposited into a bank account, it will essentially mean that the black money of Mumbaikars will be converted into white money of the jewellers on which an income tax will have to be paid. This in a rather circuitous way will be a good thing to happen.

The column originally appeared in the Midday on November 9, 2016

Why Modi Just Banned Rs. 500 and Rs. 1,000 Notes


It was sometime in April 1999. The summer was at its peak in Ranchi, the city I was born and brought up in.

I was writing my final year graduation exams in Mathematics. The examination centre was a rather non-descript college, whose name I don’t remember now.

On the first day of examination there were power cuts. The examination centre did not have any power-backup. Thankfully, I had a sort of a premonition of this and was wearing a pyjama-kurta on that day. This is something I can distinctly remember.

Everyone around me was sweating profusely. The sweating was not just because of the power cut. The question paper was totally bizarre. The questions that had been asked had never been asked before.

As anyone who has done his graduation from an Indian university would know, students essentially prepare in two ways. One, is that they look at question papers of previous years and mug up the answers to the questions asked. The other is preparation through guess papers.

Local publishers publish what they think are questions that are likely to be asked in the exam. Typically, these guess papers are ghost written by university professors looking to make some money on the side.

Sometimes, the professor who is writing the guess paper also ends up setting the question paper. And in this case, students who have prepared using the guess paper hit the jackpot.

But sometimes that is not the case. And something similar happened that morning in April 1999. The questions were neither from the guess paper nor had they been asked in the previous years.

It would be safe to say that 90 per cent of my class was caught unprepared. And some of them were totally screwed. As often happens in these cases, the universal opinion after the exam was that the questions were totally out of syllabus.

Something similar, happened on November 8, 2016. When everyone was preparing to discuss the American presidential results, prime minister Narendra Modi dropped a bombshell. The government of India decided to ban Rs. 500 and Rs. 1,000 notes with effect from midnight of November 8, 2016. In question paper terms, this was something which was totally out of the syllabus. No one was expecting it. And the media, as usual, did not come to know about it, until the prime minister started addressing the nation on TV.

The banned notes can be deposited at “bank or post office accounts from 10th November till close of banking hours on 30th December 2016 without any limit”.

At the same time, notes of only up to Rs. 4,000 can be exchanged. This limit will be applicable for the next fifteen days and will be reviewed after that.

What is the logic behind this? As per the government “Fake Indian Currency Notes (FICN) in circulation in these denominations are comparatively larger as compared to those in other denominations.”

The government is planning to introduce new notes of Rs. 500 as well as Rs. 2,000. As it said in a press release: “New Series bank notes of Rs. 500 and Rs. 2,000 denominations will be introduced for circulation from 10th November, 2016. Infusion of Rs. 2,000 bank notes will be monitored and regulated by RBI.”

The question is why is the government doing this? There is an answer based on economic theory. And there is an answer based on politics. I will try and give both the answers here. First, let’s look at the answer based on economic theory.

The move seems to be inspired from the American dollar as well as the British pound. In the United States, the highest denomination bank note is $100. When it comes to the United Kingdom, the highest denomination bank note issued by the Bank of England is £ 50. In the United States as well as the United Kingdom, the highest denomination note is essentially 50 times the smallest denomination note of one dollar or one pound.

In India, up until now the highest denomination note was Rs. 1,000 and this was 1000 times the smallest denomination note of Re 1, issued by the ministry of finance. When a currency has notes of higher denomination, it is easier to launder money i.e. store black money.

To give you an example, with Rs. 1,000 notes in circulation it takes lesser space to store black money in comparison to a situation when the highest denomination note is Rs. 100. At the same time, it also makes it a little more difficult to bribe anybody. Further, if the highest denomination note is Rs. 100, then cash transactions in black will become difficult.

That’s one point. The second point here is that with Rs. 500 and Rs. 1,000 notes being banned, the people who have black money in the form of cash will have to come forward and declare it with the banks. At least, that is the theoretical assumption.

The trouble here is that no one really knows as to how much black money is stored in the form of cash and how much has been stored in the form of physical assets like land, flats, gold etc. Hence, the move is likely to inconvenience those people who have black money in the form of cash. From my conversations with a couple of CAs, I can say that people who have cash, are worried.

Of course, the flip side to this argument is that new higher denomination notes of Rs. 500 and Rs. 2,000 are being introduced. But to get these new notes, those who have black money in the form of cash will have to deposit the banned Rs. 500 and Rs. 1,000 notes in the banking system. And if they do that, this is likely to generate some interesting data for the government. Or they will have to figure out other interesting ways to ensure that their black money in the form of cash continues to hold value.

Also, these new notes are likely to take some time to move through the system and get to a situation where they start being used to hoard black money all over again. So, that I guess was the economic logic behind the government’s decision to ban Rs. 500 and Rs. 1,000 notes.

And what about the political logic? Tackling India’s black money problem has been a pet agenda for the Bhartiya Janata Party as well as Narendra Modi. While, efforts have been made in the past to tackle this problem, the results at best have been mediocre.

By taking the decision to ban Rs. 500 and Rs. 1000 notes, Modi has managed to give a new lease of life to the black money issue. This projects Modi as a strong leader who is willing to take strong decisions which can be unpopular with a certain section of the population. And the electorates just love strong leaders.

The decision goes against the trading community which sits on a lot of the black money in India. At the same time, it is also a major financier of Modi’s Bhartiya Janata Party at the state as well as the local levels.

This decision goes against this community and at the same time projects Modi as a leader who is willing to take decisions even if they go against a section of his supporters. Also, by banning Rs. 500 and Rs. 1,000 notes overnight, Modi did not give those who have black money in the form of cash, to be able to do something about it.

The interesting thing is that this decision has come nearly midway through Modi’s five-year term and at a time when the assembly elections are due in Uttar Pradesh.

The column was originally published in Vivek Kaul’s Diary on November 9, 2016