Consumers used retail transactions to keep an estimated $1.5 billion out of the country's tax system
Many Indians exchanged old rupee notes for new ones with “strategic returns.”
Image: Dhiraj Singh/Bloomberg via Getty Images
At 8:15 p.m. on November 8, 2016, India’s Prime Minister Narendra Modi delivered a surprise address live on national television. He announced that, at midnight, all 500- and 1,000-rupee notes would cease to be legal tender. More than 80% of the country’s cash would effectively be sucked out of circulation overnight.
This move was meant to bring undeclared wealth — known as “black money” — into the tax system, to eliminate wealth accumulated through bribes, and to root out counterfeit bills. It also pitched India’s cash-centered economy into chaos.
In the hours before the demonetization policy went into effect, Indian households weighed their options. The government hoped they would head to the banks to deposit their soon-to-be obsolete bills or exchange them for newly issued currency. (The 500- and 1000-rupee notes were worth about $7.50 and $15, respectively.) Instead, many people frantically spent them. Some thought ahead and purchased goods with cash, later returning those items for crisp new bills. Some even dumped their money in the Ganges River to avoid a tax investigation.
How did consumers’ choices affect the outcome of India’s currency upgrade? That’s the question that Yewon Kim, an assistant professor of marketing at Stanford Graduate School of Business, set out to answer in a recent paper.
Kim and her coauthors, Pradeep K. Chintaguntaopen in new window of the University of Chicago Booth School of Business and Bhuvanesh Pareekopen in new window of the Indian Institute of Management Bangalore, looked at transactions between individual consumers and retailers, which typically aren’t examined closely when evaluating monetary policy. But it turns out they can play an important role in whether or not a policy succeeds.
This piece originally appeared in Stanford Business Insights from Stanford Graduate School of Business. To receive business ideas and insights from Stanford GSB click here: (To sign up: https://www.gsb.stanford.edu/insights/about/emails)