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Modi’s currency move gets Morgan Stanley thumbs up

morganUS-based Morgan Stanley has given its thumbs up to Narendra Modi’s bold and unprecedented move to curb illegal funds by swapping currency notes.

The government announced on late yesterday night that it will demonetise the high denomination currency — Rs. 500 and Rs. 1000 notes.

A new series of the Rs 500 note and a new Rs 2000 note will be introduced from November 10. The outlawed notes account for nearly 86% of the total cash in circulation in India.

The firm called it a “bold move to curb black money”.

“By curbing black money, it would help improve tax compliance in the medium term, which is much needed given the very low number of tax payers currently at just 1% approx of the total population. We believe this move will help to reduce black money more systematically, and in the long term improve the ease of doing business in India,” it said.

Though the demonetization would create inconveniences for people in the short term, these would be more than outweighed in the medium term by the positive impact on improved transparency and tax compliance significantly and consequently benefit public finances.

As Indian households have traditionally parked their savings in physical assets such as gold and property, this move would also have an impact on their allocation decisions and would have the impact on improving financial savings within the economy, it argued.

Households’ physical savings in India are around $270bn (13% of GDP) while financial savings are only $160bn (7.7% of GDP).

“This will also positively impact the share of financial savings within the economy in the longer term as households could reduce their allocation towards physical assets like gold and property,” it said.

“This is another step to curb black money keeping in theme with the government’s past policy action,” said the financial services company.

Over the last two years, the government has taken a number of steps with the aim to reduce black money such as creation of a special task force on black money, passing of a law to disclose foreign assets and income, amending the Double Taxation Avoidance Agreement between India & Mauritius and India & Cyprus. It has also been successful in getting information on bank accounts held by Indians abroad (HSBC).

In parallel, the Reserve Bank of India has been setting up an advanced payment processing platform via the NPCI.

The government has also made it mandatory to declare PAN (permanent account number) for gold transactions above Rs 2 lakh. It has also amended the Benami Transactions Act; and implemented the Income Declaration Scheme 2016.

The main purpose of the latest move is to reduce black money (unaccounted income) in the system, curb funding of illegal activities and address the problem of fake currency notes.

“From a macro perspective, the continued spike in currency in circulation may have been another factor leading to this move. This move could hurt economic activity in the near term, particularly (1) in the rural economy, where a large proportion of transactions are still conducted using cash, and (2) spending on big ticket items such as white goods, autos and property,” it said.

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