Economics and finance, Government and governance, National security | Asia, South Asia

18 November 2016

High denomination notes are heaven for criminals, but India is taking bold steps to curb the use of cash in facilitating criminal enterprise. Peter Sands looks at whether the strategy will succeed.

Prime Minister Modi’s dramatic decision to cancel the Rs.500 and Rs.1000 notes represents a marked step-up in combating the illicit use of cash. The European Central Bank recently decided to phase out the issuance of the €500 note by 2018, but will not remove its status as legal tender. Countries like France have introduced cash thresholds, putting a €1000 limit on the size of cash transactions.

These measured steps deliberately sacrifice some of their potential impact on the illicit economy in favour of minimising the disruption to normal economic activity. By contrast, the Indian Government’s strategy is clearly one of “shock and awe”. This perhaps reflects the scale of the problem they face. The shadow economy has been estimated at 23.2 per cent of Indian GDP – and is growing faster than the economy as a whole. A large number of forged rupee banknotes compound the problem of the illicit use of legal bank notes. However, taking such drastic action in a country where so much of the economy is informal and cash-based does carry significant short-term risks. No doubt Modi has decided these risks are outweighed by the benefits of disrupting illegal activity and sending a powerful signal of his determination to quash “black money”.

The role cash plays in facilitating drug smuggling, human trafficking, corruption, terrorist financing, tax evasion and other illegal activities is indisputable. Unlike any other payment method, cash offers anonymity to both payor and payee, leaves no transaction record and is acceptable everywhere. As Europol put it in a recent report, in the world of criminals “cash is king”. Moreover, as banks and regulators invest in ever more sophisticated transaction surveillance systems to detect and stop suspicious transactions going through the banking system, the attractions of cash increase.

And contrary to popular belief, Bitcoin is not that attractive to criminals. While it does offer payor-payee anonymity, it also provides a perfect transaction record. Furthermore, the ever-fluctuating value of Bitcoin, and the limited things you can buy with it, are major drawbacks. Ultimately most criminals want to be able to spend real money, so want to convert their Bitcoin into dollars or some other conventional currency. Unsurprisingly, the Bitcoin exchanges where these transactions take place are closely monitored by the authorities.

More on this: Can a change in banknotes stamp out corruption and forgery?

Cash plays a role in almost every kind of crime. Underreporting of cash receipts is the most common form of tax evasion in most economies. For example, it has been estimated that roughly 50 per cent of the cash received by small businesses in the US is not reported. Drug trafficking involves the cross-border transportation of very large volumes of cash, almost all in high denomination notes. Terrorist financing is largely in cash to minimise detection risk. Even where the original crime is via bank accounts, as in sophisticated fraud or cybercrime, the process of money-laundering almost always involves cash so as to break the trail.

The big problem with cash is that large amounts are bulky and heavy. That may not matter for petty crime, but for criminals carrying out high-stakes crime who want to move, pay or store a lot of money covertly, this can be a real problem: US$1 million in US$20 bills weighs 50 kilograms (110 pounds). So criminals tend to use the highest denomination notes available: US$1 million in €500 notes weighs less than 2.2 kilograms (4 pounds). In fact, given the ubiquity of electronic alternatives such as credit/debit cards, contactless or mobile payment systems, in many economies, the highest denomination notes are hardly ever used by ordinary people and are almost exclusively used for illegal activity. Most Eurozone citizens have never possessed a €500 note and less than 1 per cent have one in their wallet at once. Yet there are over €300 billion in €500 notes outstanding and they are often found when the police seize funds related to drug trafficking, terrorism, tax evasion or corruption.

The Rs.500 and Rs.1000 notes are not particularly high-value by international standards, since they are only worth US$7.50 and US$15 respectively, but they are the highest value rupee notes, so will be the best available to India’s domestic criminals. Eliminating them in this sudden fashion will undoubtedly have a significant impact on illegal activity. For example, reports suggest the government could gain billions of dollars in incremental tax receipts from taxes and penalties on deposits of undeclared cash income, and highlight the disruptive effect on the funding of political parties, always a source of corruption. It will also catalyse the opening of bank accounts and adoption of digital payments, accelerating India’s financial inclusion and modernisation. Yet it seems somewhat perverse for the Indian Government to remove the Rs.500 and Rs.1000 notes only to introduce a Rs.2000 note, which will undoubtedly become the new note of choice for criminals. Moreover, I suspect that serious criminals in India, including the most corrupt, prefer to stash their money offshore or use the US$100 bill. Putting restrictions on the possession and use of US$100 bills in India might have more impact on the “big fish” of the illegal economy.

Whether or not Modi’s strategy is optimal, you have to applaud his recognition that cash plays a major role in facilitating illegal activity and his willingness to take bold action to fight tax evasion and financial crime. Political leaders elsewhere in Asia should follow his lead. Eliminating high denomination notes, imposing cash thresholds, or otherwise restricting the use of cash (whether domestic or foreign) will improve tax collection, make corruption more difficult and disrupt the business models of organised criminals.

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Sands, Peter. 2017. "Curbing The Role Of “King Cash” In Crime - Policy Forum". Policy Forum.