Editorial Notes

Editorial Notes 15th November 2016

Gravity model of trade in South Asia; India – China bilateral trade; India-Pakistan bilateral trade; India’s black money network; Challenges for circulating black money.
By IT's Editorial Notes Team
November 15, 2016


GS (M) Paper-3: “money-laundering and its prevention”
GS (M) Paper-3: “Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.”
GS (M) Paper-3: “Inclusive growth and issues arising from it.”
GS (M) Paper-2: “Government policies and interventions for development in various sectors and issues arising out of their design and implementation.”


When Cash is Not King



  • PM has walked the talk and shown that when it comes to doing the right thing and eliminating the wrong he doesn’t spare even the corrupt in his own party.
  • He has effectively dealt a death knell to the private businesses of all politicians, lawyers and bureaucrats.
  • All those craving for big-bang reforms couldn’t have asked for more — corruption cannot thrive where money is traceable and it is a significant step against big-ticket corruption and black money.
  • It is far bigger in scope and scale than those attempted ever before in independent India and is the first of many bold steps which perhaps only this PM could have done for disrupting the business model of Indian politics forever.

Parallel transaction networks:

  • ‘A simple proposition is that large currency notes are used more to conceal than to purchase’. – Mr. Modi has converted this one sentence into an economic manna in fight against black money and corruption.
  • Peter Sands of Harvard Kennedy School, one of the proponents of this idea of killing large currency notes, which was later supported by former U.S. Treasury Secretary Larry Summers, argues that a million dollars in $20 bills weighs 110 pounds or about four suitcases, whereas in 500-euro notes, less than 4 pounds, making the former very hard to transport. The U.S. stopped issuing $500 notes in 1969, the European Central Bank halted 500-euro notes early this year, and Singapore killed its $10,000 note and Canada its $1,000 note in 2000.
  • Sands illustrates by arguing that bulk cash transfer plays a role in more complex drug trafficking and money-laundering schemes.

An example of one transaction network:

  • Cash couriered from Paris to Belgium was used to buy gold, which in turn was couriered to Dubai, where it was made into jewellery which was sold in India with the profits then wired back to France. This network was estimated to launder 170 million euros per year.

India’s black money network:

  • India’s black economy is estimated to be $400-500 billion, larger than several economies of the world, and almost $3.5 billion is spent in currency operation costs annually, as per Tufts University’s Cost of Cash study.
  • On purchasing power basis, Rs.500 and Rs.1,000 notes are large by Indian standards even though they may not be as per exchange rates.

Short-term pain, long-term benefits:

  • Contraction in money supply will lead to a slight deflationary impact which will cause some inconvenience in very short term for an average citizen but compensated by significant benefits in long term.
  • The deflationary impact could be felt in sectors where cash is the main instrument of transaction and perhaps in some asset prices as well, such as in real estate.
  • In the longer term, it will lead to a greater proportion of the economy shifting from black to white.

Challenges for circulating black money:

  • Those who hold large amounts of cash may be forced to join the white economy as they have to deposit money in banks and perhaps pay taxes on it.
  • This may also raise permanently the cost of holding cash by adding a risk premium.
  • Real estate firms or jewellers may not accept cash unless it is at a good discount, for they will have to declare it to the banks and pay taxes.
  • So there is no easy option to convert it via real estate or gold. It skews incentives against cash purchases, and gives a fillip to card transactions.
  • The hawala network also won’t accept non-legal tender and the ultimate end user anywhere in the world will be stuck with worthless pieces of paper after December 30, 2016.

Future focus areas:

  • The next big hit should be on purchase of benami property which is a national avocation, for that’s perhaps the other big outlet and repository of black money.
  • When the GST comes into force the government should do away with stamp duty on land at any stage of the sale, moreover the tax rates on purchase of property should be dramatically slashed.
  • Election funding reforms and online voting are big steps in the continuum of reforms which has to be done sooner or later.

Way forward:

  • This recent measure to seriously affect the stock of black money but the effect on future flows is unpredictable.
  • The flows will be reduced because of the increased risk preparation in cash transactions.
  • Further, the government should take steps to increase mobile penetration, pre-bundled with cash apps which will make it easier for those who wish to go digital.
[Ref: The Hindu]


GS (M) Paper-2: “India and its neighbourhood- relations.”


Good neighbours, bad neighbours



  • There have been calls in India for an embargo on trade with both Pakistan and China in the wake of political tensions with both countries.
  • This article examines whether such an embargo would be an economically sound option to pursue.

India – China bilateral trade:

  • Imports from China account for 16.2 per cent of India’s total imports.
  • India had its largest trade deficit of $53 billion with China in 2015-16.
  • India’s overall trade deficit has been declining, its trade deficit with China — accounting for about 44 per cent of India’s total trade deficit — has been increasing over the last five years, driven by declining exports and increasing imports.
  • Indian imports from China comprise not only cheap consumer goods but, more importantly, intermediates – which include capital goods.
  • India imported chiefly telecom instruments, computer hardware and peripherals, fertilisers, electronic components, project goods, chemicals and drug intermediaries from China in 2015-16.
  • A ban on these imports will affect India’s manufacturing capability, as also prices in our markets, given the lack of cheap import substitutes for these goods.
  • A ban on these goods will thus not only lead to losses for producers — who use these intermediate goods for further production — and consumers — who will have to pay higher prices — it will mean a loss of tariff revenues for the Indian government.
  • A rise in the costs of manufacturing the final products using these intermediate inputs would make our exports costlier, thereby reducing our export competitiveness.
  • It may also give rise to black-marketing and smuggling.
  • China, in turn, will have to bear the consequences of lower imports from India.
  • China currently has 206 import partners and 209 exporting partners, with more than 8,900 products being traded among these partners. The network effect of this trade, implies that what happens in China doesn’t remain in China.
  • While India accounts for only 2.55 per cent of Chinese exports, it is one of the top 10 export partners of China.
  • India’s size and its openness makes it a prime candidate to transmit any initial trade shocks that it experiences to the rest of the world.
  • According to the IMF’s World Economic Outlook October 2016, India has the potential to amplify initial import shocks by 30 per cent and transmit to the rest of the world, including China.

Thus, any unilateral action by both the nations to suspend trade ties might adversely affect not only them, but also the global economy at large.

India-Pakistan bilateral trade:

  • Pakistan accounted for only 0.74 per cent of India’s total exports, and 0.12 per cent of imports in 2015-16.
  • These figures mask the large volume of informal trade between the two neighbouring countries.
  • According to certain studies, the volume of informal trade between these countries is twice that of the formal trade.
  • A proper understanding of the benefits of trade and attempts to redirect trade towards formal trade channels will result in a substantial reduction in transaction costs, given the long circuitous routes that such trade takes, chiefly the Delhi-Mumbai-Dubai-Karachi-Lahore route.

Gravity model of trade in South Asia:

  • The Gravity Model, posits that the value of trade between any two countries, other things being equal, is proportional to the product of the two countries’ GDPs, and diminishes with the distance between the two countries.
  • Example: the US carries out a lot more trade with Canada — a country roughly the same size as Spain — and Mexico than with the entire EU.
  • It has been estimated that a 1 per cent increase (or decrease) in distance shrinks (or increases) trade by 0.7 to 1 per cent.
  • Political factors have, however, impeded India’s trade with its closest neighbours in South Asia, including China and Pakistan. In fact, South Asia ranks almost at the bottom among India’s trading partners by region.


The media in the respective countries need to wake up to the economic reality of trade and the power of trade gravity.

While political rapprochment — especially in the wake of continued misdemeanours of the neighbours — may take time, a knee-jerk reaction by way of disrupting trade may exacerbate the respective countries’ problems, as also those of the global economy.

[Ref: Business Line]


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