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Notes from the Field: India

Notes from the Field: India

November 21, 2016, by Marcena Hunter and Dr. Yolande Kyngdon-McKay


This week, India’s Prime Minister Narendra Modi took the unprecedented step of banning the circulation of the country’s two largest denominations: the 500 rupee (~USD7.50) and 1,000 rupee (~USD15) notes. India’s prominence in several mineral supply chains, including its position as the world’s largest consumer of gold, had us immediately drawing links between this dramatic decision and Levin Sources' work on the Gold and Illicit Financial Flows (GIFF) project, a collaboration with the Global Initiative against Transnational Organized Crime. It is also extremely relevant to the diamond and coloured gemstone sectors, in which India plays key roles in trading and manufacturing.

Prime Minister Modi’s explicit intention was to target the ‘black money’ economy in India. As a result, criminal groups, corrupt officials and tax evading businesses have seen their stockpiles of cash, which were commonly kept outside of the banking system to avoid a paper trail, and thus the prying eyes of the authorities, become worthless overnight. Modi’s goal was to see the cash economy shrink massively, and capital instead move into the formal banking system where it can be regulated and taxed. However, criminal actors and illicit financial flows rarely just evaporate—they instead evolve, or are displaced. Without cash, will criminal groups, corrupt officials and tax evading businesses in India turn to gold, or even diamonds, as a replacement currency? Will the gold and diamond industries in India shrink, due to their cash-intensive nature? And what could this mean to the global minerals industries in which India plays a key role?

We asked two experts, Marcena Hunter from the Global Initiative against Transnational Organized Crime & Dr. Yolande Kyngdon-McKay of Levin Sources, what key questions this issue raises about India and mineral supply chains.

Marcena Hunter
Senior Researcher at the Global Initiative against Transnational Crime
Project Manager for the GIFF project

This is definitely an interesting move by the Indian government. Coming at it from an organised crime perspective, my first thoughts and questions were:

How long will the impact of this change be felt?

Organised crime tends to be incredibly resilient. As such, I see organized crime groups developing strategies to circumvent the currency swap, reduce the negative impact of assets, and adapt to any changes in the market. As such, while organized crime and corrupt actors may currently be scrambling, I am not sure how effective this strategy will be in having long-term impacts. On the other hand, we ought to also consider how long will the impacts be felt be the general population. The longer economic uncertainty and instability lasts, the more likely people may turn to alternative forms of monetary instruments, including gold.

Will we see crime increase as a result of this policy?

As such, I would not be surprised if we see an increase in crime as organized crime groups attempt to recover lost profits. Increased violence is also associated with uncertainty and battles for power/wealth in the criminal world. However, I doubt this current move by the government will significantly impact balances of power and competition, and so increased violence is unlikely.

Will we see gold being used as a currency in the short/long-term?

There are reports people are resorting to barter in some locations due to cash shortages. Will gold also be used in this way? And if so, to what extent and for how long? Will the use of gold be limited to high-value transactions or could it also be used for lower-value, more common transactions? This is also an interesting consideration in the context of Hawala transactions.

Will people lose their faith in currency/banks and rely on gold to a greater degree to store wealth?

A great deal of wealth is already stored in gold in India. So, I'm not sure to what degree this would change current practices. Perhaps we could see organized crime groups start to turn to gold to a greater extent, but this would largely by speculative as it would be really difficult to monitor/confirm.

Dr. Yolande Kyngdon-McKay
Manager, Gems & Jewellery at Levin Sources

India’s black money economy is now clearly in the government’s sights—that should worry anyone whose business model is based on tax evasion. And the diamond industry in India is a hotbed of tax evasion. Conversely, it could be good news for actors in the diamond industry’s downstream who would benefit from an improvement to the industry’s general risk profile, especially for the purpose of accessing credit.

India’s diamond capital of Surat has come to a virtual standstill. Why? Because it runs on cash, and larger denominations are more convenient for large transactions. With cash, there is no paper trail, which facilitates tax evasion; the trade of illegal goods, including conflict, smuggled and stolen diamonds; transfer pricing and round tripping; money laundering; the payment of bribes, and so on. (This is also similar in the coloured gemstone industry.)

So the key questions that I’m pondering are:

  • What could this dramatic step by Modi mean for the future behaviour of India’s diamond industry? Is it going to have to formalise more of its transactions?
  • And if so, what impact could a move away from black money have on 'standard business conduct' in the industry, for better or for worse, i.e. what will be harder/easier to get away with?
  • Will some operators be forced into bankruptcy/out of the industry because their business model is based on tax evasion to enable liquidity? What impacts could that have on the sector in the aggregate? (Is there a potential Hydra effect that we need to be conscious of?)
  • As the saying goes, ‘Sunlight is the best disinfectant’—will this start the clean up of the industry, or are some actors therein just going to get more creative with their illegal conduct? And if the latter, what are the most appealing/accessible options for this?
  • To what degree could gold and/or diamonds take the place of cash, and what implications could that have on the scale of illicit financial flows in these mineral industries?
  • What effects could this have in the upstream and downstream of these commodities' supply chains, particularly, what potential new risks should the downstream be preparing to manage?
  • In the longer term, could an increase in formalised banking practices improve investor confidence in the diamond industry, not just in India but around the world?
  • Furthermore, could more formalised banking practices in India’s diamond industry do anything to reverse the trend in financial institutions halting lending to this industry (globally) due to its perceived high-risk status?
  • What impact will Modi’s decision have on the upstream purchasing of minerals (gold, diamonds, coloured gems, etc.), which is commonly done with cash? Will it help to move the flow of money into formal banking systems, or will it rather slow down buying in the upstream for the time being?

These are just a handful of questions that I think are important for anyone in the precious minerals sector to think about. Modi has definitely shaken things up.

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