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Stock Market Reactions to India's 2016 Demonetization: Implications for Tax Evasion, Corruption, and Financial Constraints

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  • Dhammika Dharmapala
  • Vikramaditya Khanna

Abstract

On November 8, 2016, the Indian government made a surprise announcement that certain currency notes (representing 86% of the currency then in circulation) would no longer be legal tender (although they could be deposited in banks over a limited period). The stated reason for this sudden “demonetization” was to combat tax evasion and corruption associated with “unaccounted-for” cash. We compute abnormal returns for firms on the Indian stock market around this event, and compare patterns of abnormal returns for different subsamples of firms defined by industry, ownership structure, and other characteristics. There is little evidence that sectors thought to be associated with greater tax evasion or corruption experienced significantly different returns. However, we find substantial positive returns for banks and for state owned enterprises (SOEs), implying market expectations that are puzzling in some respects, especially as the initial reactions do not show any evidence of reversal in the five months following the event. The bank results appear to indicate a market expectation of a persistent increase in financial depth. We also find a pattern of higher returns for industries that are characterized by a greater dependence on external finance, possibly suggesting an expectation of an easing of financial constraints. The returns for SOEs may be due to possible indirect effects of the announcement on perceptions of future corruption among these firms.

Suggested Citation

  • Dhammika Dharmapala & Vikramaditya Khanna, 2017. "Stock Market Reactions to India's 2016 Demonetization: Implications for Tax Evasion, Corruption, and Financial Constraints," CESifo Working Paper Series 6707, CESifo.
    • Handle: RePEc:ces:ceswps:_6707
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    References listed on IDEAS

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    Cited by:

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    2. Emanuele Borgonovo & Stefano Caselli & Alessandra Cillo & Donato Masciandaro, 2018. "Between Cash, Deposit And Bitcoin: Would We Like A Central Bank Digital Currency? Money Demand And Experimental Economics," BAFFI CAREFIN Working Papers 1875, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    3. Borgonovo, Emanuele & Caselli, Stefano & Cillo, Alessandra & Masciandaro, Donato & Rabitti, Giovanni, 2021. "Money, privacy, anonymity: What do experiments tell us?," Journal of Financial Stability, Elsevier, vol. 56(C).
    4. Lakshmi. B & Rebecca J Alex, 2018. "Effect of GST Rate Announcement on Sectorial Indices of National Stock Exchange," Indian Journal of Commerce and Management Studies, Educational Research Multimedia & Publications,India, vol. 9(1), pages 29-36, January.
    5. Emanuele Borgonovo & Stefano Caselli & Alessandra Cillo & Donato Masciandaro & Giovanno Rabitti, 2018. "Cryptocurrencies, central bank digital cash, traditional money: does privacy matter?," BAFFI CAREFIN Working Papers 1895, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    6. Emanuele Borgonovo & Stefano Caselli & Alessandra Cillo & Donato Masciandaro, 2017. "Beyond Bitcoin And Cash: Do We Like A Central Bank Digital Currency? A Financial And Political Economics Approach," BAFFI CAREFIN Working Papers 1765, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.

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    More about this item

    Keywords

    corruption; tax evasion; demonetization; financial constraints; India;
    All these keywords.

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance

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