Prime Minister Narendra Modi’s demonetisation program has hit the various stakeholders of the rural and informal economy in different ways over the last 50 days.

However, one recent phenomenon really takes the cake.

Smaller players in the informal economy – workers, traders, farmers and mom-and-pop shop owners – sold their Rs 500 and Rs 1000 notes in desperation at a discount of 20% to 30% during November. In almost all cases, this was legitimately earned money, and not black money. Shakuntala, who works as a part-time cook in three houses every day, had Rs 4,000 in old 1000 rupee notes when Modi made his demonetisation announcement. After standing in line for three hours to exchange them, she was forced to sell her notes for Rs 3,000 in valid notes, taking a hit of 25%, in order to make it to work on time. These kinds of distress sales were widely reported by the media in the first days of demonetisation.

Now, according to senior government officials, those very 1000 and 500 rupee notes were aggregated by middlemen and sold to businesses at a premium of 20% in December. Thus, the ‘demonetised’ 500 and 1000 rupee note became a commodity much like farm produce, which is picked up cheap by middlemen and sold in urban markets later at a premium. This bizarre commodification of the Indian currency notes happened, according to industry observers, due to the flawed implementation of the demonetisation programme.

While smaller players in the informal sector of the economy were getting rid of their 1000 and 500 rupee notes, as they had limited access to banking services and needed cash to spend urgently, various middlemen and hawala traders were quietly aggregating the notes (at a discount) for future trade (at a premium) with businesses which needed those 1000 and 500 rupee notes desperately.

What kind of businesses would buy old notes, and that too at a premium? Economic intelligence officials in the government confirmed that the demand for 1000 and 500 notes reached its peak in mid December. This is when businesses were willing to pay a premium for the old notes because on their balance sheets, on the asset side, they had “cash in hand” listed without necessarily having actual cash to back it up.

How did this happen? After demonetisation was announced, many medium-size businesses, which typically have up to 30% of their working capital from the parallel cash economy, needed to push that black cash into some legitimate accounts in the balance sheet.

So these small businesses started approaching providers of shell companies in money laundering hubs like Kolkata, Jaipur and Surat where ready-made company balance sheets are offered with a “cash-in-hand” component without the physical cash being there. These balance sheets are legitimate as they are filed with the relevant company law and income tax authorities. Normally the tax authorities do not question or verify higher cash-in-hand shown in the balance sheet as they are only suspicious against businesses who show less profits and less cash. Something like Satyam Computers, which showed much higher quantum of bank deposits in the balance sheet for many years without being detected.

So many small businesses hurriedly got access to fresh quotas of “cash in hand” through shell companies and started pushing their black cash into those balance sheets which were already filed with income tax department. Thus the black money got legitimately pushed into the system, through the “cash-in-hand” quotas provided by numerous shell companies. All of this happened over the past 50 days.

The demand for 1000 and 500 rupee notes peaked in mid-to-late December because of the rush to physically disclose the “cash-in-hand” quotas of thousands of shell companies serving as money laundering vehicles. This, government officials say, happens for two reasons. The first is that businesses that use shell companies often fall short of the ‘cash-in-hand’ component. If business ‘X’ uses shell company ‘Y’, which has Rs 100 crore as ‘cash-in-hand’ on its balance sheet, and X only has Rs 90 crore in black cash, then it needs to acquire another Rs. 10 crore in cash to fulfil that ‘cash-in-hand’ quota.

Secondly, a number of shell companies are often unused, which means that providers of shell companies need to scramble to acquire some cash in case they are caught in a government raid.

The tax department along with the cooperation of various banks will have the near-impossible task of identifying these violations in the next few months.

What this whole process has ended up doing is that it has forced struggling, small traders to sell their notes at a discount in order to legitimise fake “cash-in-hand” accounts held by businesses.

Thus it is evident that the rich have devised ingenious ways to push their cash into the banking system while the poor have been forced to sell their currency at a discount. A chartered accountant, who did not want to be named, said it would be nearly impossible for the tax department to investigate millions of balance sheets of small companies which may have pushed their cash as “legitimate assets” in the balance sheets of shell companies. Indeed, the poor have totally lost out in this bizarre game when they sold their currency at a discount only to help hawala dealers and middlemen make huge profits.