The gradual moving away from paper money : Demonetization storms India | Sunday Observer

The gradual moving away from paper money : Demonetization storms India

Demonetization is a term that we don’t hear often. And with good reasons too. It essentially means, outlawing certain currency notes and/or coins from legal circulation and getting new notes in their place. It is a huge logistical and financial exercise, so that countries generally do not go for this option unless there are compelling reasons to do so.

This word now receives much airplay and newspaper space, thanks to the shock announcement by Indian Prime Minister Narendra Modi, a couple of weeks ago that all Indian Rs.500 and Rs.1,000 notes – or 86 percent of India’s paper money supply, will henceforth be not legal tender. The only option was to change the notes to legal notes of a lesser denomination at the nearest bank.

But, it is easier said than done, with billions of Indian currency notes in circulation not only in India, but also in other countries, including, Sri Lanka. According to Prime Minister Narendra Modi, the main aim of outlawing the higher denomination notes was to flush out ‘black money’, stop money laundering and hoarding. It should theoretically have the effect of getting millions more to the formal banking system – many Indian people have a habit of ‘saving’ their money at home without going to a bank. From a wider and long-term perspective, it should help choke crime and terror funding, put a spanner in the works of counterfeiters and help fight corruption, where big chunks of money change hands for various deals.

500,000 fake notes

But, consider the sheer numbers involved in this exercise. India has a one billion plus population, spread over 29 states and seven union territories. There are 35 cities with over one million people, with others living in 638,000 villages and 5,100 towns. (Not all of these towns have formal banking facilities anyway). India is the largest producer and consumer of currency notes after China, and banknotes in circulation have increased from 124 million in 1935 to more than 90 billion in 2016. The total currency in circulation in India on March 31, 2016 was worth Rs.16,415 billion of which, notes of Rs.1,000 denomination account for 38.6 per cent (6,326 billion) and Rs.500 account for 47.8 per cent (7,854 billion).

The importance of the Rs.500 note has been increasing over the years, from 4.1 per cent on March 31, 1990 to 47.2 per cent on March 31, 2016. Similarly, the share of the 1,000 note has increased from 1.7 per cent in 2001 to 38 per cent in 2016. The total amount of Rs 500 and 1,000 notes amount to Rs.14,180 billion as compared with India’s national income of Rs.1,35,761 billion in 2015-16, or about 10.5 per cent of GDP. Both notes have been in circulation in more or less their present form since year 2000.

The challenge is essentially not about physically destroying 20 billion or so ‘illegal’ bank notes per se. In 2015-16 the Reserve Bank of India destroyed more than 16 billion soiled notes via shredding, according to the Bank. More than 14 billion were removed in 2012-2013 after nearly 500,000 fake notes were found in the system. The challenges will probably come after the demonetization process is over.

As Indians wonder where in the world they have undertaken a similar exercise, they do not have to look far. The Sri Lankan government declared 50 and 100 rupee notes illegal tender in the early 1970s on the initiative of then Finance Minister Dr.N.M. Perera. (The Rs.100 note was in fact the highest note in circulation in Sri Lanka until the introduction of the Rs.500 and Rs.1,000 notes. Now, Sri Lanka has Rs.2,000 and Rs.5,000 notes as well) Again, the reason was the revelation that a large amount of money had not come into the formal banking system, either for fear of being found out as being illegally acquired or due to taxation. Buddhadasa Hewavitharana’s book, ‘N.M. Perera’s Policies and Achievements as Finance Minister’, has covered this episode in some detail.

The exercise did rejuvenate the banking sector with the addition of previously hoarded money, and helping the Government maintain a healthy tax-to-GDP ratio. It mostly affected the rich people who had hoarded money and some others who though not outwardly rich, had hidden cash reserves. Most ordinary people did not have access to the higher denominations with salaries that did not even run into Rs.500 per month.

Polymer notes

Among the other countries, apart from Sri Lanka and India that have tried their hand at demonetization are, Nigeria (1984), Ghana (1982), Zimbabwe (which last had a 100 trillion dollar currency note after runaway inflation and where many foreign currencies are now legal tender), North Korea (2010), USSR (1990s) and Myanmar (1987). Australia phased out paper currency notes in favour of polymer notes some time back (Sri Lanka too had Rs.200 polymer notes for a brief period). Pakistan will be phasing out its old notes from December this year.

Many countries have refrained from issuing higher denomination currencies precisely due to the fear of money laundering and hoarding – the highest denomination in the US is still US$ 100 and in the UK, Sterling Pounds 100. There was stiff opposition in the EU to the euro 500 note which some feared would lead to money laundering. It was eventually printed, mainly due to the demand from Germany where cash is still king, as opposed to credit/debit cards. Of the developed countries, only Switzerland has a very high value currency note of 1,000 Swiss Francs. Among the other high value notes currently in circulation are, South Korea’s 50,000 Won, Brunei’s 10,000 Dollar, Singapore’s 1,000 Dollar, Japan’s 10,000 Yen and Sri Lanka’s Rs.5,000 note.

In India, the situation is somewhat different because many people who were not really counted among the rich had hoarded big denomination banknotes without entering the formal banking system. Moreover, India, especially rural India is still a largely cash based society where the credit card culture is still developing. People still use cash for big transactions and the Rs.1,000 note helps.

Long queues were seen outside banks and ATMs in the rush to get the new legal bank notes, while at least 12 deaths have been attributed to the demonetization chaos. In the most well-known case, a farmer in Uttar Pradesh hung himself ahead of his daughter’s wedding as he couldn’t withdraw the Rs 60,000 he borrowed for the ceremony. In another incident, shocked by the announcement, a washerwoman in Gorakhpur in Uttar Pradesh died after she heard that Rs 500 and Rs 1,000 notes were no longer legal.

Critics have thrived on incidents like these as well as the wider implications of demonetization to attack Prime Minister Modi. Manmohan Singh, the former PM and reputed economist, has said, India’s demonetization program will cut 2% from GDP. Former US Treasury Secretary Larry Summers has said, it will hurt India’s poor and not really have an effect on corruption. There are also questions of equity and efficacy. “We strongly suspect that those with the largest amount of ill-gotten gain do not hold their wealth in cash but instead have long since converted it into foreign exchange, gold, bit-coin or some other store of value. So, it is petty fortunes, not the hugest and most problematic ones, that are being targeted,” he wrote. “The impact on GDP growth is clearly going to be negative in the short run and depends to a large extent on how long the cash crunch is going to take,” said Thomas Rookmaaker, a director in Fitch’s Asia-Pacific sovereign ratings group.

Prime Minister Modi has hit back at those who criticize the move, saying they are frustrated at being caught out with illicit cash, themselves. “Those criticizing demonetization don’t have a problem with the government’s preparedness,” he said, at a book release on Friday. “They have a problem because they didn’t get time to prepare.” He has urged citizens to vote on the demonetization policy through the Narendra Modi app on their mobile phones. He asked the public to participate in a survey where a number of questions have been posed with regard to scrapping of old Rs 500 and Rs 1,000 currency notes. “I want your first-hand view on the decision taken regarding currency notes. Take part in the survey on the NM App,” he said in a tweet.

Currency rationing

The Indian Government tightened its curbs by ending over-the-counter exchange of the banned Rs500 and Rs1,000 notes at banks, despite earlier assurances from the Reserve Bank of India that small sums of the invalid currency could be swapped in this way, until the end of the year. The cancelled banknotes can still be deposited directly into bank accounts, exchanged at the RBI, or used to pay back taxes or other services from state-run entities, such as, petrol pumps and public hospitals. The dispensation of new notes has moved slowly, hindered by technical and logistical constraints. For now, Indians are being subjected to a form of currency rationing, with limits on how much cash they withdraw from their bank accounts, Indian media reported. In the light of these developments, the Indian Government has instructed the RBI to speed up the printing of new Rs.500 and Rs.2,000 notes.

The demonetization has affected the entire SAARC region, since India is its biggest economy. The Sri Lankan authorities have advised travellers to refrain from going to India (unless for essential purposes) until a clearer picture emerges. Nepal has even banned India’s new Rs.500 and Rs.2,000 notes. Foreign banks, including Indian ones operating in Colombo have refrained from changing Indian currency notes citing lack of direction from RBI and the local monetary authorities. Some customers had more luck with authorized money changers, who had however offered a far lower rate than usual.

The issue has also brought to the fore the issue of a ‘cashless society’ where paper money will be a thing of the past. There are many developments in this direction – Sweden’s Riksbank (the oldest Central Bank in the world) is debating whether to become the first significant Central Bank to issue a digital currency as it responds to an increasing move away from cash in the Scandinavian country.

This may not be immediately possible in developing countries, but it could be one way of avoiding the many problems associated with paper money, as the Indian experience has shown us. 


Crowds await the opening of a bank branch to exchange money.

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