Demonetisation: Everything you want to know about India’s much-publicised note ban

[ecis2016.org] This article explains the meaning and impact of demonetisation on the Indian economy.

In an attempt to rid India’s economy of black money, benami transactions and corruption, prime minister Narendra Modi, on the evening of November 8, 2016, announced demonetisation – a move that banned high-value currency notes of Rs 500 and Rs 1,000.

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Demonetisation meaning

Demonetisation is the act of making a currency invalid by stripping off its legal status. Typically, demonetisation takes place when a nation changes its currency. To effectuate demonetisation, the existing currency is replaced with new currency.

Currency notes are legal tenders issued by a government, promising the owner to give the value marked on the notes. Since it is a legal tender, the sovereignty of the currency is binding on the taker. However, when a government strips off the value of the said currency, it is called demonetization. Demonitisation is the end of the legal agreement, as well.

This step is used to replace old currency with new. In recent times, members of the European Union, for example, used demonetisation to adopt the Euro as a common currency.

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Demonetisation in India

The much-publicised move of demonetisation was announced by the prime minister in an unscheduled, national, live telecast at 8:15 PM on November 8, 2016, making high-value notes invalid, starting midnight. Modi’s demonetisation move resulted in 86% of the existing currency of the time becoming invalid overnight.

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The public had the option to surrender the invalid notes within the next 50 days (till December 31, 2016) or visit any bank branch in the country and exchange the illegal tenders for valid currency notes of similar value. In a country with the world’s second largest population, the move resulted in extremely long queues, chaos, panic and several deaths.

Following demonetisation, 99% of the banned currency was returned to the Reserve Bank of India. While the total amount of the banned currency stood at Rs 15.41 trillion, Rs 15.31 trillion came back to the banking regulator.

Demonetisation: Impact

For a cash-dependent economy like India, the sudden move prompted economists across the world to take an adverse note of the move. Making matters worse, the RBI restricted the daily withdrawal limit.

Touted to help the government deal with benami transactions, underground transactions and money laundering, demonetisation unsettled the local economy and resulted in the Rupee crashing against the US dollar.

With 86% of the currency in circulation tendered illegal, a state of cash crunch emerged, severely hitting cash-reliant sectors such as real estate.

What economists said about demonetisation?

‘Demonetisation was ostensibly implemented to combat corruption, terrorism financing and inflation. But it was poorly designed, with scant attention paid to the laws of the market. The demonetisation had very little to do with corruption. It is the poorer people and the informal sector, which has been hit very adversely. That was a non-starter frankly.’

– Kaushik Basu, former chief economic adviser to the government

‘The demonetisation of currency was a despotic act as the government broke the promise of compensation that comes with a promissory note. Demonetisation goes against trust. It undermines the trust of entire economy. Only an authoritarian government can calmly cause such misery to the people – with millions of innocent people being deprived of their money and being subjected to suffering, inconvenience and indignity in trying to get their own money back.

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– Amartya Sen, economist and Nobel Laureate 

‘It’s not something I think should be done for a country such as India and the level of development it has. Japan has the highest cash per capita, way more than India. The cash in circulation, relative to the gross domestic product for India was 10%, whereas in Japan it is 60%. That is not black money; that is not corruption.’

– Gita Gopinath, deputy managing director of IMF

‘A lot of money that operates in the shadow economy will now become a part of the banking structure itself. Banks will have a lot more money to support the economy. Private sector investment, which was so far lacking, will now get back into the economy. The banks, which were struggling because of the NPA problem will have a lot more money to lend for agriculture, infrastructure sector, social sector, trade and industry.’

– Arun Jaitley, former finance minister of India

‘This is a useful method of flushing out black money, given that a large percentage of cash holding is in these two denominations. The manner in which it was implemented is not surprising – such actions are always secret till announced, so that insiders do not take advantage of the information at the cost of the outsiders.’

– Arvind Virmani, former chief economic advisor to the government

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