A number of countries have introduced new currencies for a variety of reasons. All 14 former republics of the Union of Soviet Socialist Republics (USSR), including Russia, replaced the Soviet ruble in 1992-3 with each newly independent republic’s own national currency. The break-up of Yugoslavia into Bosnia and Herzegovina, Croatia, Macedonia, Montenegro, Slovenia and Serbia resulted in the replacement of the Yugoslav dinar by six national currencies. The so-called Saddam dinar of Iraq, which had the face of its former President Saddam Hussein, was replaced with notes without his picture in 2003. The Turkish lira was replaced in 2005 with a new series that dropped six zero’s from the old lira following the successful stabilization of its value after more than 20 years of high inflation. The public was given one year to replace the old currency with the new lira.
The exchanges of these new currencies for their predecessors followed many months and sometimes years of careful preparations, including clear instructions to the public on the nature and process of the exchange. The process was sometime messy in the context of freshly ended war, as in the case of Bosnia and Herzegovina, but was usually well organized and orderly.
The actions taken by the Reserve Bank of India to demonetize and withdraw the two highest-denomination banknotes (the 500-rupee and 1,000-rupee, worth about US$7.30 and US$14.60) was anything but. The loss of legal tender status of these two notes was announced without warning on Nov. 8, 2016. “In consequence thereof these Bank Notes cannot be used for transacting business and/or store of value for future usage. The Specified Bank Notes can be exchanged for value at any of the 19 offices of the Reserve Bank of India and deposited at any of the bank branches of commercial banks/ Regional Rural Banks/ Co-operative banks (only Urban Co-operative Banks and State Co-operative Banks) or at any Head Post Office or Sub-Post Office.” (From the RBI website.)
Other restrictions, such as limits on the maximum of new cash that could be withdrawn, also applied. At the same time, the RBI announced the intension to issue a new series of 500 rupee notes and a new larger denomination 2,000 rupee note sometime in the “near” future.
Suddenly, 86.4 percent by value of the cash in circulation was no longer legal tender. Ninety-eight percent of all consumer transactions by volume in India are in cash. The public was shocked, and the deliberate government-imposed hardship on hundreds of millions of poor Indians would be unimaginable elsewhere and would have been widely reported.
A Reserve Bank of India Press Release on Nov. 8, 2016 stated, “This is necessitated to tackle counterfeiting Indian banknotes, to effectively nullify black money hoarded in cash and curb funding of terrorism with fake notes.” An unofficial goal, however, was to force more of the cash economy into banks, i.e., to “encourage” India’s poor to open bank accounts. Time will tell whether much untaxed “black money” was forced into the open and thus taxed, a one-off benefit, as well as how much of the cash economy moved permanently into the formal financial system.
India’s objectives for its currency exchange are wrongheaded, and its preparation for and implementation of the operation abysmal. It imposed a huge hardship on India’s poorer citizens. The new notes will not be ready in sufficient quantity to replace the old ones (22 billion notes in all) for five or six months.
Virtually all of India’s income taxes fall on the better off, who are less reliant on cash and who are better able to find alternative avenues of tax evasion if they are determined to. This is especially true for income from illegal economic activities. Seizures of illegal wealth in the past found that only between 3.75 percent and 7.3 percent was kept in cash. As with very costly, worldwide efforts to combat crime by confiscating its suspected proceeds (so-called Anti-Money Laundering measures), it would be more consistent with the rule of law and could ultimately be more effective in combatting crime to attack it directly rather than through AML measures.
Money is an extremely useful instrument for facilitating production and commerce. Like the hammer, which can crush a man’s skull as well as drive nails that help build homes, money can facilitate bad as well as good. It has been a serious mistake to burden money and the good it can do with AML restrictions. While better advance planning could have greatly reduced the considerable collateral damage from India’s currency exchange, it considered surprise essential in order to force out and capture its “black money.” When all is said and done, the benefit of one-off, higher tax revenue will almost surely be dramatically smaller than the considerable cost, which has fallen largely on the poor. The new 2,000 rupee notes are already turning up in the “black” economy. India would do better to improve its tax systems and their administration directly.
The unofficial goal of India’s currency “reform” is to force more Indians to open bank accounts in order to use the official financial system. The goal is laudable but the method is not. Currency is likely to fall out of use in the future around the globe because of new technology that is simplifying and lowering the cost of payments with transfers of bank balances and /or digital currency. To the extent, this happens it is reflecting voluntary shifts by the public to more convenient means of payment. Kenyan authorities did not push their citizens to massively replace the use of cash with digital currency (see my earlier article on M-Pesa “The Technology of Money” Cayman Financial Review, Jan. 18, 2012). Rather, they wisely facilitated the develop and use of dramatically safer, cheaper and more efficient ways of moving and using (digital) cash. Indians will open bank accounts and adopt other modern means of payment when it is advantageous for them to do so. In fact, India’s banking and digital currency infrastructure is not up to a large shift to such means of payment and bad experiences with them by those “forced” to use them will only slow their adoption. The government can help open those doors and remove road blocks to financial system developments but forcing the public is bad policy.
Broadly speaking, the Modi government is making a mistake in executing coercive approaches to economic and financial modernization.