There was more than one surprise on election night…
By Hubert Walker for CoinWeek ….
While much of the world–and certainly much of the world’s press–was otherwise occupied on election day, shortly before midnight on Tuesday, November 8, Indian Prime Minister Narendra Modi announced that the Indian 500 rupee (Rs 500, or ₹500) and 1,000 rupee (₹1,000) banknotes would be demonetized as of Wednesday, November 9.
In the recording of the announcement above, PM Modi casts the stunning move as part of his party’s campaign to fight corruption and terrorism, though the government’s action has, in the weeks since, caused problems for everyone who uses cash in India on a daily basis.
And even though it was part of a general movement around the world to demonetize high-denomination currency, the Indian decision was far more radical and sudden than most.
But before discussing the greater context of Modi’s plan and what its ramifications are, its specific details should be noted:
As of 12:00 am on November 9, all of the latest series of Rs 500 and Rs 1,000 banknotes have been demonetized. This means that the notes are no longer legal tender for use in government and commercial transactions, although the 500- and 1,000-rupee notes were still acceptable at hospitals, airports, bus stations and train terminals through November 12. The deadline for depositing any remaining Rs 500 and Rs 1,000 bills at a bank for full credit is December 31. Anyone who cannot meet this deadline may still deposit their notes for face value as late as March 31, provided they file a declaration explaining why they could not meet the original deadline and provide sufficient proof as to their reasons.
To safeguard against a run on the banks, currently ATM withdrawals are limited to 2,000 rupees a day. Total bank withdrawals are limited to no more than 10,000 rupees a day, with a weekly maximum of 20,000.
Of course, such actions are nothing new. Global organizations and policy makers, such as the Financial Action Task Force, have for years recommended the elimination of high-denomination currency notes to combat money laundering, human trafficking, racketeering and the illicit drug trade. Even former U.S. Treasury Secretary Larry Summers has advocated the elimination of the $100 bill, which has been the highest denomination United States Federal Reserve Note since the issuance of even higher denominations ceased in 1969.
In Asia, Singapore stopped producing its S$10,000 note (worth approx. $7,000 USD) in October of 2014 and is working towards removing it from circulation though it has not been demonetized. And South Korea has plans to completely end the issuance and use of paper money by 2020.
However, the most famous recent example is the European Union (EU)‘s decision to cease production of the high-denomination 500 euro (€500) note – though in that case, the €500 banknote will continue to be issued through 2018, and will remain legal tender.
But demonetization is not without precedent in India itself.
In 1978, India demonetized 1,000, 5,000 and 10,000 rupee banknotes, ostensibly in an earlier effort to fight corruption. According to the High Denomination Banknote (Demonetization) Act of 1978, the three notes ceased to be legal tender as of January 16, 1978. All banks and financial institutions were required to exchange what inventory they had with the Reserve Bank of India (RBI) by that date. Regular citizens were given until January 24 to successfully trade in their notes, though in reality the average Indian man and woman of the time ordinarily didn’t use such high-denomination banknotes.
Then, in 2014, India phased out all of its pre-2005 series of banknotes. Calls to eliminate the 500 and 1,000 rupee notes were also made at the time, with at least one economist stating recently that 250 rupees is as high a denomination as is necessary for everyday business.
Organizations like the National Investigation Agency have long supported such a measure. The Agency is charged with fighting the spread of counterfeit currency within India and must contend with a sophisticated and robust network of counterfeiters and distributors known as the Fake Indian Currency Notes (FICN) network.
As for corruption, there is a large amount of political controversy in the Real Estate and Construction (specifically cement) sectors of the Indian economy. One of Modi’s goals is to increase financial transparency in these sectors, though the government admits that it will be a painful process.
Additionally, political election campaigns depend on cash since there is no state financing–and the majority of that cash comes in the form of Rs 500 & 1,000 banknotes.
The prime minister also casts the move as a poverty fighting measure. The right-wing Indian People’s Party—Bharatiya Janata Party, or BJP–came to power in 2014 promising to redirect billions of rupees in “black money” back into the mainstream economy. His government recently netted $10 billion USD from a tax amnesty designed to encourage Indians to reveal hidden, cash-based income.
But the timing of Modi’s latest effort seems strange, as the RBI has almost simultaneously begun to issue a 2,000 rupee note, independent of the government’s efforts to crack down on corruption and tax evasion. The issuance of the Rs 2,000 notes has been in the works for a long time. Along with a new 500 rupee note, the new highest-denomination bill comes with improved security features.
Economic Affairs Secretary Shaktikanta Das has said that the RBI will “monitor and regulate the issuance of Rs 2,000 notes.” It is unlikely that they will be issued in large amounts.
Nevertheless, there has also been an effort to move towards a “cashless” society. But one of the most prominent parts of this work–an app called the Unified Payment Interface (UPI)–will not be operational until January of next year. UPI is a mobile app supported by the National Payments Corporation of India, the RBI, and other participating banks.
According to the RBI, 16.5 billion Rs 500 and 6.7 billion Rs 1,000 notes are currently in circulation (or at least were, immediately prior to the announcement), with the 1,000 rupee bill representing 39% of all notes in circulation and the 500 rupee representing 45%. Other sources give even higher numbers, with one saying that together the two banknotes represent 86% of India’s circulating currency.
And when considering all of this and its impact on the world at large, it is important to note that India is Asia’s third-largest economy after China and Japan.
Flyer courtesy RBI
The demonetization will be felt in many different ways across a wide spectrum of the Indian economy.
At a late-night press conference on Tuesday, November 8 – one hour after Modi’s announcement – Economic Affairs Secretary Das said “This has come as a surprise to everybody. The citizens, the nation and even within most of the government!” Presumably it was the hope of the Modi government that the surprise announcement did not give the black market time to prepare, but the move probably won’t affect so-called “black money” holdings in other forms, such as gold and jewelry.
However, not all of the “black economy” is necessarily illegal; the term refers to all income that is not taxed. And since India has a large, cash-based economy, this means that many average citizens participate in the black economy on a daily basis.
Modi’s demonetization will likely have repercussions in the gold sector, where transactions are often cash-based. India is well-known as a net gold importer and a driver of gold prices on the global stage.
The move may indeed lead to greater financial transparency in important sectors of the economy, as well as higher tax revenues for the government and lower inflation. The RBI may also be induced to cut interest rates, thereby leading to longer-term economic growth.
India’s National Stock Exchange dropped 6.3 points upon news of the “Modi Shock”. Five points were recovered the next day.
There will be short-term hardship for small businesses, and those dependent on small bills will suffer this month. India’s tech sector and other “new economy” companies will have an easier time, as many rely on electronic payment methods instead of cash.
Does the elimination of the banknotes save money? The notes themselves are relatively cheap to produce: it costs Rs3 to print one Rs1,000 note, and 96 paise to print one Rs500 bill.
How much will the demonetization cost? An exact calculation has not been made yet, according to Das. The government may need as long as until May of 2017 to replace the bad notes.
But in the end, it is the poor and working class that will be the most affected.
ATMs were closed all over India on November 9, with some still closed on the 10th. They were closed so that banks could remove all of the Rs 500 and 1,000 notes they contained, though as mentioned above the process may take longer. Also, people are removing a greater amount of smaller bills to stock up, leading to several temporary cash shortages.
This from a press release (2016-2017/1265) by the Reserve Bank of India on November 21:
Consequent to the announcement of withdrawal of Legal Tender status of banknotes of ₹ 500 and ₹ 1000 denominations from the midnight of November 8, 2016, the Reserve Bank of India made arrangements for exchange and / or deposit of such notes at the counters of the Reserve Bank and commercial banks, Regional Rural banks and Urban Cooperative Banks.
Banks have since reported that such exchange/deposits effected from November 10, 2016 up to November 18, 2016 amounted to ₹ 5,44,571 crore (exchange amounted to ₹ 33,006 crore and deposits amounted to ₹ 5,11,565 crore). They have also reported that the public have withdrawn, during this period, ₹ 1,03,316 crore from their accounts either over the counter or through ATMs.
—Alpana Killawala, Principal Adviser
Long lines at ATMs to withdraw cash persist and are a common occurrence.
Rural Indians without bank accounts have also been hurt by the demonetization. At least one tragic story reported in the Indian media concerns a woman who committed suicide because she thought her life savings were now worthless. An estimated two billion around the world do not have access to bank accounts and are essentially locked out of the modern economy. According to Modi and other reformers, getting these people enmeshed in the global system “fights corruption”.
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At the time of publication, 500 rupees (Rs 500) trade for approximately $7.46 USD; 1,000 rupees trade for approx. $15.