The Politics and Sense of India’s Currency Ban

While the rest of the world was transfixed watching the presidential election in the United States last month, India implemented a radical currency policy. Perhaps the date was no coincidence, since much of the world was otherwise distracted, providing some cover for the Indian government. India has since experienced a great monetary crisis, but the long-term impact could still be positive. Certainly, the government, as well as many experts, have argued that the new currency policy is absolutely necessary.

On November 8, Indian Prime Minister Narendra Modi, in an unscheduled televised announcement, gave four hours notice that Rs500 and Rs1,000 notes (worth about $7.33 and $14.67, respectively) would no longer be legal tender. Citizens would have a limited period – until December 30 – in which to exchange their rupees for new ones, which are now being issued in denominations of Rs500 and Rs2,000, or they can credit their money to a bank account. The government has justified the suddenness of the policy as necessary to take those using forged currency notes by surprise.

This policy is not unprecedented. The British Indian government removed currency from circulation in 1946 in the aftermath of World War II, and in 1978, the Indian government attempted to curb counterfeit and black money by withdrawing the Rs1,000, Rs5,000, and Rs10,000 bills from circulation.

Curbing counterfeit and black money was a major motivation for the current demonetization as well. While the demonetization is causing discomfort among Indians – many of whom are queueing in lines at banks – it is supported by many institutions. At the same time, some Indian citizens have turned from banks to various other sources in order to exchange money and overcome cash shortages. One particularly interesting source is Hindu temples, which own a lot of small currency, as a result of their donation boxes. Many temples throughout India have opened up their cash reserves during this time of crisis.

The governor of the Reserve Bank of India (RBI) applauded Modi’s “very bold step” because it addressed concerns regarding the “growing menace of fake Indian currency notes.” The Supreme Court of India has declined to halt the government’s initiative. Nonetheless, most of India’s opposition parties have protested the government’s demonetization move, with one leader from the Congress Party, Anand Sharma, claiming that the government had pushed India toward “financial chaos” and an “anarchy-like situation.” The chief ministers of Indian states are fairly split on supporting or critiquing the policy.

The Indian government has argued that, given the scale of corruption in the country, the current demonetization is the best way to combat black money, because the move would bring a lot of money into the formal economy. Over 80 percent of the bills in circulation in the Indian economy consisted of the now-defunct Rs500 and Rs1,000 notes. The demonetization plan could most certainly lead to the removal of much fake money from the Indian economy.

The Indian government has alleged that much of the currency in circulation is counterfeit, originating from Pakistan, a charge that Pakistan vehemently denies. Many commentators have noted that the number of stone-pelting incidents and other acts of civic disobedience have decreased in the Indian state of Jammu and Kashmir, implying that people were taking (likely fake) money from Pakistani agents to cause trouble. There is no direct causal evidence to support this assertion, but it is true that stone-pelting incidents have decreased; according to information released by the Jammu and Kashmir home department, there were 179 stone-pelting incidents in October and only 49 up to November 14.

While there are obviously immediate benefits to the government’s policy, many of the criticisms of the demonetization scheme also have merit. These criticisms have centered around the efficiency of the plan in actually stamping out black money, as well as the short-term logistics of the scheme, which have caused immense hardship, especially among poor people. Numerous evasive practices for disposing of the black money have centered around spending it before the deadline, using it to buy things such as Rolex watches and plane tickets, or converting it into gold.

The hardship has extended to food prices in rural areas. Additionally, almost half of India’s 9.3 million trucks were initially abandoned, because truckers did not have enough cash to take care of their various transportation and food expenses, leading to shortages of goods throughout India. It is unclear if all monetary exchanges will be made in time for the December 30 deadline; it would be enormously controversial for the Indian government to not allow people, especially the poor, to maintain their savings if they cannot meet the December 30 deadline.

Beyond short-term consequences, India’s currency move could have some positive long-term results if handled properly. As the world is increasingly headed toward a cashless economy, taking paper money out of circulation will force more Indians to open up bank accounts and handle more money virtually. The majority of the Indian population does not have an active bank account and 90 percent of transactions in the country are made with cash. Bill Gates, who was in India in November, said that demonetization was worth the pain because it would lead to a deep reduction in the cost of borrowing for the poor: “India is pushing towards digitization in a big way. The scale of the country means that once India gets there, the amount of digital innovation here will be greater than anywhere else in the world.”

It remains to be seen if the government’s demonetization initiative will yield the results it is supposed to. But it will continue to fuel politics in India, with opposition parties using it as an example of the government’s carelessness toward the poor and the ruling Bharatiya Janata Party (BJP) using it to demonstrate Modi’s decisiveness and vision.