India’s Cash Problem

lining up at the bank
Lining up at the bank

What happens when a country suddenly finds that 86% of the currency in circulation is invalid?

On November 8th, India prime minister Narendra Modi announced that the two highest-denomination notes, worth 500 and 1,000 rupees ($7.50 and $15), were legally worthless. Effective pretty much immediately. Two days later, the government issued new 500 and 2,000 rupee notes to replace the old ones. Old bank notes can be exchanged at banks and post offices until the end of the year.

rupees

In theory, the surprise demonetization should flush out black market money — ill-gotten gains from illegal financial activity. People who want to exchange their canceled notes have to show proof of identity and are limited to Rs 10,000 a day, and Rs 20,000 per week. ATM withdrawals are limited to Rs 2,000 a day.

The prime minister calls the demonetization a “minor inconvenience”, but India isn’t exactly known for its expedient financial infrastructure. ATMs quickly ran out of cash. People are literally dying: Not just because they’re waiting in line for hours, but also because they can’t buy necessities like food or gas. India is a country where 90% of transactions are conducted in cash, and now that existing cash has been declared illegal, no one can buy anything.

Ideally, people will take this opportunity to move their money to banks and the government will be able to track future financial activity, ensuring peace and prosperity for all. Except that over half of Indian households don’t have a bank account and a quarter of the population has no form of ID. Click over here

India has tried this demonetization strategy twice before, in 1946 and 1978. Both times, the effect was pretty much nil. After the conversion period in 1946, the amount of outstanding cash did not change. In 1978, the amount of outstanding cash actually increased.

In 2014, the Reserve Bank of India pulled a smaller-scale surprise demonetization by canceling pre-2005 currency notes. The Bharatiya Janata Party (the current ruling party) criticized the move as anti-poor: “The aam aurats and the aadmis, those who are illiterate and have no access to banking facilities will be the ones to be hit by such diversionary measures.”

The ruling party doesn’t seem to be so worried about the unbanked this time around. Conspiracy theory: There are assembly elections coming in January, and political parties are holding large cash donations, which they use to bribe voters (India has a long history of vote-buying). So the ruling party wants to financially cripple the opposition.

The Delhi chief minister has accused Prime Minister Modi of informing his political aides of the currency ban ahead of time so that they could launder their unaccounted money. So a move that was advertised to eliminate corruption may turn out to in fact enforce it.

10 thoughts on “India’s Cash Problem

  1. Hi Elaine,
    An Indian here. I can think how the demonetization can look to a foreigner, and how easy it is to get swayed by the media reporting things all dull and gloomy and apocalyptic.
    On the ground however, I stood in queue for over 2 hours day before (to deposit cash in my account and then to withdraw some in the new currency) and that gave ample time to chat with other peeps. There was NO one who was unhappy. Inconvenienced, yes, but happy that many money hoarders dealing primarily in black money are screwed. That’s the spirit I see in the nation.
    Indians have a long standing history with bribes and black money and under the table dealings, but the kind of positivity I see every day from fellow Indians (been standing in queue for 3 days to get bits of money everyday) is just fabulous.
    The lower and middle class people are frustrated with a system which primarily favors people who have tons of disposable cash (which is not easy to earn in a cut throat economy like India, and thus is mostly black money). For the first time in decades, we have a government which is trying to put all stops towards black money. I was surprised to see local vegetable vendors putting up mobile wallet systems (like PayTM) for payments. Everyday I see lower and middle class giving up conveniences for the betterment of the country, and in turn, for a better future of their children.
    Personally, I’m positively awestruck by how bold this move is. All the best to PM Mr. Modi.

  2. As a ‘foreigner’ who has spent close on to five years in India over the past ten I would beg to differ strongly with the above comment. No one who hoards serious amounts of cash in India hoards it in 500 and 1000 rupee notes. Without exception the money is converted into Euro, $, £, yen, etc or that Indian favourite ‘gold. Such is the love of gold in the Asian community that in the UK we have a specific crime known as Asian gold burglaries http://www.thamesvalley.police.uk/crime-prevention/home-garden-security/other-types-burglaries/asian-gold-jewellery.htm https://www.theguardian.com/uk/2012/jan/31/gold-theft-asian-families

    My familiarity with this market is I’m afraid down to being a cash junkie who changes £’s and Euros’ with the money dealers in Paraganj and elsewhere. Money dealers who give better rates than the banks. Similarly the more you change and the higher denominations you have…the better that rate is… ummm I wonder why?

    The fact is that no rich Indian uses 500 and 1000 rupee notes for stuffing the mattress and after this even less will …

    1. Thanks Malcolm. I guess even a foreigner like you was able to understand the currency situation better than the prime minister.

      1. I do not agree with Malcolm. Most of black money is kept is higher value notes. All political parties have large amount of cash. elections are coming in UP and Punjab. I am sure that congress and other parties are in serious trouble. I am a NRI for last 21 years. I have always sent money to my account in India through banking system. I have no trouble with this scheme of government and fully support Mr. Modi.

        1. yes but those high denomination notes are $100, 100euro, £50 notes not 500 (£5) and 1000 ($15) notes… this bbc report is the reality for most Indians http://www.bbc.com/news/world-asia-india-38000087.. The majority in Rajasthan (as with all of India) are poor low caste villagers, people of insignificance to a right wing elitist like Modi. Worth noting too that without exception every women in the photos in this story covers not only their heads but there faces.. this is a common practice in Indian villages where low caste hindu women seek to avoid the attention and rape from higher caste hindu men….

  3. Hi Elaine,

    Just found your blog as I was trying to look for more perspectives on demonetization. I have hard time believing that rich people will be able to convert all their black money into gold and land with a click of button. If they purchase gold through jewelry shop, the shop owner will get under the scanner of IT dept. Even in the instances cash is converted into gold, we know gold prices are going down so its not a wise investment. A person with black money converted into gold will be sitting on something that can’t be used to buy cars, smart phones, etc (unless India switches to barter system) and at the same time the value of gold will continue to decline.

    Land deals are even more difficult to execute as land is just not easily available and needs lot of documentation. Any land deal that has to undergo registration will get into the scanner as well and the owner might get into trouble for that. If you don’t register the land deal, there is no security so could be quite risky move.

    Lastly, all the critics I have heard so far are all ‘status quo’ in nature. They criticize the move of current government but haven’t offered alternate solution that can be implemented in real life. I live in Ahmedabad (urban area of Gujarat) and have barely found anyone who is critical of the move itself. People are indeed going through lot of inconvenience and you also feel pity and sympathy for those who are receiving end for little fault of their own (fault of not opening amount and minor tax evasion). I hope the influx of new money will be faster than predicted and it will set micro economy back in motion soon.

    1. My sentiments exactly.
      Only gripe is the FM should have been clear about the scarcity of new notes. Been trying to withdraw money from my account for the past 3 days, but the banks always run out of cash. On talking to one of the branch managers, they said they hardly receive 5-10 lacs on any given day and it’s not enough for more than 40-50 distributions (current accounts can withdraw 50k daily).
      On the ground, there’s a severe cash crunch.

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