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.
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.
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.