Flaws of demonetisation: Lessons from India's experience

The saying goes "a wise man learns by the mistakes of others". Many countries may go for demonetisation in near future looking at the success of India in curbing fake notes circulation and curtailing black money. Demonetisation in the short run would slow down aggregate demand but as Prime Minister Modi says, it's a cleaning process for the economy for establishing faith and fear in the society. The impact of demonetisation in India is too early to be assessed. But certainly loopholes in the implementation are clearly visible. The experience in India suggests that if demonetised currency's exchange and deposit mechanism is not planned and monitored properly, the whole exercise would turn futile.

Demonetisation is a process of removing the legal tender status of any banknote; generally, high value currencies of a particular denomination are taken out from the financial system of a country. The same volume, or usually less than that volume of currency, is again introduced into the market through banks. Before implementation of demonetisation plan, various factors are considered such as level of literacy, extent of mobile and internet penetration, availability of new financial transaction and banking technologies, political strength of the government i.e. majority in case of democracy, extent of coverage of unique identification number or tax identification number, size of population and extent of penetration of financial system in the country. 

In India, prior to this bold step, financial inclusion was targeted by Pradhan Mantri Jan-Dhan Yojana in which Rupay debit cards were distributed. Internet banking, mobile wallets, and unified payment interface were encouraged. Income declaration scheme was also launched in which an opportunity was given to citizens who have not paid full taxes in the past, to declare their undisclosed income and pay tax, surcharge and penalty of about 45 percent undisclosed income declared. Similarly, other financial sector reforms like Benami Transactions (Prohibition) Bill was also passed, which prohibits a person to pay and own property in another person's name. The planning of demonetisation has to be done in a very secretive manner and its declaration has to be sudden, giving almost no time to the black money hoarders to act. The new banknote has to have many unique features with the help of new technologies, making it quite impossible to be duplicated. These features should be well publicised soon after the launch through reliable media sources, along with different methods of cashless transactions. The new currencies should be stocked in sufficient amount by the central bank and made available as per the bank's requirements. In India, a private bank was alleged to have provided undue advantage in converting the demonetised banknotes with new ones, hence, a day to day basis monitoring by central bank could discourage such cases. After the declaration of demonetisation the old banknotes could be either exchanged or deposited. Exchange of old banknotes by new banknotes is important when banknote demonetised is of very high volume to allow flow of cash in the market. As far as deposits are concerned, there need not be any restrictions to the amount deposited, which can later on be reported to the income tax department. But this process is not as simple as it seems. The government of India realised it and made some interim corrections in the implementation. But by then some clever big fishes were already out of the net. These flaws should not be repeated by other economies. 

Firstly, as the cash in hand is limited for a particular individual or entity at the time of demonetisation and as there are no further possibilities of getting cash in future, banknotes are no longer exchanged in the market. Hence, multiple deposits options should not be given to an individual or entity. Government can still have a liberal approach by allowing deposit of limited amounts for the second or third chance. But withdrawal has to be strictly monitored and a limited amount must be allowed for withdrawal per week. Furthermore, the government should take details of deposits made by asking depositors to first report to tax authorities about their demonetised cash in hand and, thereafter, deposit them in banks. Banks can also directly give such details to the income tax department. Secondly, currency exchange is a method in which all money goes unaccounted; hence, a limit in this is a must. The state should allow only one type of photo identification card (as proof) such UID or social security number to facilitate exchange. While exchanging banknotes, identification number is fed into the software and limited repetitions are allowed for an individual. Ink mark used during elections can also be used with prior permission from the election commission. Thirdly, after tackling the above loopholes, black money hoarders could still split their black money in smaller accounts. They might open new bank accounts or deposit in other bank accounts. Therefore, all new accounts opened during this period should be thoroughly monitored and Know Your Customer (KYC) norms should be strictly followed. To demotivate lower income groups from indulging in any fraudulent practices (such as allowing their accounts to be used by others), a guideline can be issued stating that those people involved in illegal activities of serving black money hoarders to convert demonetised banknotes to new banknotes would be devoid of social security benefits. Some relaxation in the implementation could be provided for hospitals, tourists, travels, and for buying other essential commodities. The task of demonetising 86 percent of currency was not easy. Holidays and leaves of bank employees were cancelled. The government worked on war footing with multiple police and income tax raids. The bullion and foreign exchange dealers were strictly monitored. It was termed as "surgical strike against corruption".

Dr. Shreekant Sharma is Associate Faculty, National Institute for Micro, Small and Medium Enterprises, Hyderabad, India. 

E-mail:shreekant21@gmail.com



Mr. Chaturbhuja Barik is Chief Manager, Circle Office, Punjab National Bank, Hyderabad, India. 

E-mail: chatupnb@gmail.com