Demonetization in India: Not a Move for the Fainthearted

On November 8, 2016, Indian Prime Minister Narendra Modi announced that India’s 500 and 1000 rupee notes were no longer legal tender, subject to certain exceptions and a grace period to exchange the notes.  The demonetization announcement took much of the Indian public and the world at large by complete surprise.  In fact, PM Modi said that surprise was absolutely critical to accomplishing the avowed goal—forcing those hoarding large amounts of black money to relinquish the illicit cash without giving them the opportunity to find creative ways to convert the notes.

Image Courtesy of Keenicon (c) 2015

I arrived in Delhi just two days later for a long-anticipated holiday, but I soon discovered that the rupees I obtained in advance were essentially worthless.  And this situation wasn’t limited to me.  Not long after the announcement, it became impossible to withdraw rupees from ATMs; they simply ran out of cash and the lines in banks were virtually unmanageable.  Putting aside for a moment the inconvenience—a minor setback in the grand scheme of things—created for tourists in India who found themselves limited to credit-card friendly venues, the impact of demonetization in India was and continues to be much greater for local residents who often wholly depend on cash transactions for their day-to-day lives.  According to news reports, the 500 and 1000 rupee notes comprised approximately 86% of cash in circulation at the time of the announcement.

In the days that followed PM Modi’s announcement, critics and pundits postulated on lessons learned and the actual long-term impacts of demonization in India. The scope and breadth of all the potential lessons are too extensive for an article of this length, but there at least three questions that merit further discussion because other countries may consider using a similar tactic to fight crime and corruption.  If criminals were the only persons actually using these allegedly “high value” notes, why was there such a widespread (and extended) disruption in the daily routines of ordinary citizens?  Regardless, how does forcing people to relinquish illicit cash actually accomplish the avowed goal of India’s demonetization, which is helping the poor through a concerted effort to stand up to corruption?   India is also home to a large number of startups, like Paytm, and a massive number of internet users.  Would we have seen less chaos if there had been more of a government focus on or collaboration with companies like Paytm to ensure a reduced disruption for the average Indian citizen immediately following the announcement?  Finally, putting aside the issues with calibrating ATMs to distribute the new 2000 rupee notes, should PM Modi have worked more closely with banks to make sure they had the analytic structures in place to actually identify illicit cash exchanged at their locations? Otherwise, how will any enforcement actions or punishments actually take place?

For countries considering similar action in order to fight corruption and black money, the chief lesson from India’s demonization appears to be that such a move needs to involve a better balance between public-private sector collaboration and the discretion required to minimize signals to corruption targets.  If Indian banks are unable to meaningfully track the return of illegitimate funds, then it is unlikely there will be a related corresponding punishment.  Following the November 8th announcement, Paytm saw an unbelievable jump in the number of its subscribers.  However, if PM Modi’s announcement was a political or economic attempt to force India to move its economy away from cash, perhaps such a goal could have been achieved through better partnerships with the private sector, particular tech focused on mobile payments, in order to incentivize Indians. Finally, demonetization should almost certainly be part of a multi-faceted approach. According to one commentator, cash is just one way that unreported wealth or other illicit funds are held, as opposed to foreign bank accounts, real estate, or other mediums.  In the months to come, there will likely be other lessons learned that will provide invaluable guidance to countries around the world with cash-heavy economies and a renewed focus on fighting corruption.

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