Old notes are now commanding a premium of 5 percent when exchanged for new notes. (Graphic: Harsh Sahani/The Quint)
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Note Ban Perversity: Old Notes Now Command a Premium of 5 Percent

As the deadline to deposit defunct Rs 500 and Rs 1,000 notes inches closer, individuals and companies with significant cash holdings – in many cases legitimate – are rushing to arrange cash in old high denomination notes.

The cash-in-hand many individuals and business entities show on their books are often used for other purposes, including bribes and unaccounted purchases. These entities need to now put that cash back in their bank accounts to match the numbers.

The result is a new perversity: Old notes are now commanding a premium of 5 percent when exchanged for new notes. This disturbing trend has started in the last three days, punching yet another hole in demonetisation.

In other words, if an individual has Rs 1 crore in old notes and wants to dispose of it, there is a buyer who is willing to pay Rs 5 lakh extra to get that Rs 1 crore.

Snapshot
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  • Post demonetisation, individuals struggling to exchange old notes for new ones were paying a premium
  • In a surprise reversal, old notes are now commanding a premium of 5 percent when exchanged for new notes
  • Many business entities show cash on their books, but often don’t have the money because it was used for other purposes, including bribes and unaccounted purchases
  • With that cash gone, but shown as being “in the hands of the entity”, these entities need to put the cash back in their bank accounts

Forget New, Now Old Notes Command Premium

So, gone are the days when new high denomination notes were commanding a premium of upto 30 percent.

People familiar with these developments in the financial sector told The Quint that in the first two weeks following Prime Minister Narendra Modi’s demonetisation move, people struggling to exchange old notes for new ones were willing to pay a premium of 30 to 35 percent. The system was then flushed with only Rs 100 notes – and there was an acute shortage of high denomination notes.

As the demand for new notes waned, the premium dipped to 15 percent by the end of November. A leading business daily, too, reported this dip. The report found that for the delivery of new notes within three to six months, the premium was at 10 percent.

The situation began to change in the first week of December. The premium vanished as most old notes – nearly Rs 12 lakh crore of them by 6 December – made their way to banks.

First new notes, and now old notes, are commanding a premium. (Infographic: Rhythum Seth/The Quint)
First new notes, and now old notes, are commanding a premium. (Infographic: Rhythum Seth/The Quint)

Why the Sudden Rush For Old Notes?

This is how the market was created: A large number of individuals and business entities have cash-in-hand on their books. But they don't necessarily have that cash in hand.

The money is used for purposes including bribes and other unaccounted purchases and expenditure. Or the amount paid in cash for property or even under-invoiced goods. These cannot be brought onto the books.

With the cash gone, but the books still showing it as being “in the hands of the entity”, these entities need to put the money back in their bank accounts before 30 December. If they fail to do so, they could be questioned on why they didn’t put their “legitimate cash holdings” in their bank accounts. This is resulting in the desperate “buying” of old currency notes.

With time running out, there is a mad rush to get old notes, tilting the demand-supply scale in favour of immobilised notes. It is hard to estimate the amount held in cash by companies, but experts say it may run into several thousand crores.

Another Failure of the Scheme?

Others who need old notes are the ones who declared income under the Income Disclosure Scheme (IDS) that ended on 30 September. They have to pay income tax before 31 March. The first deadline ended on 30 November. The amount to be deposited is close to Rs 25,000 crore.

This must be a rude shock for the government that is trying hard to stop the conversion, but has almost failed. There is the spectre of raids by various agencies, but the total seized amount is not significant – according to some estimates, less than Rs 20 crore so far.

It is difficult to assess how much money got converted and what percentage of cash in old notes got deposited in the banks. Though the government has been trying to scrutinise books closely to catch suspected capital gains, loans and equity holding, it is a time-consuming process and may take several years.

Moreover, it is hard to say whether the government has the wherewithal to scrutinise the books of companies with significant cash holdings.