(This article was first published on 8 November 2021 and is being republished from The Quint's archives with minimal changes in light of the sixth anniversary of demonetisation, on 8 November 2022.)
“To break the grip of corruption and black money”, the Prime Minister declared on 8 November 2016 which took the nation by a complete surprise, “we have decided that the five hundred rupee and thousand rupee currency notes presently in use will no longer be legal tender from midnight tonight”.
Calling the demonetisation a ‘mahayagna’ in the “fight against corruption, black money, fake notes and terrorism”, the Prime Minister called upon every citizen to participate in that “Imandari ka Utsav” (festival of honesty) and “Pramanikta ka Parv” (celebration of authenticity).
This was the movement for “purifying” the country, the Prime Minister asserted.
All Notes Came Back to the RBI
Currency in circulation (CIC) on 4 November 2016 was Rs 17.74 trillion. Demonetisation of Rs 500 and Rs 1000 on 8 November divested Rs 15.44 trillion of banknotes of their status of legal tender, putting in motion a drastic move to take out as high as 86% of currency out of circulation.
The Prime Minister did expect some of the demonetised currency not to come back when he mentioned that “the five hundred and thousand rupee notes hoarded by anti-national and anti-social elements will become worthless pieces of paper”.
Further, linking “cash” in circulation directly to the level of corruption and inflation, the Prime Minister did not fail to underline that there was “no restriction of any kind on non-cash payments by cheques, demand drafts, debit or credit cards and electronic fund transfer”. The promotion of digital payments was not specifically mentioned as the objective of demonetisation.
In its annual report for the year 2016-17, RBI reported that demonetised banknotes, formally called specified bank notes (or SBNs) under the Specified Bank Notes (Cessation of Liabilities) law, of an estimated value of Rs 15.28 trillion (98.96% of demonetised notes), were received back as on 30 June 2017.
A small number of notes, not still returned, were accounted for as well. The Annual Report mentioned that there were SBNs held by District Central Cooperative Banks, the Nepal Central Bank and were also in the custody of law enforcement agencies under the orders of courts, which were not part of the Rs 15.28 trillion count.
Quite unexpectedly, 100% of the demonetised notes were received back or otherwise accounted for. It raised some suspicions whether the count of these notes in circulation was under-reported.
The CIC, or the cash, was also back to its pre-demonetisation levels soon. On the first anniversary of demonetisation in November 2017, the CIC had reached Rs 16.13 trillion (90% of pre-demonetisation level). By the close of the financial year 2017-18 (in a space of 16 months), the CIC had reached Rs 18.17 trillion, crossing the pre-demonetisation CIC in absolute numbers. The CIC, on this fifth anniversary of demonetisation today, exceeds Rs 29 trillion, having increased by about 65% over pre-demonetisation levels.
As the GDP of India in nominal terms has not grown as much, the CIC-to-GDP ratio is higher today than it was in the year of demonetisation.
But it Significantly Reduced Counterfeit Notes
It was quite common for people to encounter fake notes while depositing cash in banks in the pre-demonetisation period. Most bankers and people preferred to destroy such notes in place of formally reporting or lodging police FIRs.
RBI’s reported Rs 274 million worth of counterfeit Rs 500 and Rs 1000 notes in 2015-16 was certainly a grossly under-reported assessment. The real culprit -- the high-quality counterfeit notes -- almost disappeared post demonetisation, though there were numerous instances of poor fakes or copies being seized by the police. For at least one year post-demonetisation, there was not a single high-quality counterfeit note of ₹2000 detected.
Instances of counterfeit notes financing terrorist activities in J&K and elsewhere were also not uncommon in the pre-demonetisation period. There was a visible reduction in instances of stone-pelting and other terrorist activities post-demonetisation for quite some time.
Formalisation of Economy Got a Boost
India did have a large informal economy, with more than 95% of its businesses operating therein and employing crores of workers. A good part of this economy worked on cash arbitraging by saving both value-added taxes and income taxes.
The suction of almost all of the cash by demonetisation hurt this economy hard. This was quite painful in the short run but encouraged the formalisation of the Indian economy. India could not even aim to become a $5 trillion economy with such a large scale of the informal economy.
Registration under the Goods and Services (GST) Act soared after it came into force in July 2017, partly on account of demonetisation effects. Personal income tax returns filed increased noticeably as well.
The formalisation process initiated by demonetisation received further fillip post-COVID-19. The share of the unorganised sector in India’s GDP has come down significantly in the last five years.
But It Failed to Unearth Black Money
The principal objective of demonetisation was to make the black money hoarded in large denomination notes of Rs 500 and Rs 1000 worthless pieces of paper.
While the government did not officially specify the extent of this black money, some senior officials of the government did indicate that this might be of the order of Rs 5 trillion or more.
The SBN law extinguished the liability of RBI and the guarantee of the government for these SBNs not returned to the RBI, conjuring up the dream of gaining a Rs 5 trillion windfall for the government.
Whether Rs 15-plus trillion of CIC was not hoarded as black money or the hoarders took advantage of legal and administrative loopholes in the demonetisation implementation mechanism to change the colour of money from black to white, the fact was that the entire demonetised currency came back to RBI. Nothing became worthless pieces of paper.
17.92 Lakh 'Suspicious' Accounts
The Income Tax Department surveyed the SBNs deposited in bank accounts and identified 17.92 lakh deposit accounts as suspicious. More than Rs 2.5 lakhs aggregating to Rs 4.2 trillion (approximately 25% of demonetised CIC) was deposited in these accounts.
The Department issued notices, calling explanations under the standard operating procedures (SOPs) established and scrutiny/enquiries made. While the process is still going on, the enquiries did not seem to have yielded much in hard cash as tax.
The government also announced an amnesty scheme – the Pradhan Mantri Garib Kalyan Yojana – targeting holders of these SBNs to declare black money. It proved a damp squib and netted less than Rs 5,000 crore.
The windfall evaporated in the air.
Digital Payments Was a 'Coincidental' Correlation
The immediate aftermath of demonetisation with massive liquidity squeeze saw people struggling to find ways to make payments for their day-to-day purchases. There was a good rush to sign up for digital payment wallet companies. As the economy remonetised, this forced resort lost steam.
The government came up with many other promotional schemes for encouraging digital payments – no charges for use of cards and most government payments. Merchant user charges were also exempted/reduced.
These measures did help, but the expansion of digital payments at the end of one year after the demonetisation was up by hardly 10%.
Innovations like UPI for payments, the use of QR codes, and the proliferation of good quality fintech companies have given a big fillip to the adoption of digital payments in the last four years. This transformation received further impetus during the COVID-19 pandemic.
There is a real push for digital payments expansion in the country. India is fast adopting digital payments as a way of life, though still more than 80% of payments in volume (number of transactions) are made in cash.
Rs 2000 Note: A Stopgap Arrangement
Rs 500 and Rs 1000 notes were considered high-value notes, fit to be demonetised. These were the highest denominated notes in India, though in terms of their value in US$, Euro-€ or British-£, these notes were hardly high value.
On the premise that black money hoarders hoard cash in these high denomination notes and that neighbouring rogue states print their counterfeits, these notes were demonetised. It was ironic that the currency re-monetisation took place through a still bigger note of Rs 2000.
The government released Rs 2000 of more than Rs 7 trillion over the next few months after demonetisation to help build up requisite cash in the system.
This note, however, was of higher value than the notes which people could use in day-to-day transactions. As expected, this did not catch the fancy of people. There was not much demand for this.
Its printing was stopped in July 2017. Over the years, the Rs 2000 notes in circulation are coming down. The RBI reports that by the end of the financial year 2020-21, the Rs 2000 notes in circulation had come down to be of less than Rs 5 trillion value.
As these notes are reducing by about Rs 1 trillion a year in the last three years, the Rs 2000 notes are likely to get demonetised by non-circulation in the next five years unless the RBI decides to phase these out earlier.
Rs 500 note has become and would remain the cash warhorse for the foreseeable future in India.
Demonetisation Was Some Gain, With a Lot of Pain
Looking back at the demonetisation shock administered five years back, one cannot fail to note the enormity of the measure in terms of its impact on the economy and people’s lives. Forced formalisation of India’s large tax-evading informal economy was worth the short-term pain it caused in terms of loss of businesses and employment. But its impact on the elimination of corruption and black money has hardly been noticeable. It did have a good impact, at least initially, on curbing terrorist activities and the injection of counterfeit money.
On account of the sheer nature of the operation, its implementation was chaotic and caused considerable pain. Nonetheless, it was completed in a fairly short period of time.
With very few long-term impacts of demonetisation lingering on by the time of its fifth anniversary today, it is time to consign this episode to the monetary history of India.
(The author is an economy, finance and fiscal policy strategist and former Finance and Economic Affairs Secretary, Government of India. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)