Piecing Together Parts of the Demonetisation Puzzle

What was the true objective of the demonetisation policy and what has it achieved since?

7 min read

A year after the Narendra Modi led government declared that Rs 500 and Rs 1,000 notes would be stripped of their legal tender status, many questions have remained unanswered. An estimated Rs 15.44 lakh crore, or 86 percent of the economy’s currency in circulation, was withdrawn as part of the plan.

But whose idea was it? What was its true objective? And what were the pros and cons for the economy? Those and many more such questions remain unanswered, either completely or partially.


Among these many lingering issues is the question of the role that the Reserve Bank of India played in the process. Why did it go along with the idea and could it have been better prepared? And how did 99 percent of the currency come back?

This story attempts to answer those questions.

A detailed email sent to the RBI seeking clarity on its role and preparation remains unanswered.

Not A Sudden Decision

The idea of demonetisation had been put on the table in early 2016. At the time, Raghuram Rajan was the governor of the RBI. Rajan in his book released in September, disclosed that he had been asked for his opinion, which he provided orally. His view, as detailed in his book ‘I Do What I Do’, was that the short-term costs of demonetisation would outweigh the long-term benefits, which could be better achieved through other means.

While Rajan expressed his reservations, the government did not give up on the idea of demonetisation.

According to two people familiar with the matter who spoke on condition of anonymity, the RBI soon after presented a detailed note to the government on the issue. This note laid out various scenarios of preparation and the expected impact under each of those scenarios.

Also Read: What’s the Verdict on Demonetisation Data? Q&A With Raghav Bahl

Watch former Prime Minister Manmohan Singh speak on demonetisation.

The key parameter used by the central bank was the amount of new currency in hand before the announcement of a demonetisation, said the first person quoted above. This person added that the central bank had laid out scenarios ranging from ‘necessary preparations’ to ‘desirable preparations’ ahead of such an announcement.

The necessary preparations involved having a minimum amount of new currency in hand before old currency was withdrawn. BloombergQuint could not determine the exact amount of new currency the central bank had suggested be printed. The person quoted above said this depended on the value of currency being withdrawn. At the time, the government was considering two options – withdrawing only Rs 1,000 notes and withdrawing both Rs 500 and Rs 1,000 notes.

Obviously, the RBI would have wanted more time and more currency in hand but the final decision on the timing of demonetisation rested with the government, said the person quoted above while adding that the decision was announced soon after the minimum amount of new currency as suggested by the RBI had been printed.

According to the response to an RTI query by activist Anil Galgali, the RBI had just under Rs 5 lakh crore in new Rs 2,000 notes at its currency chests on November 8, when demonetisation was announced. It had no Rs 500 notes.

The Rs 2,000 Note

According to both people quoted above, a 2014 proposal to introduce Rs 2,000 notes came in handy during demonetisation. The introduction of the Rs 2,000 note had been discussed against the backdrop of high inflation, which erodes the purchasing power of currency. As such the introduction of the Rs 2,000 note had nothing to do with the demonetisation, confirmed the people quoted above.

The timing of its introduction did.

According to the first person quoted above, the government, in early 2016, had suggested the RBI go ahead with the printing of the Rs 2,000 note. However, the government suggested that these notes be stocked rather than released into circulation immediately.

Regular meetings were being held through the year on the demonetisation proposal and the government was aware of the stock of Rs 2,000 notes that had been build up. By August 2016, these notes had been stored across a number of currency chests across the country, this person said.

Once the value of the Rs 2,000 notes stocked had reached the minimum suggested by the RBI, the government decided to go ahead and announce the withdrawal of legal tender status of Rs 500 and Rs 1,000 notes, said the first person quoted above. At this point, the RBI had no grounds left on which to oppose the decision, this person added.

Also Read: ‘The Flying Lotus’: AR Rahman Unveils Track on Demonetisation

The Quint

Could The RBI Have Opposed The Decision?

According to a third person familiar with the matter, soon after the government discussed the idea of demonetisation, the RBI had sought an internal view on jurisdiction over matters of currency.

While the RBI Act gives the central bank powers to recommend the introduction or discontinuance of series and denomination of notes, any decision pertaining to demonetisation rests with the government, said this person speaking on condition of anonymity.

On 8 November, the demonetisation decision was brought to the RBI central board, which was required to sign off on the matter.

The central board discussed the preparations in place but was not required to vote on the matter since there was no precedent of voting at the central board level, said the third person quoted above.

The first person confirmed this.

To the outside world, it appeared that the RBI had gone into this unprepared. The chaos at banks soon after denomination was announced, the lack of planning on recalibrating ATMs in time and the shortage of new currency also suggested that the central bank had been caught off guard.

Also Read: Demonetisation Helped Banks Gain, Even as Customers Endured Pain


When asked what the central bank could have done better, Kenneth Rogoff, an economist at Harvard University and the Author of ‘The Curse Of Cash’ said that the one thing the RBI should have done was have more currency in hand before such a move was announced.

They did not have nearly sufficient cash on hand. It was not the central bank’s fault. It was the government’s decision because they did not want word to leak out that they were printing money.
Kenneth Rogoff, an economist and author said, as reported by BloombergQuint 

Former deputy governor of the RBI, KC Chakrabarty told BloombergQuint that the central bank should not be blamed for the decision and its aftermath.

The decision was not the RBI’s. It was the government’s decision to take so I don’t think it damaged the central bank’s credibility.
KC Chakrabarty, former deputy governor of the RBI told BloombergQuint

At the time demonetisation was announced, many expected that a part of the scrapped currency would not return to the banking system. The premise behind this expectation was that those holding unaccounted cash would not be able to deposit it. One estimate, by SBI Economic Research, pegged the amount of currency unlikely to return at Rs 2.5 lakh crore.

This, if it had happened, would be seen as a destruction of a portion of the stock of black money. It was also speculated that the government may eventually be able to claim these extinguished liabilities in the form of a special dividend.

It didn’t play out that way.

The RBI Annual Report released on 30 August, showed that Rs 15.28 lakh crore in old notes were deposited during the demonetisation period between 11 November and 30 December. This was nearly 99 percent of the Rs 15.45 lakh crore in currency that had been withdrawn.

According to the second person quoted above, unaccounted cash came back into the system in a number of ways.

Some chose to split the cash into smaller chunks and deposited it using persons who had bank accounts but not much cash to deposit, said the second person speaking on condition of anonymity. Cash was split up, dormant accounts and money mules were used but this should have been expected, the first person quoted above added.

In a paper released as part of the RBI’s Mint Street Memos, the central bank said that ‘unusual’ cash deposits of upto Rs 1.7 lakh crore had been detected.

These deposits were flagged off via cash transaction reports and suspicious transaction reports generated by banks as part of their reporting requirements. The Financial Intelligence Unit (FIU) which looks into these reports is now studying these deposits, said the second person while adding that the number of such suspicious transactions has jumped manifold during the demonetisation period. The FIU will take months if not years to investigate these accounts, this person added.

Also Read: ‘Demonetisation Has Reduced Terror Activities’: FM Arun Jaitley


In addition, cash was also used to pay insurance premia, prepay loans and deposit into small savings instruments.

But the largest chunk of black money has come in via the network of shell companies, two people quoted above confirmed. One of them pointed out that many of these companies were showing high ‘cash in hand’ on their accounts but may not have actually had cash to deposit. Those who needed to deposit cash, used these shell companies to do so.

In the months after demonetisation, the government has cracked down on shell companies.

In a statement on 5 November, the Ministry of Corporate Affairs said that 2.24 lakh shell companies have been struck off for remaining inactive for atleast two years. A preliminary inquiry into these firms revealed that Rs 17,000 crore had been deposited and withdrawn by these firms after demonetisation.

This was unavoidable, says Rogoff.

“I think when you are doing something so dramatic, which affects the economy so much and there is collateral damage going on everywhere, so in the end the government is not able to tediously check everyone bringing cash back. That part of it is just not realistic,” said Rogoff. “The real test is to restrict the use of cash in the future,” he added.

Also Read: IMF Lowers India’s Growth Forecast Over Demonetisation, GST

(This story was first published on BloombergQuint)

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