High denomination currency notes — ₹500 and ₹1000, which constitute about 84 per cent of the total currency in circulation — ceased to be legal tender from midnight of November 8.

Although the announcement was a bolt from the blue, both the Centre and the Reserve Bank of India (RBI) have been working in this direction for quite some time with utmost secrecy. Complete withdrawal of ₹1000 and ₹500 notes, keeping ₹2000 notes ready for circulation as a replacement for ₹1000 notes, introduction of new ₹500 notes with enhanced security features, preparing commercial banks for such an eventuality, asking them to keep adequate ₹100 notes in the ATMs and so on, could not have been possible overnight.

Historic move The Government has taken a historic step to address several issues. This will not only reduce terror financing, arms smuggling, corruption, drug financing and black money, but also improve transparency in tax compliance, increase government revenues, support electronic transactions, and reduce demand for currency in the medium term. It is better to uproot corruption through policy initiatives rather than by chasing tax evaders through enforcement agencies, which is discretionary and sometimes controversial in a democracy.

Counterfeit notes, mostly in high denominations, injected into India through porous borders with neighbouring countries, have been a matter of great concern for quite some time. Besides diluting the underlying strength of the economy, this has been the cheapest source of terror financing in India.

Detecting counterfeit notes, chasing culprits responsible for pumping such notes into India and weeding them out from an economy of this country’s size through enforcement agencies has been a Herculean task. The demonetisation of ₹500 and ₹1000 notes would cripple the design of financial terrorism by overseas enemies, sometimes operating in connivance with unscrupulous elements within the country.

Deep-rooted The problem of a parallel economy in India is old and deep-rooted. An opportunity was given to all those who had unaccounted income with them to come clean by paying tax under a voluntary income declaration scheme, valid up to September 30, 2016. The Government was partially successful in this endeavour.

Given the size of the parallel economy in India, voluntary disclosure schemes can unearth black money only up to a limited extent. While other policy initiatives such as the setting up of special investigation teams to study black money, the review of double tax avoidance treaties with several countries, the recent enactment of the Goods and Services Tax, and so on will take some time to clean up the system, there was an urgent need to eliminate unaccounted income held in the form of cash by tax-evaders, smugglers, anti-social elements and the like.

Since FY2015-16, currency circulation in India has been growing at around 15 per cent y-o-y, which is much above the 10.7 per cent seen during the previous three years. The sudden increase in demand for currency has been debated by several experts. The RBI, in its Annual Report 2015-16, has offered possible reasons for the recent spurt in currency demand. They include general and State elections, festival demand, the jewellers’ strike and banking habits. Unlike on earlier occasions, this currency did not come back to the banking system after the election/festivals were over. Even e-commerce transactions, which are mostly cash on delivery, do not fully explain the surge in currency demand.

Conventional wisdom cannot explain the underlying reasons behind the unprecedented rise in currency in circulation, particularly when the manufacturing sector has not been doing well and when rural demand has been sluggish for the last two years. Moreover, the RBI has been trying its best to promote electronic transactions through several initiatives to help India move towards a cashless economy. Clearly, there is something that does not meet the eye.

The audit trail All transactions routed through the banking system are subject to an audit trail while cash transactions can escape this and thereby support the parallel economy to thrive further. In fact, the ratio of deposit to gross national disposable income in India has been falling: it fell from 6 per cent in 2012-13 to 4.7 per cent in 2015-16.

Given the seriousness of the Government to unearth black money and the technological progress made so far to detect high-value transactions in banks, tax-evaders and people with unearned income through illegal activities preferred to hold a chunk of their unaccounted income in cash. Hence the shock-and-awe strategy adopted constitutes by far the biggest crackdown on black money in India.

In order to reduce hardship for the common man, both the Government and the RBI have made elaborate arrangements, which include the depositing of old notes in banks and post offices with proof of identity up to December 30, 2016; limited exchange of these currencies over bank counters; no restrictions on non-cash payments through cheques, demand drafts, credit/debit cards, electronic funds transfer, and so on.

Stakeholders will have to brace up for the logistics involved in replacing currency in ATMs in the immediate aftermath of the announcement, ATM shutdown for that time period, temporary bank withdrawal restrictions, and so on. Some inconvenience is inevitable, but these may be worth putting up with in view of the long-term impact. All in all, this is a game-changing moment.

The writer was principal adviser to the monetary policy department, RBI. The views are personal. Via The Billion Press

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