India’s Demonetisation: Short-Term Pain For Long-Term Gain

Prime Minister of India, Narendra Modi, shook the economic world on 8 November 2016 with his unprecedented ban on certain Indian currency bills – known in India as the demonetisation policy – which among other things was put in place to curb black money, and create a credit-driven economy in the name of his anti-corruption movement. The Washington Post stated that this policy represents ‘by far the most sweeping change in currency policy that has occurred anywhere in the world in decades.’ Furthermore, given that before this policy, India was named to be the fastest growing economy in the world, the economic movements that take place in the coming months will be crucial in determining its global position.

In this context, the term ‘black money’ means the money that was being hoarded by the millions of people who were ‘dodging taxes’ along with all the forged cash in the country. Modi announced that ‘all 500 and 1,000 rupee bills’ currently in circulation – the most used bills in the country – ‘to be illegal tender (about 86 per cent of cash in circulation) in a matter of hours, and introduced new 500 and 2,000 rupee notes.’ However, given the large population of the country and the apparent insufficient amount of new notes, banks, ATMs, and pockets seem to be completely dry.

Forbes reported that the Indian government ‘allowed for a 50-day grace period to exchange old banknotes,’ however, the lack of supply of new bills still resulted in extensive lines of people at bank and ATMs waiting to exchange their now illegal notes. Along with the already growing lines, the government put a ‘strict cap on bank and ATM withdrawals: 24,000 rupees per week from banks, and 2,500 rupees per day from ATMs,’ creating a cash crunch among the large section of the population. This means that people would have to repeatedly go to the banks and ATMs in order to withdraw larger amounts of cash. The Hindustan Times states that even now, almost two months since the 50-day grace period deadline, over ‘one-fourth of the ATMs across the country are running dry again.’


Image courtesy of Ajay, © 2012, some rights reserved.

While there have been broad criticisms lobbied against the demonetisation policy by news agencies and economists, it is important to acknowledge Modi’s commitment to rid India of corruption and black money. This was central issue in his political platform during the 2014 general elections, as a candidate representing the Bharatiya Janata Party (BJP). While there are clear consequences to demonetisation in the short-term, the benefits may outweigh them in a long-term view.

Many argue that the Prime Minister’s decision has the most drastic consequences for India’s poorest populations. At the same time, however, this move also reduces the incidence of sex trafficking and other illegal trades such as human and drug trafficking. There has been an immense ‘slowdown’ in child labour, given that the industry mainly ‘runs on liquid money’ just like trafficking. And yet, these positive effects have not swayed all critics. The BBC reports that: ‘Some economists say the move will have a limited impact as people will simply begin to accumulate black money in the new currency as soon as that becomes available.’ In responding to this criticism, it would be appropriate to say that fearing or expecting further production of black money in the future is not a valid reason to not address the current black money flowing in India’s economy. Issues such as black money creation cannot be solved unless some steps are taken against them in the first place, as the prime minister has done.

Another critique suggests that ‘thousands of ordinary people who hold cash but not black money will get caught out and the fear of harassment by officials could trap them in a bureaucratic net they don’t know how to deal with.’ This is a very pertinent and genuine concern. India’s bureaucratic system is as immense as the country itself, and because the majority of the population is unfamiliar with the system, directly addressing it can and most likely will be difficult. However, if India is to transform its currently informal economy into one that is managed by the government and the nation’s banks, these difficulties must be accepted.

The Guardian reports that India’s small businesses have been suffering due to the ‘biggest financial experiment in history.’ Small businesses, which are primarily cash heavy, have been both unable to attract customers and pay their employees wages. It seems though that this was an expected side effect since the government was still firm in their position on keeping the 500 and 1,000 rupee notes illegal. The hope is that once the economy recovers, so will these businesses.

The Guardian also observes: ‘More than a month on, India’s Reserve Bank has issued around 1.7 billion new notes’, a third of what was removed; the ‘sixth-largest economy in the world is running on 60 per cent less currency than before.’ This is by far the most pressing concern given that the rate at which the new notes are being printed is simply not fast enough and Modi’s intent to turn India into a largely credit-driven nation cannot manifest if there is no cushion for people before applying for credit. And due to India’s immense population, making sure everyone has access to and is eligible for credit is a monumental task.

Looking ahead, more notes must be printed by the government to compensate for the lack of credit in India. As credit gradually becomes available across the country, the government must also monitor the use of the newly printed bills to the best of its ability. Demonetisation is not a fast process and expecting quick results will only end in disappointment. In spite of the challenges, there is great reason to expect prosperous and legal economic growth across India in the years to come.