India's Removal of Currency from Circulation Only Causes Chaos

Prime Minister Modi’s announcement to remove all 500-rupee and 1,000 rupee notes as an anti-crime move ended up mostly destabilizing the country’s cash-dependent ‘informal economy’.

In November 2016, India’s Prime Minister Modi made a decision to do something about what he saw as growing corruption in the country. He went on television to issue a decree declaring that all 500 rupee and 1,000 rupee notes, then worth about $7.50 and $15 each then, would be immediately withdrawn from circulation. There would be a limited time to get them deposited in bank accounts, but after that anything not deposited would be declared worthless.

Modi also noted that deposits of over $3,700 would be subject to investigation, even though the banks would accept them.

The idea behind this was to force those hoarding cash as untaxed reserves from illegal activities to either turn them in or make the money worthless. For those with major cash hoards, the government reasoned the criminals involved would not dare deposit them for fear their crimes would be discovered.

As with many plans not completely thought through, this one from Modi’s government did not go precisely as planned.

One major glitch for the country was that India depends heavily on what is known as the “informal economy’. That economic category handles its transactions with cash changing hands to buy and sell small values of items. It is often intentionally kept out of banks both because the very poor who do much of this often do not even have bank accounts, and because the money is so precious to them that even small amounts of tax are a burden for them. As opposed to exposing a major corrupt group of white collar criminals, forcing this group to have to turn in the cash into banks or risk it becoming worthless simply caused many to have to scramble to get it into bank form. It also caused many of the small cash note transactions which are central to this base to grind to a halt.

The poor and the middle class in India have always depended on cash for most of their transactions.

For the rich gangsters Modi was attempting to target, they of course had no interest in depositing money into banks which might get them in trouble. So when his decree went into effect, enterprising syndicates and individuals of various kinds went into action to develop a brand-new currency black market for the criminals. There were charges of various kinds for laundering the money, but the sheer volume of currency in circulation made it easy for this now supposedly worthless cash base to take on a new life in the black markets.

India’s reserve bank, called upon to tally what had happened, noted that as a result of what Modi did approximately 99.3% of the estimated $217 billion in currency swept up in the decree ended up being returned to the banks.

In commenting about the decision, Gurcharan Das, a financial writer and former head of Proctor & Gamble India, said the “demonetization was a mistake”. As he explained, “You can’t overnight change that in a country which is poor and illiterate”. He called the decision to do this not just “an economic failure but a moral failure as well.”