RTD Ep:54 “Demonetization: The Modi Way” – Kalyan Chakrabarti (Rising Straits Capital)

Sep 19, 2022 | Financial Literacy, Monetary Education

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In this interview we discuss:
1. What comes to mind when he hears the words, “Rethinking the Rupee”?
2. Why is it important for viewers to learn about issues such as what’s happening in India?
3. What is some of the background surrounding India’s monetary policies?
4. What is black money or a black money economy?
5. How have the citizens in India received the sudden demonetization of the 500 and 1000 note rupee?
6. How big of a problem is counterfeit money in India and will adding a higher denomination and better security on bills help combat the counterfeiting?
7. What are some of the phases the Government is taking to help the economy get back on track due to currency shortages?

Article written by Kalyan Chakrabarti below:


Demonitization – A Quick History

Tokyo is 3.5 hrs. ahead of New Delhi. Lacing up for an early morning run at 6am on 9th Nov, around the imperial palace on a windy and cold Tokyo, I just glanced at my twitter handle expecting nothing to have happened back home. For the next 2 hrs. I was stuck to my handheld going through all the action I missed. “Demonetization” was announced the prior evening.

The highest denominations in India, INR 1000 and INR 500 were stripped of their status as a legal tender. Absolute indifference of currency statistics was substituted overnight with understanding trivia like 86% of total cash in the economy being in these denominations.

Google helped many Indians, track the history of demonetization, most proving irrelevant in the back drop of the sheer magnitude of this proposed change coupled with the absence of an event of reasonable recency.

  • In 1946, demonetization was resorted to but the Direct Taxes Enquiry Committee in its interim report had observed, “Demonetization was not successful then, because only a very small proportion of total notes in circulation were demonetized in 1946 and its worth was INR 12,350 Million.”
  • On January 16, 1978 demonetization of high demonization notes was introduced. The high demonetization rates as on that day amounted to INR 1,460 Million.

Countries who have implemented demonetization in the past (as highlighted below) have not have a pleasant outcome to show either.

  • Nigeria – In 1984, during the government of Muhammadu Buhari, introduced the new currency and banned the old notes. Since Nigeria was debt-ridden and inflation had also hit the country, the change did not go well and the economy collapsed.
  • Ghana – During 1982, this nation ditched their 50 cedis note. This move was taken to tackle tax evasion and empty the excess liquidity. People were not supportive of this sudden move and, hence, they started investing in physical assets, which obviously made the economy weak.
  • Australia – This was the first nation to introduce polymer notes. This was done to stop the widespread of counterfeiting. It did not have any side effects on the economy. As I write this, Australia is talking about phasing out its $100 bills.
  • North Korea – The demonetization was done to banish the black market. Negative impact for economy.
  • Soviet Union -The government had ordered a withdrawal of large-ruble bills from circulation to take over the black market. Negative impact for economy.
  • Myanmar – Myanmar’s military invalidated around 80% value of money in 1987 to curb the black market. Negative impact for economy.

The context in which the decision was taken necessitated the secrecy with which it was planned and implemented. In the absence of a proven case study, internationally, leave alone nationally, makes it not only a large scale change but also very bold. It needed intentions and motivations which are founded on principles strong enough to withstand any negative outcomes of this move.

So what was the motivation?

Motivation One: Render the black money useless. India has a fairly substantial parallel economy (depending on whom you speak with and on which day of the week, this could vary between 25% to 65% of the GDP). This economy transacts without paying any direct and indirect taxes. This informal economy also essentially means that several markets are distorted. One example is that of labor laws; laws meant for labor welfare (e.g. minimum wages act, bonus act, employee state insurance act etc.) are given the go by in the parallel economy, which imposes a cost on those abiding by the rules. This needed a rebooting and that’s at the core of the motivation grid.

Motivation Two: Increase the tax base. Out of a population of Rs 1250 million only 12 million people end up paying income tax: a mere 1% of the population. India has one of the narrowest tax bases (15%) among the G20 and BRICS countries. This has more to do with the way Indian economy functions.

Empirical data says that more than 90% of economic transactions in India are made with cash. With demonetization, some of this cash income (or black income) is expected to come under the ambit of tax as 90% of cash would come back to banking system and would leave a trail to be tracked by the tax authorities.

Motivation Three: Fixing Government Finances The happiest lot post demonetization have thus been the diligent, tax paying, salaried class and the poor. They see a direct impact of this move in terms of reduction in their tax burden now that government revenues are expected to increase going forward.

Increased government revenues also are likely to result in increased government spending on critical sectors like early education, health care, infrastructure etc.

Motivation Four: Fake currency. Indian rupee is supposed to be the ninth most counterfeited currency in terms of its value and stands third in terms of the number of fake currency detected around the world. Reports suggests that 4 out of 1000 currency notes in India are fake and this number has been steadily increasing. Besides reducing the value of the currency and contributing to the inflation, counterfeit currency is getting used to fund terrorism and covert activities targeting India. 

The demonitization is not a cure-all measure as far as counterfeiting is concerned, but it would definitely rock the boat of fake currency. Demonitization has already rendered the existing infrastructure of the counterfeiting agents useless and the new denomination currency (INR 2000) with advanced printing technology and security features would make counterfeiting all the more difficult. In addition, the more time it takes to counterfeit the new currency, the greater the damage to the informal supply chain network of the state actors involved in counterfeiting thereby curbing the menace. Recreating the supply chain would be expensive and time taking.

Motivation Five: Digitization

Scarcity of cash has ironically accelerated the growth of digital payment ecosystem and adoption of cashless ways of transacting. An economy where 90% of transactions used to be done through cash, when faced with sudden shortage of cash is adapting to work around the issue. And this along with support from the government and active participation by private players in terms of various methods of e-payments – Digital wallets (PayTM, MobiKwik, Freecharge), USSD transfer (transfer money through your non-smart phones by dialing USSD codes), Unified Interface Payment by RBI, Online/Mobile banking, Credit/Debit cards – is ensuring that the common man is keeping aside the cash and signing up of e-payments. Even the local grocery shops (mom and pop shops) now have PayTM accounts now to facilitate cash less transaction and protect the loss of business because of lack of cash with customers.

 Motivation Six: Making it costly for criminals to operate

Most of the criminal/anti-social activity is funded through black money which has been amassed though illegal/criminal activities. Demonetization is expected to create a high barrier for them to carry out any criminal/anti-social activity in the economy.

Is there a strategy the government is following?

For somebody looking at “Demonetization by Modi Govt” sitting outside India, it might seem like a one off and knee jerk move. However, this move needs to be read in conjunction with the JAM (Jandhan, Aadhar and Mobile) trinity which the government introduced as soon as it came into power to clean up the Indian economy, improve financial inclusion, make credit available to the little guy, make the process of subsidy transfer transparent and leak-proof etc.

  • Jan Dhan Yojana (PMJDY) – aims to extend the banking services to the unbanked population in the country
  • Aadhaar- the Unique Identification number for each citizen with the help of bio-metric identification which is further linked to individual bank accounts and
  • Mobile connectivity for citizen to access governance from anywhere

JAM was implemented to ensure large-scale, technology-enabled, real-time, direct benefit transfers to the India’s poor. By this scheme, nearly 120 million bank accounts were created in the last year alone— at a blistering, record-setting pace of over 300,000 bank accounts per day, over 75 percent of the population and nearly 95 per cent of the adult population now hold Aadhar cards and most of the Indian states boasts of over 60% mobile penetration.

Beyond JAM, initiatives like Benami Properties Act, renegotiating international treaties with foreign countries, signing information sharing arrangements and a scheme called Income Declaration Scheme have created a string of related initiatives taken by this government.

Demonetization: The Change in Behavioral Aspect

A change of this nature implemented suddenly of course has its concomitant behavioral outcomes;

  • Hoarding of cash: Demonitization along with restrictions on cash withdrawals has led to a cash crunch, forcing people to stand in long queues for hours from ATMs or banks. This has had the negative impact of cash being treated as a commodity in short supply and people hoarding cash anticipating that the liquidity crunch is here to stay.

The fact of the matter is till December 10, close to 80% of all cash withdrawn has been deposited in the banking system and RBI (the Indian central bank) has introduced over 4.2 lac Cr in new currency notes. As more and more new currency gets injected into the system, the liquidity situation should ease.

  • Going digital

The low liquidity has forced many to try alternate methods of transactions like the convenient Online/Mobile banking channels, Mobile wallets etc. Once they have tasted blood, it’s expected to continue and grow.

Going digital is more an adaptation phenomenon. The sellers don’t want to lose out on business and hence are equipping themselves with POS (Point of Sale) machines and are accepting mobile wallet payments. For the buyers, it is the convenience and control that is likely to make them getting glued to digital ways.

  • Reduction in purchases

This has been a critical behavioral impact. Discretionary purchases have been delayed by many people, luxury goods purchase is badly hit, anything which can be avoided has been avoided. Anecdotally, post demonetization, I have heard people talking about their realization that they used to spend unwisely. One hopes that, consumers flock back to their old buying habits in the next 2 quarters and we should see a V shaped recovery.

  • Credit Offtake

An expected downward shift of the yield curve combined with uncertainty around consumption is also delaying businessmen from delaying credit offtake. Even individuals are delaying their credit offtake in anticipation of decline in rates.

On the other hand, a decline in asset prices is anticipated to happen in a large way (already being seen in some asset classes like land)

Intuitively, the process followed by Mr. Modi goes against the governance principle of winning support of the public before initiating a new policy. Surprisingly, Mr. Modi’s popularity and credibility among the electorate coupled with the resonance his message of the need to be secretive has ensured that it was well taken.

It is important that some of the common criticism is understood;

  1. Demonetization per se won’t help and black money would rise again from the ashes. There is merit to this criticism and one hopes the government follows up with more action to ensure we don’t let this happen.
  2. We were doing so well, what was the need to bring the economy to a standstill. This criticism effectively is advocating ethical ambivalence. Accepting the wrong doers and their acts can’t be an optional battle fought at a time convenient in the distant future. There is nothing called a good time.
  3. Black money is not in cash form but in other asset classes. This criticism is also fair. That doesn’t mean however that one should do nothing about black money in cash. One hopes that the follow up action on other classes of assets would be done with equal zeal and soon.

It’s still too early to call this move a success or a failure. But what is not arguable is the following;

  1. It’s a bold and massive move, never attempted before anywhere
  2. It would take a couple of quarters for reversion in consumer behavior and liquidity in the economy
  3. The economy is expected to realize some benefits – elimination of some amount of black money, creation of deterrents for those who participate in the parallel economy, increase in tax base and hence better fiscal condition for the government etc.
  4. Leveling the playing field for those who play by the rules versus those who do not

There are commentators who are willing to call the outcome early. It started on Nov 8th itself. I for one believe that the bullet left the gun 5 weeks ago, with 2 more to go. We need to be patient and await the outcome instead of indulging in silly speculations. Economists and commentators have gone wrong on their predictions and analysis on far simpler things in the past and in situations where they had a lot of historical learnings and data to lean on. There are better and rewarding professions than fishing in troubled waters.

This is virgin territory and most economists in the case would prove the adage, “in the long run all economists are wrong!!!” In this case the long run would be 2 quarters from now.

*Kalyan Chakrabarti is the Managing Director of Rising Straits Capital, a Private Equity Fund investing India. The views expressed here are his personal opinions. He can reached at [email protected]. In this piece, he was generously assisted by Mr Harris K A and Lohit Rastogi


DISCLAIMER: The financial and political opinions expressed in this interview are those of the guest and not necessarily of “Rethinking the Dollar”. Opinions expressed in this video should not be relied upon for making investment decisions and do not constitute personalized investment advice. The information shared is for the sole purpose of education.



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