Big Data Analytics Solutions | Financial Services in India |Decimal Point Analysis

Decimal Digest
24 Nov 2016

Demonetization : Economic freedom begins now...


This one small sentence printed on the Indian currency note of Rs. 500 denomination alongwith another phrase “GUARANTEED BY THE CENTRAL GOVERNMENT” gives the essence of money to a piece of paper.

Now, let us first see what this combination of sentence and phrase means:

  • Any person, whether Indian or Foreigner, can walk to the counters of any RBI branch and demand to be paid the equivalent rupees printed or minted by Government of India (GOI) in exchange of the currency note issued by RBI (Reserve Bank of India)
  • The GOI guarantees that RBI will have sufficient one rupee notes printed or coins minted by GOI to fulfill the above promise.

Implicit assumptions, in the above, is that:

  • In normal course of business, RBI will wait indefinitely for someone to come and ask to make good on the promise;
  • RBI requires the bearer to be merely having currency in its possession, and does not wish to know who the bearer of the currency is.

Two things have changed on the night of Eighth of November of Two Thousand and Sixteen. Both the implicit assumptions above have been challenged. Firstly, GOI/RBI have said the old high value notes have to be exchanged for new notes or else the old notes lose their value come 1st April 2017. Also, the operative guidelines for exchange are such that GOI will know who the bearers of the currency are as of close of business of Eighth November. Also, GOI has expressly prohibited use of old high value notes for trade except for a few exemptions.

In other words, what the media is calling demonetization is nothing but an elaborate inventory taking effort of the distribution of high value Indian currency notes. At the best it can be called as immobilization of old high value currency notes. As the first order effect, there is absolutely no loss of wealth or there is no transfer of wealth from someone to someone else, as no holder of currency is prevented from exchanging her old notes to new notes in any quantity. As the second order effect, till the new currency comes in circulation, there is definite friction in the small value transactions at retail shops due to paucity of currency. But, just as commerce does not emerge merely due to presence of a medium of exchange; petty commerce does not come to standstill if the medium of exchange is temporarily scarce, and there are interesting stories of how traders are finding ways to carry out genuine transactions in the face of paucity of currency. It must be noted that banks are open for trading, are well capitalized, and the cheque clearing and electronic clearing is functioning normally. Credit cards and debit cards, mobile wallets, digital money (more on this digital money later below) are operating normally. Hence, any large value, or wholesale, or business to business or electronic commerce should not see any friction at all in their operations.

The situation with regard to high value currency in India is just like the airport security check-in. At the airport to catch that one terrorist in tens of millions of passengers, everyone has to agree to the give up their privacy momentarily. All free democracies who care for the welfare of their innocent traveling public force them to security check-in. India, by asking people to forcefully reveal their identity and amount of high value currency owned, is showing that it is a mature, caring and free democracy which will go to any extent to enforce rule of law and weed out criminals from honest citizens. Now, the question begets, what is the rule of law that we are talking about and that will be discussed in detail below, after we differentiate the Indian demonetization / immobilization as against other demonetization of legal tenders.

Demonetization has occurred in the past for various reasons as described below:

  • Change in the coinage fractional decomposition of the national currency from archaic to decimal fraction. For example, introduction of decimal system in the UK in 1971. The cost of and the pain caused by this change is enormous as all the retail establishments, producers, distributors have to reprice, and relabel all the merchandize and the entire population have to get used to new system of counting money. There is no loss or redistribution of wealth as a first order effect.
  • Introduction of new monetary union on voluntary basis, such as joining Eurozone. Again the costs and the pain are very high and there is no loss or redistribution of wealth as a first order effect.
  • Breakup of nation states, for example introduction of Bangladeshi Taka In lieu of Pakistani Rupee. This costs of the pain are extremely high and what is worse they are borne at the time of extreme political turmoil.
  • Defeat in the face of Hyperinflation, for example demonetization of Zimbabwe Dollar. The redistribution of wealth happens due to hyperinflation. The economic costs are severe.
  • Demonetization to counter hoarding by criminals, for example cancellation of Euro 500 notes by ECB in May 2016.

Clearly the Indian move comes close to the recent ECB move, with a major difference. In Indian case, GOI is trying to Identify the holders of currency, while ECB is incapable of doing so, lacking sole authority of any single sovereign, due to irreparable design faults in the structure of the euro system.

Also, it can be easily seen that the costs of Indian demonetization/immobilization are much lower as compared to all other demonetization types save the #5 above. Now that it is established that the sole objective of the Indian immobilization is identifying criminals, let us see what categories of the criminals the system hopes to catch:

  • Unscrupulous businessmen who do not report their trade volume and profit to government and ignore paying both indirect and direct taxes, by dealing in cash instead of through banking channels where footprints can be traced.
  • Corrupt government officials who accept bribes in cash
  • Maoist extremists operating in the heartland of India using cash to run their operations
  • Islamic terrorists operating in the state of Jammu and Kashmir using forged Indian currency printed in Pakistan to run their operations
  • Bangladeshi gangs smuggling forged Indian currency printed in Pakistan
  • Islamic terror groups in Brussels supporting their co-conspirators in India.

All these various criminals have differing strategies to defeat the purpose of immobilization. However, based on various media reports, the criminals in category #3 through #5 have not been able to find a way out and their operations have stopped completely. It has been reported by Doordarshan (Indian TV channel) that that Brussels terrorists have taken huge hit on their holding of Indian currency stash.

The unscrupulous businessmen have found some ways to reduce the marginal impact on them by paying their employees advance salary using old currency and similar such tactics. However, based on the media reports, still huge amount of core cash holdings has been rendered useless for them unless they pay heavy penalty on the cash deposited in bank when Income Tax authorities and Indirect Tax authorities come calling. The taxes and penalties will exceed the illegal cash deposited, and hence most of the cash is unlikely to be exchanged for the fear of identification.

Similarly, the corrupt government officials will not have any way of exchanging cash for most of their ill-gotten holdings for the fear of identification.

Hence, it is likely that in spite of everyone being eligible for exchanging their old notes, many will not voluntarily choose to exchange, leading to distribution from the wealth from the criminals to the state.

Now on the issue of difficulty faced by Indians due to this immobilization. India has a population of 1310 million (2015 est) with about 279 million households. About 407 million of the population, or about 86 million households, is poor with consumption below Rs. 1000 per person per month1. If we note that the currency notes that are cancelled are of denominations of 500 and 1000, that is half-month and full-month per capita consumption, we can safely assume that this segment of population can go about their daily lives with smaller denomination notes provided they have jobs and income. Also the government has run special bank account scheme for the poor under financial inclusion and there were 255 million bank accounts2 as of 9th November under this financial inclusion scheme called “Jan Dhan.” Assuming half of the poor being adults, nearly every adult poor most likely has access to a bank account. Also, government has issued special debit cards to the poor to operate bank accounts and there were about 194 million such special debit cards on 9th November, that is about two special debit cards per poor household. Hence if the merchant is willing to accept, most poor can operate their bank accounts through debit card.

Now, for the remaining 193 million households who are not poor, the outstanding number of credit and ordinary debit cards is 544 million (removing special debits cards double count)3. That is just less than three debit/credit cards per household who is not classified as poor. In other words, most Indian households can potentially pay for their daily expenses using debit/card provided the merchant is willing to accept this mode of payment.

The issue lies in the willingness of merchants to accept debit/card cards for payments. As discussed above, many businesses want to transact in cash in order to avoid creating banking footprint so as to avoid paying indirect and direct taxes. Hence, hardship and slow commerce, if any is the solely due to corrupt business practices and not due to lack of banking facilities.

It would be interesting to note here that India is one of the first country in the world, possibly the only country in the world where the central bank has launched digital money through a special entity controlled by RBI. More information of digital money, launched recently without much fanfare can be found at ( .

The above analysis clearly shows that hardships if any caused in the retail trade is mainly due to intransience of the trading community and not due to lack of preparedness of the government.

Now, on the issue of old currency notes not exchanged for new notes. It is estimated that about Rs. 5 trillion worth of old currency will not be tendered for various reasons discussed. To the extent the legal tender expires worthless on 1st April 2017, the liabilities of RBI fall, without commensurate fall in the assets. Also, money supply falls by the same amount. A sudden long term fall in money supply is not advisable for a vibrant and fast growing economy like India. It is advisable that RBI notionally shows the untendered currency as tendered to it by GOI on 1st April 2017 and credit the account of GOI by the same amount. This will prevent destruction of money supply and its adverse effects on the economy.

The long term positives of this move are many. Some of them are mentioned below:

  • Behavioral change among consumers and businesses, with respect to use of formal payment channels.
  • Coupled with GST this behavior change would imply increase in tax compliance
  • Higher money velocity
  • Additional resources with government for social welfare, especially healthcare and education.

However, it should be noted that the current move is just one battle in the long-drawn war against corruption and for implementation of rule of law. The additional steps are required to address existing stock of unaccounted wealth held in the form of real estate and gold, or offshore banking accounts. Also additional steps are needed to further encourage cashless transactions across all sectors of the economy by having minimal explicit transaction costs on debit cards, bank transfers and digital money transactions and at the same time imposing tax on cash withdrawals.



Decimal Point Analytics (DPA) will process the information in this form to share information as requested. By checking the above box you confirm your acceptance to receive the communication. You can unsubscribe any time by clicking the ‘Unsubscribe’ link in the footer of any email you receive from us, or by contacting us at

We use cookies to measure website performance, provide social media features and personalize content.
Close this dialog to confirm you are happy with that, or find out more in the privacy statement.