A few days ago, on January 22nd, the Reserve Bank of India made a surprise announcement, that all currency notes(bills) issued prior to 2005 would be withdrawn from circulation. These notes can be identified from the fact that they carry no date of issue. Predictably, as with most government announcements, this was followed by confusion, consternation and commotion. The RBI announcement initially said that all such currency must be exchanged by June 30, after which it would no longer be legal tender. Or at least, that was the implied consequence. Then the RBI issued a clarification, that the notes could be exchanged without question up to June 30, after which one could only change currency at one's own banking institution. To further confound the public, the RBI said the currency would continue to be legal tender after that date, which should mean that one can continue to use it in everyday transactions. This is contrary to normal practice in withdrawing currency, in the sense that it is usually withdrawn via normal banking transactions, not through deadlines and conditions for exchange.
There is widespread speculation on the reasons behind RBI's move, ranging from anti-counterfeit measure to ferreting out "black money". The RBI finally put out a statement that the move was designed to remove low-security currency from circulation although, typically, it added the confusing statement that, ideally, all pre-2010 currency should be removed, triggering further angst amongst the hoi polloi, who are now speculating that such a move will occur in the next year or two. There are now a rash of opinion pieces in the media speculating on both the reasons for the withdrawal as well as the macro effects. Generally, they seem to concur that there was intelligence on massive amounts of counterfeit currency of the pre-2005 variety, which is the easiest to duplicate, and that the move is intended to bring "black money" into the general economy. They focus on the mechanisms by which people would set about converting this "black money" into "white", including the possibility that touts and agents would facilitate this for a steep fee.
Notwithstanding the RBI's claim that this is intended to strengthen the security of the currency, it appears that the execution was not properly planned. Banks are only now gearing up to meet the expected rush to exchange the currency, and of course, everyday use of pre-2005 currency will immediately be hampered, as people refuse to accept it. With my usual curmudgeonly skepticism, I set out to examine the motive, methods and consequences of this action. To get at the motive, one could take the RBI's anti-counterfeit reason at face value, or look at the methods and consequences to arrive at a different motive. Looking at the haphazard handling of the announcement(with several "clarifications" following), and the ill-preparedness of the banking system to handle this, I don't find it likely that this was a pre-planned operation. It may have been, given the typical Indian way of executing a project, but I find it unlikely. It appears more as a project that was conceived in December and rushed out. A well-thought out project of this nature would have naturally examined all the logistics and consequences before rollout, and the facts on the ground do not bear that out. Banks are now rushing to obtain currency counters, counterfeit-detectors and new cash before the April 1 rollout. No doubt, the more well-heeled will use this fortuitous advance knowledge over the next two months to shift masses of their tax-avoided cash safely into the banks using their behind-the-scenes connections, and exchange crisp new cash for it. Just a matter of swapping cash from the strongroom, I would think, without disturbing the accounting.
So, the consequences. As I said, the immediate impact is likely to be that people will have difficulty using their non-dated currency in daily transactions, as everyone looks to avoid having undated currency in their possession. I examined the bills I had in my pocket, but found only two without a date, both of the 10-rupee denomination. The date is quite difficult to read, or even see sometimes if there is dirt in the center crease. The average middle-class person, I would think, keeps less than 20,000 rupees on hand, given the ubiquity of ATM and debit cards. That should not pose a great difficulty to swap, even after the July 1 deadline. The poor, of course, probably have quite a bit less cash on hand. But, more importantly, would the 800 million Indians living in villages and small towns be aware of this change, or even care enough to do anything differently? They likely use the small denominations, which would not be the target of anti-counterfeiting measures, or of unearthing "black money". The difficulty, I think, is for the upper middle class, who keep fairly large sums of cash on hand(they spend money freely on dining and entertainment, I note), and small businessmen who typically keep everything in cash and pay no taxes. They usually don't have a "working relationship" with key bank executives, and in the short term will, I believe, overpay to acquire hard assets such as property and gold. I expect these will rise in price in the short term.
Looking at a post-July 1 scene, I think the net result will be a fair chunk of the old currency being locked out of the monetary system. How much this will amount to, I have no idea. I guess a large part will depend on the RBI's ability to rein in the nexus between banks and their large cash clients, who are likely to have the lion's share of "black money" on hand, in the form of these old bills. Assuming the RBI is successful in this, the net effect would be to effectively curtail the real money supply in the system. And Rajan wants to do even more, removing all pre-2010 currency which, when one accounts for the massive role of the parallel economy, would put a very significant further crimp in real money supply. Economics 101 says that inflation is too much money chasing too few goods. When you reduce the supply of money, you reduce inflation. RBI Governor Raghuram Rajan's focus, ever since he took over, has been to curb inflation, which he recently described in strong terms as being the biggest threat to the Indian economy. When I look at how hasty this program seems to be for its purported intent, the unpreparedness of the banking system for this exercise, and the possible impacts on people and the economy, it seems to me that the real intent is to curb money supply, not by the normal channels, but by rooting out the money in the parallel economy. Successfully doing that would lead, not necessarily to deflation, but at least a significant lowering of inflation. So, looking at this thing from every angle, I am inclined to think that this is really a sneak attack on inflation by the RBI, and there could be some good collateral effects, like channeling money out of the parallel sector, people paying their taxes rather than paying touts to convert the cash, and so on. And, conveniently, the program ends shortly before tax filing time. I think it's a good move by the RBI, I just wish it was just a little better planned and coordinated.
