How Demonetisation Wrecked Those It Was Supposed to Serve

Extracts from C. Rammanohar Reddy’s Demonetisation and Black Money exploring whether the note ban had any impact on the rich, how Digital India entered the narrative and the impact on the poor.


What was the impact of demonetisation on whose behalf the war on black money was unleashed? Credit: PTI

The announcement by Prime Minister Narendra Modi on November 8 that the Rs 500 and Rs 1000 notes – accounting for 86% of Indian currency in circulation – would cease to be legal tender within four hours, was possibly one of the biggest decisions ever taken by a country in peace time. With no crisis –  internal or external – on the horizon, Modi announced that the scheme would end corruption and root out terrorism in the country. The unforeseen decision left potentially a billion people holding currency notes that were suddenly of no value.

From C. Rammanohar Reddy’s swiftly turned out book Demonetisation and Black Money, we reproduce extracts that show whether the move had any impact on the rich, how Digital India entered the narrative and the impact of the move on the poor.


Money Laundering and the Return of the Taxman

There was Rs 14.18 lakh crore (trillion) in denominations of Rs 500 and Rs 1000 in circulation when they were demonetised on 8 November 2016. The government did not offer an estimate of how much of this currency it thought would not return to the banking system. Informal estimates were that the GoI expected 25 to 30 per cent of this Rs 14.18 lakh crore (trillion) to not be surrendered, which would have made it the black money unearthed by the exercise.

In the event, a much larger amount than expected seemed to have been deposited in the banks and much sooner than expected. On 12 December, the RBI reported that as of 10 December 2016 – less than five weeks after the announcement and three weeks before the deadline of 30 December – as much as Rs 12.44 lakh crore (Rs 12.44 trillion) or 88 per cent of the Rs 14.18 trillion had already been deposited in the banking system. When the final numbers are officially revealed, they may show that very little of black money held as cash was ‘extinguished’. One view was that even if more black money had not been exposed, it had now come into the formal financial sector and was therefore a development for the better.

People were perplexed that large amounts of cash had returned to the banking system with so much ease. It was evident that the rich and corrupt who had black money as cash had found ingenious as well as simple ways to deposit their illicit money in banks. Money laundering appeared to have taken place on a large scale. While ordinary people stood for hours in queues to exchange their high denomination notes for new currency notes, holders of black money in cash were able to beat the system. Figures revealed in Union Finance Minister Arun Jaitley’s 2017-18 budget speech gave an idea of the scale of large cash deposits made in banks between 8 November and 30 December 2016. About 1.09 crore bank accounts received cash deposits of between Rs 2 lakh and Rs 80 lakh (average of Rs 5.03 lakh). Higher up, 1.48 lakh accounts received deposits of more than Rs 80 lakh (average deposit size of Rs 3.31 crore). The larger deposits were going to be investigated for the source of funds.


C. Rammanohar Reddy. Credit: Orient Blackswan

Perhaps recognising the scale of money laundering that was going on, midway through the period scheduled for depositing cash in banks, the GoI came out with a new amnesty scheme for holders of black money, the Pradhan Mantri Garib Kalyan Yojana 2016 (PMGKY). The aim seemed to be to get those who had laundered their black money to take advantage of the amnesty and come clean. The success of this scheme will be known only when it ends on 31 March 2017.

The laundering of black money into the banking system raised fears that the tax authorities would be asked to deliver on what Demonetisation 2016 could not achieve. In the first two-three months after demonetisation there were periodic reports of raids across the country (including one on the residence of the Chief Secretary of the Government of Tamil Nadu) and seizures of black money in the form of cash and assets. While what was seized ran into crores, they were trifling sums compared to the magnitude of black money that the GoI had been seeking to extinguish.

In December 2016, the tax authorities created and publicised an email address which citizens could write to about individuals/organisations with black money. Within days, the Income Tax (IT) department had received thousands of emails. This appeared to take its reliance on information from the public to a new level, and there were fears that this would encourage inquiries on a false basis.

The large amount of information collected when deposits were made on an unprecedented scale after 8 November 2016 began to be analysed soon thereafter. After the Union Budget for 2016-17 was presented, a new drive, ‘Operation Clean Money’, was launched. In the first stage, holders of 18 lakh accounts were asked to explain within a week the source of funds for the deposits made between 8 November and 31 December 2016. It was clear that this was the first step to unearth black money laundered after Demonetisation 2016. But could an under-staffed IT department be able to analyse millions of bank accounts, the returns of the holders of these accounts and identify those with black money? Or would it give up and instead pick on randomly chosen accounts to show that it was doing something?

The big fear was whether the new drive would lead to new and higher levels of harassment. There were voices within the government as well cautioning against asking the IT department to go all out and unearth black money without putting any safeguards in place against harassment of the honest taxpayer. The anxiety was that the past record of the IT department in harassing taxpayers and at the same time being susceptible to pressures would rear a new ugly head to prove that Demonetisation 2016 was a success.


Shift in Narrative: Towards Digitalisation

The Prime Minister’s speech of 8 November made no mention of electronic forms of monetary transactions (more commonly referred to as ‘digitalisation’). The gazette notification on demonetisation also did not mention digitalisation. However, soon the narrative changed, and digitalisation became the mantra (see chapter 8).

The morning after the demonetisation announcement, on 9 November, many newspapers carried advertisements of mobile wallets on their front pages, welcoming the decision. The firms which operated in the digital sphere evidently knew a business opportunity when they saw one.

When the cash scarcity hit, with banks unable to provide cash even for the low allotments, the authorities displayed an insensitivity bordering on the callous. Within a few days, one advisory stated,

Public are encouraged to switch over to alternative modes of payment, such as pre-paid cards, Rupay/Credit/Debit cards, mobile banking, internet banking. All those for whom banking accounts under Jan Dhan Yojana are opened and cards are issued are urged to put them to use. Such usage will alleviate the pressure on the physical currency and also enhance the experience of living in the digital world.

Digital transactions did indeed show a huge increase across platforms, especially among mobile wallets. But the GoI and Reserve Bank of India (RBI) should have been aware that access to digital platforms was very limited among people and that it was not going to change in a few days at a time when the public starved of cash were often struggling to make ends meet.

Demonetisation and Black Money

C. Rammanohar Reddy
Demonetisation and Black Money
Orient Blackswan, 2017

When the GoI found that it was losing control of the demonetisation narrative, it shifted to speaking about demonetisation ushering in a ‘cash less’ society, which, fortunately, later became a ‘less cash’ society. Soon the speeches of the Prime Minister and senior ministers shifted to the many benefits of moving away from cash towards using digital forms of payments.

A high-level committee of chief ministers was constituted to recommend ways to accelerate a shift to digitalisation. Charges on digital transactions up to a certain value were reduced. ‘Lottery prizes’ were announced to encourage use of credit/debit cards, mobile wallets, and the like. A bewildered public tried to adapt. Those who were comfortable with the digital platform expanded their use and those who could get access began to learn to use them. The larger population, however, struggled to manage with whatever little cash it could lay its hands on.

This shift to prioritising digitalisation over destruction of black money and the general confusion about why all this was being done allowed various conspiracy theories to be circulated about international forces and agencies driving the agenda. There was indeed a new global discussion on doing away with cash, but the context in the advanced countries was about dealing with criminal activities, which had little relevance to the digitalisation thrust in India after Demonetisation 2016. Finance would benefit from the charges it collected from digital transactions, but there is no evidence that it was behind the new digitalisation mantra.

There were two economic policy arguments advanced officially as well as independently linking digitalisation with demonetisation and setting forth a scenario of transformational change. One was that with digitalisation there would be greater ‘formalisation’ of the informal sector, transactions could be tracked, and therefore there would be greater tax receipts. The second argument was that with digitalisation, financial savings would enter the banking system and be available for an expansion in formal lending.

It would seem that the shift in the agenda towards digitalisation of transactions has now been cemented. Where the Union Budget for 2015-16 had a detailed listing of measures to be taken to tackle black money, the Union Budget for 2017-18 has another detailed listing of measures, this time for accelerating the pace of digitalisation.

An unusual aspect of the current digitalisation drive is that while RBI statistics showed that there was a boom in electronic transactions carried out by individuals in November and December 2016 (when cash was in short supply), these actually declined in January 2017. It appeared that once people who embraced digital transactions got hold of some cash, they gave up their newfound digital habits. The events of a single month do not make a trend, but this does indicate how much of a compulsion there was behind the digital spike of November and December 2016 and how much people were going to resist this compulsion.


Overview of Suffering of People

The decision by the government to strip 86 per cent of the currency in circulation of its status as legal tender, followed by the restrictions on withdrawals from banks and then the general shortage of cash, deeply hurt people at different levels and in different dimensions.

Delegalisation of such a large amount of currency – much of which had been used in everyday transactions – shook people’s faith in the ‘promise to pay the bearer’ which is the basic premise of the trust that any currency enjoys. It was no solace to the public when it was then told that it had not lost its money, but could exchange the demonetised currency at banks for new currency notes. The hurdles that people had to overcome to exchange old for new and the limits that were placed on weekly withdrawals made them feel that they were being made to ask for what was not theirs.

The ceilings that lasted for weeks and months on how much savers could draw of the savings that was legitimately theirs strained their faith in the government and the RBI. People were put through physical and psychological strain to access these savings. The physical strain of having to wait in line for hours on end had to initially be repeated every week. The bewilderment of having to go through this process to access their honest savings was no less painful.

The withdrawal of legal tender of such a large amount of currency and then the scarcity of new currency also had painful material impacts which seemed to affect all sections of people in every walk of life – other than, of course, those who had the means and ability to get the better of the system.

Families with sick [members] found that the cash they had was not acceptable at private hospitals. Vegetable vendors found that the cash they used as working capital was temporarily useless. Women who had scrimped and saved for the family and hidden the cash from abusive husbands found their savings were now out in the open; they feared that questions would be asked about their modest savings, and they faced new threats of violence from their husbands. Migrant workers, whose families in villages depended on weekly or monthly remittances, found that they could not send money home. Parents found they could not draw sufficient cash in time from the banks to pay school fees for their children. The elderly found that they had to cope with the same constraints on cash withdrawals as everybody else.

All this pain took on a new and even more difficult form when the self-employed found they had no cash to buy material and no one to buy what they produced. Small enterprises shut down in the city and the village, workers were not paid and then let go. Migrant workers were compelled to return home without work and without savings. Economic activity in many areas which provided work and income to the not-so-fortunate ground to a halt.

At the same time, activities which the wealthy organised and patronised seem not to have been disturbed. Events like lavish weddings in the families of leading politicians were organised as elaborately and as garishly as before with massive expenditure and an enormous display of wealth by the hosts and the invitees.

While the honest citizen found herself without work or waiting in queues at banks to draw small amounts of her savings, the holders of black money were not worried. They were able to find ways, to circumvent demonetisation, launder their black money and deposit it in banks. Faced with this circumvention, the government appeared to lose its professed determination to attack black money. Midway through the demonetisation exercise, it announced an amnesty scheme for holders of black money (the second of 2016), under which those who came forward would be allowed to keep, first, 25 per cent of their black money, and then after four years, they would get back another 25 per cent. So much for the unaccounted cash turning worthless after 8 November 2016.

This in brief has been the impact of Demonetisation 2016 on those on whose behalf the war on black money was unleashed. The wealthy and the criminal as usual did not experience any of this pain. It was those who had the least capacity to cope who bore the entire burden.

C. Rammanohar Reddy is an economist who has been writing on economic policy since the late 1980s. He was editor of the Economic and Political Weekly between 2004 and 2016. He is now Readers’ Editor,

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  • S.N.Iyer

    The vote in the State assembly had nothing to do with demonetisation. It is well known that cash inducements have always been used in any election. The EC have officially stated that large amounts of cash had been found in the UP elections. Logically if the Govt announced note bandhi to stop political funding in elections, one party who regularised foreign donations exempt from IT and EC, one party gained the most and won the elections. Besides a false justification was made in electioneering that the rich had paid a price – which they didn’t- and the poor and honest were ‘promised benefits’ which has proved false. The PM promised transparency in election funding on Jan 1st and reduce cash donations to 2000. But the Finance Bill has liberalised corporate donations ( which is a form of corruption) with no limits and to keep such contributions anonymous. Corruption zindabad and the ruling party with strong links abroad can win all elections in the future. And these amendments have been made thru a “money bill”” with no opposition. Do we yet need an answer if demonetisation has stopped corruption. Nor has forfeiting in the new notes been stopped. Nor has there been less militancy because of the ‘brave’ announcement of Nov 8th. And RBI is yet counting after 5 months how much black money has been recovered. Instead the PM has ridiculed worthy economists of ignorance!

  • S.N.Iyer

    The elections were won with money and caste/ religion factors – and wild promises which are already taken a saffron colour. And lies re note bandhi which failed on all counts- black
    Money eradication, stopping counterfeiting and cease militancy! One needs facts and not blind following of a party