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If We Don’t Learn From Demonetisation’s Missteps, We Are Bound to Repeat Them

We must have an exhaustive investigation of every minute aspect of this whole disastrous experience. This includes a government-led comprehensive one, resulting in a white paper or report tabled in Parliament.

People stand in queue to withdraw from an ATM post demonetisation in November 2016. Credit: Reuters

People stand in queue to withdraw from an ATM post demonetisation in November 2016. Credit: Reuters

Note: Palanivel Thiaga Rajan, author of this piece, is MLA, Madurai central constituency and secretary of the Dravida Munnetra Kazhagam’s IT wing. 

It was clear even a week after the announcement of demonetisation on November 8, 2016, that the goals were admirable, but the approach thoughtless.

A year later, the fears expressed were not only proven to be well-founded, but even understated in terms of the scale and scope of the actual disaster that was to unfold.

It never occurred to me that such a complex programme would have been contemplated, let alone undertaken, without basic preparations i.e neither having enough of the new notes printed ahead of the announcement, nor having adequate printing capacity to replace the stock in a reasonable time frame.

The negative economic consequences of demonetisation, and the humanitarian tragedy caused by it have already been eloquently covered by several eminent politicians, writers and economists. Here I would focus solely on the design and implementation features – leaving aside any consideration of the motivations and aims of the policy. As someone with education and experience in engineering, systems analysis, psychology, consulting, banking and financial markets, I have been fascinated (albeit morbidly) at the cascading effects of various design flaws and policy limitations as demonetisation took full effect.

Fundamental flaws

That the policy was both not fully thought through as well as rushed prematurely into execution is evident from some fundamental flaws. Let us start with what I had label ‘first order defects’, the fundamental design problems that led to both direct and induced problems in implementation. Perhaps the most elegant quote on the first order defect came from the inimitable Raghuram Rajan, who stated in an interview that “I think the view of any monetary economist would be that you first print the money and then do the demonetisation.”

That is, of course, a basic suggestion at some level, seemingly not worthy of the experience and wisdom of such an accomplished economist. However, the sheer extent of the unpreparedness of the government and the RBI (used interchangeably going forward, as the past year has shown that any separation that once existed between the two has been obliterated) makes this seem sage advice. Not only were the new notes not printed, there was no reasonable hope of printing them within any reasonable time frame like 50, or even 100 days – given the limited capacity and functionality of the available presses. To make matters worse, reports suggest that the required stock of raw materials (paper and ink) was neither already in inventory nor on order.

By now, everyone is familiar with a few more first order flaws that led to serious consequence. The decision to change the dimensions of both the new notes (2000 and 500 denominations), without any prior action to create the appropriate cassettes and pre-fit ATMs decimated the distribution capability of the whole banking system – as there were then about two lakh ATMs in operation, compared to less than 1.4 lakh branches.


Also read: One Year After Demonetisation, Modi Government’s Claims About It Have Clearly Been Proven False


Further, the decision to first print the 2000 denomination notes (printing of the new 500 denomination notes were not even started till after the November 8 declaration) with the logic that greater value could be printed in a shorter time failed to deliver the fungibility of value that was expected. Without adequate value and supply of smaller denomination notes (as 86% of the total value of currency in circulation was rendered useless), many people found it difficult to use these new high denomination notes for small transactions – such as when shopping for vegetables or groceries, or buying necessary medicines or paying for a doctor consultation in a small practice.

A Rs 2000 currency note. Credit: Reuters

Rs 2000 currency note. Credit: Reuters

There were other flaws which didn’t get as much attention. Consider the very likely scenario that when the RBI is finally done counting all notes, over 100% of the value of notes in circulation will have returned. This is a likely outcome, as the RBI’s August 2017 report states that all but about 16,000 crores (that is 15.28 lakh crores out of the total 15.44 lakh crores in circulation) has been tendered and counted. The report also explicitly states that this does not include the notes held at the district cooperative societies.

In any event, it has long been rumoured that the reason the RBI suddenly and inexplicably ceased reporting the value of notes on December 8 was that they recognised the real possibility of such a seemingly inexplicable outcome. If return of more than 100% is true (and large quantities of counterfeits are clearly not a valid explanation), then it stands to reason that at least some of the old notes were deposited “more than once.” And if that is true, the most likely explanation is that the “reverse-supply chain” of delivering the deposited notes back to the RBI for counting and disposal sprung “leaks.” Now at some level, even the best-designed and managed supply chains in India are subject to “leak-risk” as it were. So the fact that this “reverse-supply” likely resulted in substantial leaks is not just plausible but highly likely given the unprecedented nature and scale of such an operation in the cash management system.

A reasonable way to reduce the likelihood of this would have been to insist upon some form of systematic defacement of the note – ideally a stamp of “CANCELLED” in indelible ink perhaps. If that was not possible (for logistical/supply of stamps and ink reasons), the RBI could have simply asked all deposit takers/counters of notes deposited into ATMs to punch holes in the notes in a specified location/pattern using widely available paper punches. The failure to institute this kind of safeguard – despite dozens of other programme changes announced over the 50-day period – must surely be listed as a near-fatal first order flaw.

Beyond the flaws inherent in the system, one incident stands out in my memory as an extreme example of the reality-disconnect that seemed to affect some of the senior officers overseeing the demonetisation programme – that of the then revenue secretary announcing one morning that all bank branches would start marking the fingers of those exchanging notes at a bank counter with indelible ink, starting almost immediately. Now leave aside for a moment the fact that the exchange-at-counter rules had already been changed many times before that announcement with respect to acceptable frequency, transaction size, etc. Think instead of a system already overburdened with not being able to either print or supply new notes rapidly enough to bank branches, not to mention the logistics of getting the cancelled notes returned without leaks.

Banks were required to ink the fingers of those exchanging old currency notes. Credit: Reuters

Banks were required to ink the fingers of those exchanging old currency notes. Credit: Reuters

What manner of delusion would lead a senior officer, presumably well-informed and well-aware of this at-breaking-point status of the system, to even contemplate the possibility of managing the logistics on such short notice of, ink manufacture, procurement, distribution and training of staff in roughly 1.4 lakh branches (who had never done anything like this before), and putting in place system checks to ensure they were doing it properly. And, it was proposed that this would come into effect within a day or two. There was a greater likelihood of first-ever snowfall in Chennai that week than of successful implementation of this announcement. As expected, the whole notion was dropped rapidly, and replaced with a total ban on all counter-exchanges.

Other negative consequences

Let us move on to second and third order negative consequences. Consider the unintended consequence on India’s banks –already under severe earnings and capital pressure due to the massive volume of bad loans – that were stuck holding all these unwanted interest-bearing deposits (value of the of old demonetised notes), solely due to the inability to pump out new notes anywhere near the pace at which the old notes came in. For every 1 lakh crore of forced deposits, the then (RBI/govternment mandated) savings bank interest rate of 4% per annum meant that banks were paying out roughly Rs 11 crore in incremental daily interest. No wonder then that the banks demanded the government issue additional bonds (under the market stabilization scheme) of up to Rs 6 lakh crores in early December, to absorb the roughly Rs 50 crores a day in incremental interest they were collectively forced to pay daily by then.

Finally, consider the consequences of the disruption of the supply-demand equilibrium in many perishable goods (best exemplified by tomatoes), which linger even now. The cyclical glut in the production of tomatoes during the peak demonetisation period coincided rather unfortunately with the precipitous drop in demand for high-nutrient, low-calorie, food items like fruits and vegetables, as people struggled to maximise the calorific intake value of their greatly reduced purchasing power. Because of this exacerbated supply-demand imbalance, the price of tomatoes in most retail markets fell from about Rs 30 a kilo to less than Rs 5 a kilo – with devastating consequences for tomato farmers.

But as surely as night follows day, this balance reversed dramatically one crop-cycle later (around March 2017) where the price of tomatoes spiked to about Rs 75 a kilo or more in most markets. Because this time, the crop was much smaller than usual (most poor farmers had not been able to overcome the debt consequences of the previous crops failure in order to plant again) while the demand increased directly proportional to increased cash in circulation (three months of printing and distribution later). My best guess is that the planners of demonetisation didn’t factor in such consequences.

Sekhar Reddy case

But over and above all these, there remains one ultimate effect – an insult added to injury, if you will – which summarises the wide landscape of unintended higher order effects. In December 2016, the CBI arrested one J. Sekhar Reddy, an alleged sand mining baron in Chennai after finding over Rs 170 crore in unaccounted holdings during raids on premises associated with him. This hoard included about Rs 34 crores in newly minted Rs 2000 denomination notes. This volume of notes in one location, while most of the country was on a cash-starvation diet, naturally raised many further questions. The CBI and Enforcement Directorate subsequently registered cased against Reddy which are ongoing.

A recent article in The Hindu stated that the case has hit a bit of roadblock. It turns out that – due to the huge quantum of notes that had to be handled by the RBI during the hectic demonetisation period – the RBI has no records of notes of which serial number went to which bank between November 8 and the second week December 2016. Consequently, the RBI was unable to help the investigators identify from which bank Reddy may have obtained his unaccounted stash. Of course, this also means that the nation has been trapped in a Kafkaesque circle of black money, where the very demonetisation policy intended to wipe out black money has resulted in the RBI distributing many lakh crores of not-traceable-to-source money in conveniently storable bundles of Rs 2000 denomination notes – ideal for conversion and storage as new black money.


Also read: As Opposing Narratives on Demonetisation Clash, Even Modi Can’t Fool All the People All the Time


There is an old saying attributed to the poet and philosopher George Santayana – “Those who cannot remember the past are condemned to repeat it.” That has perhaps never been truer than in the context of this disastrous demonetization policy, where our senior politicians and civil servants either never knew the dismal history of such attempts (in countries as close as Burma) or completely forgot them when conceiving and developing their plans.

What is worse, the government seems to be repeating exactly this speed/secrecy at the expense of thoroughness/fail-safe implementation trade-off strategy yet again during the ongoing implementation of the Goods and Services Tax (GST). In an eerie reminder of the ghost of demonetisation, the GST rollout on July 1, 2017, was followed by many dozens of rates and procedural changes in the first 90 days after the rollout.

If we are to break out of this pattern of easily-forgotten history (and the associated consequences of such a pattern), we must have an exhaustive investigation of every minute aspect of this whole disastrous experience, including the detailing of the specific role of every single person in the allegedly microscopic circle of people who actively participated in the conception and development of this self-inflicted disaster. This is simply an attempt at a preliminary post-mortem. We must have a government-led comprehensive one, resulting in a white paper or report tabled in parliament. We must extract lasting lessons, and use such learning to implement robust systemic barriers to any possible repetition.

Such an analysis may not be possible before a change in government because this regime, far from any introspection, is not even admitting any failure. A regime-change will surely come at some point in the next decade at the latest. It will then be the moral obligation of the incoming government to ensure such a post-mortem is done.

As a nation, we owe it all those who paid the price – in fatal and non-fatal ways – during the worst self-inflicted economic policy disaster in the history of independent India.