That the gaudy pink unwanted child, born out of the whimsical demonetisation of high-value currencies in November 2016, would have to die early was always expected. Indeed, when the Reserve Bank of India (RBI) matter-of-factly announced through a press release on May 19 that it had initiated a time table for the withdrawal of the Rs 2,000 currency note from circulation, it only served as a reminder, yet again, that the effects of Prime Minister Narendra Modi’s Tughlaqian adventure linger on for far longer than most people had imagined.
The RBI announced on May 19 that it intends to phase out of circulation the Rs 2,000 note, the aesthetically ugly pink currency note that nobody wanted to own. The central bank admitted that the currency note, an aberration in the denominational structure of the Indian currency regime, was only introduced to facilitate the “expeditious” expansion of the value of currency in circulation after demonetisation. The note was introduced because of the sudden evisceration of more than 86% of value of all currency in circulation in the economy, following the withdrawal of the Rs 500 and Rs 1,000 notes.
The RBI appears to admit, without any embarrassment whatsoever, that once the purpose of inflating the value of currency in circulation has been served, there is no further need for the denomination. Indeed, no denomination in the history of the Indian currency regime would have had as short a life as the Rs 2,000 note. In essence, the latest move confirms yet again the debauchery of the national currency in 2016.
The RBI said 89% of these banknotes were issued before March 2017. What the central bank forgot to mention was that by March 2017, the Rs 2,000 note accounted for a whopping 50% of the value of all currency in circulation, indicating just how hopelessly warped the rupee’s denominational structure had become as a result of demonetisation.
Ironically, RBI governor Shaktikanta Das, who served as secretary, economic affairs, when demonetisation happened, and who in that role was not particularly forthcoming with facts about the extent of remonetisation, addressed a press conference on May 22 to clear lingering doubts about the latest move. For someone who heads the institution that is in charge of the country’s currency management, his admission that the primary purpose of the Rs 2,000 note was to “quickly replenish” the void caused by the withdrawal of the Rs 500 and Rs 1,000 notes was startling but not surprising. Whether the national currency can be trifled with in this manner is an obvious question that comes to mind. Das reaffirmed that the pink note remains “legal tender”. However, whether the local tea vendor would be willing to accept it is not something that the central bank can enforce at the point of transaction.
Currency as a lubricant of exchange
Why is the denominational structure important in any currency regime? To appreciate just how the prestige of the national currency has been trifled with, one needs to understand the purpose of money in a modern economy. To reiterate what basic economics tells us: money functions as a medium of exchange and as a store of value; it is also a unit of account, enabling economic participants to compare relative prices, but this is not of immediate concern in the context of demonetisation.
Superficially, an economy may appear to provide several options for facilitating exchange, but other payment methods — credit cards or even the now-ubiquitous Unified Payment Interface, for instance — cannot act as a store of value. Any transaction requires two parties to agree on the terms of exchange, normally facilitated by a currency or a mode that is acceptable to both. We have all been through situations when one or another party is either unable or unwilling to accept a particular currency denomination or a form of payment, a particular option on the UPI platform, for instance. Multiply this on a vast scale — which is what happened on after November 8, 2016 — and you are guaranteed chaos on a gigantic scale that freezes the economy.
In its role as a facilitator of exchange, money, as expressed in its currency avatar, needs to act in a stable and predictable manner. That is, its acceptance must be universal and guaranteed to succeed in every instance of exchange. Failure can have only one result: a gridlock that throws sand in the wheels of the market. More importantly, a currency’s role as a stable medium for facilitating the circulation of goods and services — the very meaning of economic activity — is seriously compromised. This has serious and real-life consequences for the economy and livelihoods, as the nation experienced painfully after November 2016. Indeed, a regime that is agnostic to the mode of payment is ideal because it allows for the smoothest exchange of goods and services in an economy. The dim-witted notion that the state ought to privilege one form of payment over another is unacceptable because it erects barriers and introduces rigidities that prevent smooth exchange.
The RBI’s declaration that the Rs 2,000 note will continue as “legal tender” is meaningless if economic agents feel that it is not safe tender. It is not difficult to visualise how this will unfold between now and September. In particular, citizens’ lack of trust in the validity or stability of the currency regime, based on their lived experience since 2016, would render the declaration meaningless. What matters to citizens on a here-and-now basis is whether the pink note will be accepted by counterparties for transactions they wish to initiate.
Moreover, since everyone is aware that these notes can only be exchanged or deposited in banks till September 30, 2023, they would be unwilling to be the one to undergo the pain and cost of having to surrender them at a bank before that date. Instead, they would be inclined to simply refuse to accept transactions executed with those notes. The needless limit of 10 notes per visit to the bank adds another additional layer of deterrence. Effectively, the RBI has only succeeded in creating another needless logjam which hinders the circulation of goods and services in the economy.
And, reminiscent of the 2016 disaster, this time too confusion reigns. Even before the deposit of Rs 2,000 notes could commence on May 23, banks, among them the biggest, the State Bank of India, announced that customers need not fill up forms in order to deposit their notes. Significantly, the central bank, in whose name the national currency is managed, chose to remain silent. However, the bizarre limit of 10 notes per trip to the bank remains. The ostensible claim that this would reduce pressure on banks is illogical. Pray, how would multiple trips to the banks by a holder of these notes reduce “pressure” on the banks? To be sure, bank staff, who suffered enormously in the months after November 2016 — many died on the job — are in for another round of severe stress.
A short history of the short life of the pink note
The denominational hierarchy of currencies anywhere in the world is premised on the logic of ensuring maximum liquidity. Before demonetisation, the central pillar of the Indian currency regime was the Rs 500 note, much like the Rs 100 note was about two decades earlier, reflecting a lower general price level in the economy as well as its smaller size then. The Rs 500 note accounted for almost half of the entire value of currency in circulation; together the Rs 500 and Rs 1,000 notes accounted for 86.4% of the value of currency; and along with the Rs 100 note, the three denominations accounted for almost all the value — 96%. The RBI now says that the share of the Rs 2,000 notes in total value of currency in circulation has dwindled to just 10.8%; by last March, the Rs 500 note’s share was almost three-fourth of the value of all currency in circulation. The withdrawal of the Rs 2,000 only means that its share would rise even higher, warping the currency regime even further.
The hierarchy was based on a logic. Notice that before demonetisation the distance in monetary value between the highest denomination and the next in the hierarchy was exactly double. The introduction of the Rs 2,000 note — and the elimination of the Rs 1,000 note — increased the distance between the two highest denominations to four times. This immediately implies that although the Rs 2,000 note acts as a store of higher value, its liquidity is drastically diminished. This is exactly why people have shunned it throughout its short life. Indeed, at the height of the crisis in 2016, the driver of a van carrying currency notes in Bengaluru hijacked the vehicle but abandoned it after realising that it was carrying only the new pink notes!
As the distance in monetary value between the two top currencies in the hierarchy widened from twice to four times, the pressure on the Rs 500 rupee note mounted because a large proportion of these notes were merely supporting the illiquid Rs 2,000 note. That is, instead of being readily available for transactions, a significant proportion of the Rs 500 notes were merely present in order to facilitate the circulation of the Rs 2,000 note. Obviously, one could not carry a Rs 2,000 note without necessarily carrying other denominations, particularly the Rs 500 note. This the primary reason why nobody wanted to hold the new highest denomination note.
In the denomination scheme that existed before demonetisation, the Rs 500 note was the main pillar because it not only provided immediately available liquidity but was available on call as a store of value. In that scheme the Rs 1,000 note acted as a vehicle for relatively high-value transactions. But note that relatively high-value does not necessarily mean well-heeled holders of the currency. Give that about half of India’s national income is generated by informal activity, a relatively high-value transaction does not necessarily mean the participants have high incomes or are wealthy.
Just take the case of a fertiliser dealer — and that would be a good example to cite because the sowing season is just round the corner (it is noteworthy that the 2016 demonetisation happened just after the harvest operations) — selling di-ammonium phosphate in a rural or semi-urban setting. A dealer selling about 25 bags (50 kg each) a day would have a turnover of Rs 30,000, but the dealer’s profit would only be a small faction of this turnover. The assumption that these notes are evidence of ill-gotten wealth reveals not just ignorance about the nature of the economy but a callous disregard for elementary principles of currency management.
It is obvious that the idea of the Rs 2,000 note had nothing to do with any principles of currency management; instead, it was simply meant to address the immediate crisis. In effect, the new denomination’s sole purpose was to address the production problem of printing new notes in order to quickly inflate the value of currency in circulation. That this was done without any respect for the longstanding principles governing the hierarchy of denominations was shocking.
As a result of this desperate flogging of the currency presses, the value of Rs 2,000 notes accounted for more than half of all currency in circulation by March 2017. What happened in the case of the Rs 2,000 note was also replicated in the case of the Rs 200 note, albeit on a much smaller case. Quite apart from the 200 being an odd denomination in the world of currencies, this too was guided purely by the objective of scaling up liquidity quickly while providing some support to the overburdened Rs 500. The number of Rs 2,000s in circulation peaked in 2018, at about 336.3 crore (3.363 billion), but between then and March 2022 more than one-third of these notes were withdrawn.
The RBI’s recent statement justifies the withdrawal of the Rs 2,000 note, claiming that its Clean Notes Policy requires it to phase out notes that have outlived their four-five year lifespan. If that was indeed so, why did it have to phase out such a large proportion of these notes well before they needed to be extinguished? In any case, the Clean Note Policy has nothing to do with the utility of the denomination; if it did indeed serve a purpose, all that the RBI needed to do was replace old notes with new ones.
A self-inflicted liquidity crisis
The sudden evaporation of value of currency in circulation in November 2016 resulted in the unprecedented collapse of liquidity. This self-inflicted crisis was unlike anything thew world had ever seen. It required the RBI to run its currency printing presses at full tilt. But even this was not enough, simply because their capacity was not meant to address such a massive collapse of liquidity. The production of the gaudy pink note was given priority — Indians would recall that the Rs 500 note was nowhere to be seen in the immediate months after demonetisation. The extent of the liquidity collapse can be gauged from the fact that the value of currency in circulation at the end of March 2017, four months after the disaster, was actually 20% lower than a year earlier. Shockingly, in end-March 2018, the value of currency in circulation was just about 10% higher than two years earlier — much lower than what a growing economy would have required or what inflation rates would have dictated.
The withdrawal of the Rs 2,000 note was preordained. It is also a reminder that the effects of demonetisation are not over yet. Indeed, if anything, there is a greater need now for the return of the Rs 1,000 note. Given the increase in the price level and the expansion of the economy, however anaemic, there is an urgent need to provide support to the Rs 500 note, especially for relatively high-value transactions. But who is to tell the Modi acolytes that relatively high-value transactions does not automatically mean the transactions of the elite and their ill-gotten wealth. Only the cussed refusal to see reason and logic explains the unwillingness to bring back the Rs 1,000 note. In fact, even if one accepted the logic that high-value notes were synonymous with black money, how did it make sense to introduce a denomination with an even higher value in 2016?
Economists like Prabhat Patnaik, Pronab Sen, Arun Kumar and Jayati Ghosh have repeatedly pointed out for years that black money is not a stock but a flow. Just as capital seeks ever-wider realms in search of greater returns, so would ill-gotten wealth that basically arises from evasion of not just taxes but from the overstatement of business costs and understatement of incomes. If that is so, it makes sense to not just heighten scrutiny of businesses where black money is being generated, instead of trying to catch it after it has been allowed to escape the arm of the law. To focus on cash and go hunting for high denomination notes, assuming them to be the manifestation of black money, is thus not just silly, but results in the victimisation of an entire people.
One of the less appreciated aspects of demonetisation was the fact that it facilitated the transfer of wealth from the poor to the rich on a scale that would not have been normally possible. This was achieved because of its differential impact; it was not scale-neutral in its impact; the small suffered much more and many were wiped out as a result. In hindsight, the demonetisation of 2016 was just the first of a triple whammy that has hit India’s most vulnerable repeatedly.
Every instance of demonetisation in history — and there have been very few of them — has been made in a country hit by hyperinflation. No country staking claims to a seat at the high table, and certainly not one whose leadership never tires of boasting that it is one of the world’s largest, has ever deigned to have achieved anything by using demonetisation as an economic policy tool. In fact, no standard textbook on economics cares to even make a passing reference to demonetisation. Modi thought otherwise, and the country paid a very heavy price.
The same sections that were hit hard by demonetisation, in particular small and informal businesses in both urban as well as rural areas, were hit again, first as a result of the imposition of the Goods and Services Tax in 2017 and since 2020, as a result of the pandemic. The K-shaped growth of the Indian economy, one in which a thin sliver of society is doing very well, even as livelihoods of most Indians have turned significantly worse, is testimony to the widening inequality. Demonetisation was thus the harbinger of the forced immiseration of the Indian people. And it remains a work in progress.
V. Sridhar is a journalist based in Bengaluru.