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Why Narendra Modi’s gamble on black money may not pay off

17 November, 2016

On 8 November, Prime Minister Narendra Modi announced that Rs 500 and Rs 1000 notes – or 86% of money in circulation – were no longer legal tenders. Even as this took the entire country by surprise, it has evoked strong reactions both in support of the move and against it. The government’s decision has also managed to unite large sections among India’s otherwise fractured opposition parties who are now demanding that the move be rolled back.

Banks, ATMs and post offices have seen serpentine queues and the government has been criticised for mismanaging the fallout of its decision. But this decision has precedence in history. Not only is it the third time that this is being done in India, demonetisation has been tried in other countries in the past, with mixed results at best.

So, when did India demonetise its currency in the past?

India did so twice – in 1946, when the British were ruling the country, and then again in 1978, when the Janata Party government under Morarji Desai was in power. Both times currency notes of higher denominations were withdrawn. While in 1946, the government of what was then British India, withdrew Rs 1,000 and Rs 10,000 notes, in 1954, the Jawahar Lal Nehru government brought back the Rs 1,000, Rs 5,000 and Rs 10,000 notes. These notes were again demonetised in 1978 by the Desai regime.

Did it help curb the menace of black money?

Not really. Demonetisation drives in the past have not been very successful. In fact, a 2012 report on measures to tackle black money in India and abroad, by the Central Board of Direct Taxes was itself categorical in saying that demonetisation in the past had “ miserably failed, with less than 15% of high currency notes being exchanged while more than 85% of the currency notes never surfaced as the owners suspected penal action by the government agencies.”

The report said that “demonetisation may not be a solution for tackling black money or economy, which is largely held in the form of benami properties, bullion and jewellery, etc.” Further, “demonetisation will only increase the cost, as more currency notes may have to be printed for disbursing the same amount. It may also have an adverse impact on the banking system, mainly logistic issues, i.e. handling and cash transportation may become difficult and may also cause inconvenience to the general public as the disbursal of payments of wages/salaries to the workers will become difficult. Besides, it may also adversely impact the environment as more natural resources would be depleted for printing more currency notes,” it noted.

So, have other countries tried this too?

Yes, but different countries had different end goals. Here’s a brief look at what happened in some of these countries:

Ghana: In 1982, the country abolished its 50 cedi notes, in a bid to curb black money. But not only did the move shake the confidence of the people in the country’s banking system, it also forced people to turn to physical assets outside of the country. Much like India, the unbanked poor bore the brunt of the move, and led to an underground currency market.

Zimbabwe: Zimbabwe is perhaps the most studied case in recent times. The country went through a period of hyperinflation and in June last year the local currency was demonetised with a multiple currency system. Effectively therefore, the Zimbabwe dollar itself was demonetised, and ceased to be legal tender after inflation went as high as 4 billion percent.

Pakistan: Pakistan demonetised Rs 3 and Rs 500 notes, and in June last year, announced the phasing out of old notes of various denominations like Rs 10, 50, 100 and 1,000. Unlike India however, the window for tendering in the same with banks is much longer, with the deadline being the end of 2021, although these notes will cease to be legal tender by December this year.

North Korea: In 2010, the dictatorial regime of Kim Jong-II demonetised several denominations, a move that led to food shortages. The level of unrest in the country was such that Kim, otherwise known as a ruthless dictator was forced to apologise, and reportedly executed his finance chief.

Libya: The country’s central bank began withdrawing old notes in early 2012, soon after its dictator Muammar Gaddafi’s death. The move was carried out to curb excess liquidity, as vast amounts of cash – of the order of 96% of the available money – was being stored outside the banking system, possibly because of the political turmoil and civil war in the country.

Soviet Union: On the verge of its breakup, in January 1991, the Soviet Union withdrew notes of large denominations to try and curb the black economy. But the move was an unmitigated disaster as not only did it fail to arrest inflation, it also eroded public confidence in the country’s banking system. The Soviet Union eventually collapsed.

Iraq: Following UN imposed sanctions in the aftermath of the 1991 Gulf war, the oil rich country was forced to abandon its Swiss printing method, and go in for notes of inferior quality. Interestingly, this did not entirely shake the confidence of people in the old currency, which continued to be in circulation in some parts of the country for at least another 10 years.

Myanmar: The military regime abolished nearly four-fifths of its currency in 1987 in a move to get rid of the black market. But move failed and led to overall chaos and large-scale protests, and brutal reprisals from the state.

Zaire: The African nation demonetised its old currency in 1993, leading to inflation and a plummeting of its exchange rate. This eventually led to a civil war in which the country’s dictator was ousted.

Nigeria: The country’s military regime abolished old banknotes as part of its anti-corruption drive. The move completely backfired. Eventually leading to a coup.

Other countries that have, in the past demonetised their currencies include Germany, Australia, the Philippines and Singapore.

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Why Narendra Modi’s gamble on black money may not pay off

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