Demonetisation: Ignore Early Hiccups, It’s a Great Long-Term Plan

The long-run benefits of demonetisation are huge, writes former RBI Deputy Governor Subir Gokarn.

Apprehensions about liquidity pressure follow after PM Modi’s masterstroke on black money. (Photo: Rhythum Seth/ The Quint)

There are two objectives of demonetisation – ridding the system of counterfeit currency and destroying cash hoards. Both of these goals were cited by the government while carrying it out on Tuesday. Both can only be achieved by complete demonetisation of the existing series of currency notes. If this is not done, the cleaning-up process becomes excruciatingly slow. Old notes can only be withdrawn when they pass through the banking system.

The effectiveness of introducing new security features in notes is diluted by the fact that old notes remain in circulation as long as they do not pass through banks. Counterfeiters can simply copy the older notes, while the value of cash hoards remains intact. If it had to be done, it had to be done at one stroke.

Also Read: 86% Of Indian Currency Now Illegal: Masterstroke Or Big Blunder?

An efficient exchange process will help calm apprehensions about liquidity pressures.(Photo: iStock)

Apprehensions About Liquidity

In the short term, the mitigation of these risks depends on three factors. First, the size of the stock of the new notes (supplemented by the existing stock of smaller denomination notes) is critical. Statements by the Reserve Bank of India indicate that new, high-tech notes have been in production for a while and a sizeable stock has been been built up.

Second, an efficient exchange process will help calm fears about liquidity pressures. This assurance has also been provided by increasing the number of exchange counters and extending banking hours.

Third, a large number of people will have to use cash alternatives. When this happens, the capacity of the payments and settlements system will be put to test. Indications are that this capacity is very large and uninterrupted performance will greatly boost confidence in the system.

Also Read: Bye-Bye Rs 500 & 1,000 Notes: Modi’s ‘Achhe Din’ Are Finally Here

Also, it is quite likely that local innovations will spring up to deal with liquidity pressures. The use of toffees in lieu of coins as change has become so commonplace that they might be considered a currency in its own right! In short, a combination of institutional actions and grassroots innovation should be able to deal with any immediate liquidity pressures.

A systematic and broad-based promotion of cash alternatives is key to sustaining the benefits and minimising the risks of disruption. (Photo: iStock)

Benefits of Demonetisation

Looking ahead, the best course of action would be to consolidate on the benefits of demonetisation. On the currency management front, regular upgrades of currency notes along with a complete withdrawal of the old series may have been good practice in the past. But this may not be required now thanks to the high-tech features built into the new notes. Still, periodic disruption is will help fight both counterfeiting and hoarding.

Also Read: Modi’s Currency Crackdown Not Enough to Catch the Big Fish

People wait outside ATMs in New Delhi after Prime Minister Narendra Modi announced demonetisation of Rs 1,000 and Rs 500 notes on 8 November 2016. (Photo: IANS)

Cash Alternatives

More importantly, a systematic and broad-based promotion of cash alternatives is key to sustaining the benefits and minimising the risks of disruption. The government itself can play a critical role in this process by enabling the use of cash alternatives for all payments to be made to it.

There are encouraging developments on this front by way of online payments for a number of services. However, both the range of payments and the variety of means that can be used to make them has to be increased. This, in turn, requires that the payments and settlements system become a fully open access system, usable by all payments service providers.

To conclude, the long-run benefits of demonetisation are huge. There are short-term risks, but they can be managed.

(The writer is former Deputy Governor of the Reserve Bank of India and Executive Director for Bangladesh, Bhutan, India and Sri Lanka at the International Monetary Fund. He can be reached @SubirGokarn. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)