Prime Minister shocked the entire nation by banning Rs 500 and Rs 1000 currency notes from circulation quoting the measure would fight the black money and fake currencies. Withdrawal of high-denomination rupee notes is a radical measure the governments normally resort to in an attempt to counter forgery.
However, the move was hardly unprecedented we wouldn’t predict the impact of the measure immediately, as it is a long term measure to counter forgery and bring equality in the nation.
Financial Measures Taken in the Past
It was done twice in the past and what history says about it. Yet, the third time in India’s history saw a new thing is the introduction of new Rs 2000 currency notes. The primary focus is to stall the liquid cash flow and make the cashless transaction accountability.
The first was when Rs 1,000, Rs 5,000, and Rs 10,000 currency notes were taken out of circulation in January 1946, a year and a half before the country won independence from the British. The Rs10,000 notes were the largest currency denomination ever printed by the Reserve Bank of India, introduced for the first time in 1938. All three notes were reintroduced in 1954.
The second has happened in January 1978 that pulled Rs 1,000, Rs 5,000, and Rs 10,000 currency notes from circulation. However, this denomination has a backstory.
In the early ’70s, the Wanchoo committee, a direct tax inquiry committee set up by the government, suggested demonetization as a measure to unearth and counter the spread of black money. However, the public nature of the recommendation sparked black money hoarders to act fast and rid themselves of high denominations before the government was able to clamp down on them, Mint reported.
The Reserve Bank of India’s (RBI) history (third volume) describes the process in detail. It goes something like this:
On the morning of 14 January 1978, R. Janaki Raman, a senior official from chief accountant’s office in RBI, was asked by a government official over telephone to go to Delhi to discuss matters relating to exchange control.
On reaching the capital, Raman was told that the government had decided to withdraw high-denomination notes and asked to draft the necessary ordinance within a day.
During that period, no communication was allowed with RBI’s central office in Mumbai, “since such contacts could give rise to speculation.”
The draft ordinance was completed on schedule and sent for signature to President N. Sanjiva Reddy in the early hours of 16 January. The news was announced on the All India Radio news bulletin at 9 am on the same day. The ordinance provided that all banks and treasuries would be closed on 17 January.
The then RBI governor I.G. Patel was not in favour of this exercise. According to him, some people in the Janata coalition government saw demonetization as a measure specifically targeted against the allegedly “corrupt predecessor government or government leaders”.
Patel recalled in his book Glimpses of Indian Economic Policy: an Insider’s View, that when finance minister H.M. Patel informed him about the decision to withdraw high-denomination notes, he had pointed out that such exercises seldom produces striking results.
Most people, Patel said, who accept illegal gratification or are otherwise recipients of black money, rarely keep their ill-gotten earnings in the form of currency for long.
The idea that black money or wealth is held in the form of notes tucked away in suitcases or pillow cases is naive, Patel said. In any case even those who are caught napping or waiting will have a chance to convert notes through paid agents as some provision has to be made to convert at par notes tendered in small amounts for which explanation cannot be reasonably sought, he added.
2016 Demonetization Measure
For the most part, Modi’s measure mirrors Desai’s—except this time, he has the backing of his RBI governor, Urjit Patel, who applauded Modi’s “very bold step” addressing concerns about the “growing menace of fake Indian currency notes.” But that doesn’t mean all the skeptics are off his back. Economists doubt the impact of his decision.
“That’s because people don’t stack black money in cash. Rather, they stash it in undisclosed accounts in Swiss Banks,” said Abhiroop Sarkar, a professor at the Indian Statistical Institute. “So the demonetization won’t affect the biggest fish.”