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Old Is Not Always Gold

Posted in Finance Articles, Total Reads: 4054 , Published on May 17, 2014

On the 22nd of January 2014, the Reserve Bank of India(RBI) released a circular stating that after 31st March 2014, it would withdraw the circulation of banknotes issued prior to the year 2005, including Rs 500 and Rs 1000 denominations. This move was clarified by the RBI governor, Mr. Raghuram Rajan as a technical action since the older notes have fewer security features as compared to the newer ones thereby making them easier to counterfeit. The circular also stated that from April 1st, people would have to approach banks for the exchange of such notes. The banks would have to exchange these notes from both customers as well as non customers.

The RBI though, also gave the assurance that after July 1st, such notes would continue to be legal tender and anyone in possession of such notes can get them exchanged in any bank, the condition being that the person would be needed to furnish his identity and address proof for exchanging more than 10 notes. The RBI has also been withdrawing these notes from the banks. The notes printed prior to the year 2005 do not have the year printed on the backside and thus is easily distinguishable from the notes issued after 2005. The RBI has encouraged the people to get such notes exchanged and it believes that this would also help in curbing black money and tackling counterfeit notes since the notes printed before 2005 could be duplicated easily.

This decision by the RBI has since been scrutinized by the experts for its validity and effectiveness. Critics have gone on to analyze the pros and cons of this decision and the impact it would have on the economy. The most important positive is that the move would force the currency hoarders of notes published before 2005 to bring out such notes into the market. The black money in the form of currency notes would also have to be converted to white if they are to be used for transactions after April 1st. In order to get rid of pre-2005 notes, people would increase their spending in the market which would boost the GDP of the country. The notes would continue to be legal tender which means that even though people would not be able to use them for transactions, they can get them exchanged from the banks and use it. This move may also help eradicate corruption once and for all. Money is an important asset for the people and it does them good which indirectly helps the economy of the country as well.

The RBI governor has also clarified that the move is not intended to carry out demonetization unlike what happened in 1977 when notes of higher value were demonetized to curb black money. The move backfired with the currency moving to Nepal where it had the same status as India. Another positive about this decision is that with the elections coming up the ruling party would have to support this decision which might also help curb corruption which has increased manifold in the recent years. One of the reasons for the depreciation in the value of the rupee is the storing of cash. This move would also help in steadying the value of the rupee in the international market since every note printed after 2005 would be practically in use and with better security features.

There is one more side of the story which is arguably valid. The question that arises is whether this decision of the RBI really serves the purpose. The measures will affect different sections of the economy differently. Although the governor has explicitly iterated at various occasions that the notes will remain valid and that the RBI has no intention of demonetizing the higher value currency notes, a sudden panic has spread among the common masses. The confusion is justified as most of the population does not understand the rationale behind such a move. Unlike US and UK, transactions in India take place in cash for almost all the deals. Salaried employees are least affected by these measures as their basic transaction of money takes place in the electronic form thus eliminating chances of finding older notes. Traders and businessmen will bear the major impact. Their entire business depends on the exchange of cash and with the notes prior to 2005 being considered as ruled out, though it is not the case, the core business will take a sharp hit. Shopkeepers and cab drivers have already started rejecting such notes.

Another section that will take a blow is the poor and illiterate residing in the remote areas with practically no access to banking facilities. Sixty five percent of this population does not have a bank account and refrain from making any banking transactions. They will be forced to exchange notes through middlemen who will earn by taking commissions and may misguide them as well. The most important reason cited for these measures is to get rid of counterfeit notes. The RBI has been removing and exchanging these notes in the back-end since the last three years. Any note that was printed prior to 2005 was being given back to the RBI by the banks and new notes were issued for the same. So the amount of notes should be minimal.

Many economists are also viewing these measures as an attempt to counter black money. However, there are no provisions of sharing the information about the people with the income tax department. Notes printed prior to 2005, counterfeit currency and even black money may be hoarded up in lockers. These notes can be easily changed in the allotted time by the RBI without any limit on the number of notes and if produced before the stipulated time, identity proofs will not be mandatory. It may turn out to be a tool for converting black money into white and also getting the real note instead of a fake one. No decision has been announced on the courses of action if a fake currency is encountered. Thus, the banks will have to simply replace the notes without taking any action.

The measures have also put the credibility of the currency under question. This might result in people shifting their money by investing in other instruments such as gold and real estate causing a sudden hike in their price. This might increase the gold imports, which will further increase the current account deficit and result in the depreciation of rupee. The actual owners will get rid of the currency but that currency might still persist in the economy. The timing of the move by the central bank also raises suspicions as the general elections are near. This can be aimed at sucking out the black money that the political parties and their supporters have hoarded for the next elections. The suspicions arise because the number of fake notes has already gone down from 8.1 in a million in 2007-08 to 7.51 in a million in 2011-12 which is above the average value in most of the emerging economies. The notes printed before 2005 were of paper with average time of usage approximately 10 years. So most of them might have been torn or soiled and already exchanged. Also the requirement of proving identity and address proof might complicate things and might lead to huge serpentine queues in banks.

In the current political and economic scenario, these measures were uncalled for. The RBI should have given a larger window for the exchange such as the entire year. Confining it to three months, it caused a lot of commotion. Concentration should be shifted on mechanisms of detecting counterfeit currency and introduction of plastic and polymer notes. A committee can be constituted consisting of members from RBI, Government and Income tax department. The committee can discuss and come up with more effective measures to tackle issues concerning all the three institutions and the economy as a whole.

This measure taken by the RBI to tackle black money and counterfeiting has met with a mixed response but it is important that it is implemented only after a detailed analysis about the repercussions of the same. People should be made aware about the entire process so that it goes on smoothly and doesn’t create panic among the customers. Rural and poor class people who do not have proper access to banking facilities should be provided with alternative means of getting such notes exchanged legally with minimal fuss. Only time will tell whether this move by the RBI bears fruit or turns out to be a dud.

This article has been authored by Ashish Menon, Ankit Chaturvedi from SIMSR


• Economic Times

• Business Standard

• http://businesstoday.intoday.in/story/rbi-to-withdraw-all-pre-2005-currency-notes/1/202580.html

• http://www.firstpost.com/economy/rbi-to-withdraw-pre-2005-currency-notes-to-battle-black-money-counterfeits-1353861.html

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