Currency ban: black money need not be back

This demonetisation programme has met with polarised responses. Supporters argue this action will help rid the economy of black money, lower interest rates, and deliver a huge dividend from the Reserve Bank of India (RBI) to the government treasury.

Detractors, however, are skeptical and claim the move impacts the store of physical cash rather than acting to curb the flow of black money since much of the black money is in the form of gold and real estate.

Further, they charge that this move will lower deposit rates, not just lending rates, and importantly, that it breaches the solemn legal promise to pay the bearer of cash the tendered amount, without conditions.

Another expectation from this move is that it will accelerate the adoption of e-money. However, it is not practical to use e-money to fill air in the tyre of a bicycle or for a child to buy candy.

The small sizes of these transactions, which form the majority in an average Indian consumer’s daily life, make the fixed cost of e-money uneconomical for the merchant. Black money is created in two broad ways. Firstly, under-invoicing of legitimate activities like those of self-employed professionals, and secondly, failure to report income arising from illegal activities such as corruption, extortion, terrorism funding, and others.

Steps do need to be taken to ensure there is no future avenue for creation, circulation and conversion of such monies.

One way to do that is to put all high denomination notes on an ‘auto-demonetisation’ mode. Under this proposal, all high-value notes would expire as legal tender after a set number of years from the date of their printing. Let me elaborate on this proposal further. Any currency is an IOU (I owe you or a debt) of the government, issued by the monetary authority, which in this case is the RBI in India, and is founded on a promise to pay the bearer. It is, in fact, a zero coupon perpetual promissory note with ‘no call’ option. Further, all currency is money, all money is not currency.

When the government or RBI de-notifies a currency as valid legal tender, it declares that currency cannot be used for economic transactions. The promise to pay the bearer remains intact but it requires the bearer to go back to the RBI (or a designated bank) and get an equal value in exchange.

This is routinely done to weed out counterfeit notes, or, as is happening in the UK where the paper five pound note is currently being replaced by a polymer one.

The RBI cannot profit from unreturned notes. Only when the RBI ‘sights and destroys’ a currency note, is it absolved of the liability or promise to pay. Doing otherwise would be a breach of contract. A promise in eternity is, well, just that.

Currency, of course, comes in various denominations. The smaller denominations are used for majority of transactions and the larger ones are generally used as a store of value. It is the latter that fuels the black money economy. The former keeps the economy chugging along daily, the importance of which all Indians have come to realise in the past few days. The RBI, therefore, should increase the quantity of small denominations significantly to accommodate most retail transactions—from buying a cup of tea to paying the bus conductor.

The argument that it is costly to print smaller denominations is flawed as it neither takes into account the velocity of such denominations nor considers the cost of the alternative solution to undertake small transactions, which is the lifeblood of the economy. It is like arguing over the cost of stamp paper on which a property sale deed is being registered.

Tackling unaccounted wealth calls for a restriction of supply of high denominations and also for them to be kept on an ‘auto-demonetisation’ schedule. This would significantly curtail their use for anything other than legitimate activities. Undeclared physical assets will also become difficult to monetise using such currency. The cost of frequent printing will pale in comparison to the benefits reaped.

Under this idea, most high-value transactions would be performed electronically by credit or debit cards, e-wallets or bank transfers, and therefore can be tracked. All low-value transactions would remain in cash and would support the large fragmented retail sector, for whom the cost of accepting e-money is not insignificant. Finally, it will significantly curb the black economy.

Why not abolish all high denominations? Many people, like this author, do not trust banks with all their savings for a variety of reasons including the fact that they are limited liability companies, that they can be affected by cyber-attacks and that their recent performance in lending leaves much to be desired.

There should always remain an option to keep some savings in currency (another option can be e-currency issued by the RBI).

This would result in some inconvenience every few years, like one needs to access a bank locker once in a while, when these legally obtained notes would be required to be converted into that day’s legal tender.

Even if these notes are forgotten for years, they can still be converted upon production of legitimate documents. A promise is a promise, and a currency carries one made under the seal of the President of India.

The present action of the government is like ‘A Great Purge’ where sins have been cleansed by a symbolic dip in the Holy Ganga. All new money is white now. But if the government does not take further steps then it will lead to ‘A Great Surge’ and the black economy would get reincarnated and the recent pain of honest citizens would have been in vain.

Huzaifa Husain is head-equities, PineBridge Investments, India.