Dear Governor Patel,

It is an understatement to write that the last month has been busy for Indians, overseas investors in India and economic commentators. The globally unprecedented scale of the experiment to transfuse 86% of the bank notes that will no longer be legal is being keenly watched. There is immense interest in its uncertain but negative impact on economic growth in the near term, and its potentially favourable—but still uncertain—impact in the long-term.

No one expected the early days of your governorship to turn into a trial by fire—similar to the experience of your two immediate predecessors. The critical difference, however, is that both D. Subbarao and Raghuram Rajan dealt with economic disruptions that had global triggers; these amplified the fallout from our domestic economic fault lines. You, on the other hand, are presiding over a home-grown, conscious policy-driven disruption. Some might even reason that its aetiology has a stronger basis in politics than immediate economic necessity.

My limited purpose in writing to you is to flag a few relevant issues that have been screaming for clarity from the Reserve Bank of India (RBI). It is almost a month since the historic 8 November announcement but there has been no guidance on these issues. The confusion is compounded by the chronic lack of transparency around the RBI board, differing practices and interpretations across major central banks within their respective laws and the best practices followed.

First, how extensively did the RBI board deliberate the pros and cons of its never-before disruptive “recommendation" on 8 November to the government?

Second, were other options also considered, and if so, why did the board zero in on the recommended path? One would like to believe there was some cost-benefit analysis—no matter how inexact—of its recommendation, unless the board doesn’t let facts interfere with its decisions.

Third, what was the pressing need to hit the stock of unaccounted wealth immediately and without even the most basic preparation? The need to keep the announcement a surprise is understandable but it is a poor apology for the conspicuously shoddy implementation that appears to be decided on the go.

The issue about the urgency of the decision is significant because the implementation of goods and services tax (GST) next year would have improved tax compliance meaningfully. Of course, the RBI can duck its duty of greater transparency. However, that course of action won’t dress up the RBI and its board in glory.

Fourth, how long can the old notes be exchanged at RBI? The central bank’s press release on 8 November categorically mentions the opportunity to exchange the old bank notes at specified offices of the Reserve Bank until a later date. Will that “later date" be end-March 2017 (end of the government’s financial year), or end-June 2017 (end of RBI’s financial year)? Could it be several years later?

One wonders why anyone in future should believe RBI’s promise to pay the bearer of its fiat currency when any government can decide—for whatever reason—to make some denomination of its currency illegal, and that automatically absolves the central bank of its promise to pay the bearer.

The legality of modern-day fiat currency is relevant for ensuring confidence in using them for private-sector transactions. However, the explicit promise by a central bank is of a qualitatively higher order and goes to the heart of having confidence in paper money.

Fifth, does the government’s decision to make some denominations of bank notes illegal extinguish RBI’s promise to pay the bearer of these bank notes? The unclear answer explains the rampant confusion about the possibility of a huge decline in RBI’s currency liability, which in turn could, according to some, prompt a “windfall" transfer of surplus by RBI to the government.

This “windfall" has become less relevant now that it is becoming clear that the amount of currency that isn’t converted or deposited for exchange is going to be significantly less than the reported official guesstimate of Rs4-5 trillion. Perhaps the ingenuity of some dishonest Indians forced the original game plan to be altered, despite the surprise element.

Frankly, even if this was never an option, the boost to revenue from the reportedly hurriedly put together second income disclosure scheme by the government would still be a positive for public finances. Of course, it also raises questions about policy credibility, after the government’s assurance that the income disclosure scheme earlier this year would be the last one.

Modern-day fiat money isn’t born illegitimate; illegal transactions and tax evasion make it so. Indeed, it is the political executive’s poor design of tax policies and shoddy implementation of laws and compliance that create unaccounted income.

Even after the ongoing disruptive exercise, the government will rely on the same army of tax officials for filtering the misreporting, or lack of reporting, of undisclosed income which earlier couldn’t be relied up to do a credible job. Ironically, the very policy measure meant to nab illegal wealth also throws up opportunities for generating new unaccounted income!

I look forward to RBI redeeming itself with effective and comprehensive communication that also enhances transparency.

Rajeev Malik is a senior economist at CLSA, Singapore. These are his personal views.

Close