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Business News/ Opinion / Retiring the 1,000 rupee note

Retiring the 1,000 rupee note

Currency notes store value anonymously and the higher denomination ones are the preferred mode of moving illegal money

Currency notes offer anonymity and leave no trail. High denomination notes are anyway not used in most legitimate transactions. Photo: Pradeep Gaur/MintPremium
Currency notes offer anonymity and leave no trail. High denomination notes are anyway not used in most legitimate transactions. Photo: Pradeep Gaur/Mint

Two years ago, the Reserve Bank of India (RBI) announced that it would phase out all currency notes issued prior to 2005. It gave a three-month window to exchange the old notes for new, after which all such exchanges, especially for larger denominations, would need identity and address proof. It created quite a flutter. Ostensibly, this was to weed out fake notes, since they were mostly from pre-2005 vintage. But was it also to attack black money?

It was pre-election season after all, and there is always apprehension about the large flow of illicit money during elections. There was pressure on RBI to go easy. RBI blinked, and extended the deadline to turn in old notes well beyond the May 2014 elections. Of course, RBI would have stoutly denied any connection of its deferral to elections.

Currency notes store value anonymously, and are the preferred mode of moving illegal money. Election spending in India is far in excess of prescribed official limits, and the Election Commission has repeatedly raised this serious issue. Early in 2014, a prominent politician declared in a public speech that he had spent 8 crore in his 2009 campaign, well in excess of the 40 lakh limit. (He later said he was misquoted.) So all that excess spending is black money by definition. Multiply that with the total number of candidates, and then multiply that by the number of elections we have annually across the country. Then you have the scale of the problem of black money in elections. This column is not about electoral reforms, but rather the role of currency notes in the underground economy. Higher denomination notes are particularly useful to criminals and tax evaders. What if we demonetized the high value notes?

Just this month, the former chief executive of Standard Chartered Bank, Peter Sands, published a paper at the Harvard Kennedy School proposing to take high denomination notes out of circulation. He says “by eliminating high denomination, high value notes we would make life harder for those pursuing tax evasion, financial crime, terrorist finance and corruption". Sands also points out that despite a global push from the G-20 on anti-money laundering measures, and on transaction surveillance systems, less than 1% of illicit financial flows are seized.

Currency notes offer anonymity and leave no trail. High denomination notes are anyway not used in most legitimate transactions. In fact, notes and coins are a small part of money supply to begin with. In the UK, they are about 3%, while in the US about 10%. In India, they are 12% of M3 (broad money). For the US, most of the high value notes such as 100 dollar bills actually circulate outside US borders. The largest ever cash seizure from drug trafficking was $207 million in Mexico, and most of it was in 100 dollar bills. This large quantum of dollars circulating outside the US borders is a source of seigniorage or inflation tax collected from non-US citizens. And that might explain the persistence of 100 dollar bill printing, and it’s faster than GDP growth.

The role of cash is diminishing in most countries. Credit and debit cards, digital wallets, prepaid cards and online money transfers are all making cash redundant. In India too, the value of transactions settled electronically is well over 90%, according to RBI data. An early pioneer in the retail space was the Indian Railways’ online ticketing portal. It has been operating for more than a decade, and now handles more than 300 million passengers who carry out electronic transactions annually, most of them of relatively low value. The recent granting of payments bank licences along with the spread of Internet will lead to rapid proliferation of digital and mobile payments, and a smaller role for cash. Even microfinance companies in India have moved to cashless disbursal and collection. Truck fleet operators long ago issued smart cards and electronic wallets for their drivers to fill up at petrol pumps. The huge success of the Jan-Dhan Yojana with over 200 million bank accounts, and direct benefit transfers, implies less handling of cash. Income tax refunds are increasingly electronic. All of India’s tolls will be fully electronic in a few months. What role then for cash?

Indeed, in most countries, according to Kenneth Rogoff of Harvard University, more than 50% usage of cash is to hide from the tax authorities. To get to these tax evaders and illegal transactions, a first step is to cut off the supply of high denomination notes. Ordinary folk rarely use the 100 dollar bill. This face value is roughly 0.25% of the US per capita income. Using that as a thumb rule and adjusting for purchasing power parity, the highest face value in India should then be 250. Thus, prima facie, we have a case for phasing out both the 1,000 and the 500 rupee notes. Unlike the US, the Indian government does not get significant seigniorage from non-citizens since the rupee is not yet an international currency. On the other hand, discontinuing the 1,000 rupee note has many benefits, is feasible, and will surely make an impact on the black money stock. The time has come to say goodbye to the big note. And one hopes that RBI does not blink this time.

Ajit Ranade is chief economist at Aditya Birla Group.

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Published: 16 Feb 2016, 10:56 PM IST
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