Demonetization: Too Much Too Soon

Length Estimate: Long (words > 1000)


Sorry for the absence last week. I was derailed by an event of world-historical proportions – the American election results  the conclusion of my research on Indian land reforms and colonial peasant revolts. I actually wrote the following piece on the Great Indian Demonetization last Monday and sent it out to various online news outlets as a contribution. Due to the lack of response I have decided to post it below. A week has passed since this piece was written and many of the concerns that are outlined below have been vindicated in the meantime. The long-running tropes of administrative inadequacy and legislative myopia were baked into the demonetization cake and many commentators were similarly skeptical about its likely outcomes. Although I don’t want to ascribe more importance to this event than it deserves by making it the subject of an article, its resonance with the themes covered in this blog makes it fair game.


The announcement made by Prime Minister Narendra Modi on the eve of November 8, 2016 that currently circulating 500 and 1000 rupee notes will cease being legal tender was masterfully timed for maximum dramatic impact but left many questions unanswered. It is the latest in a succession of larger-than-life measures declared under the Modi government and comes on the back of the record-breaking Pradhan Mantri Jan Dhan yojna, which sought to expand banking services to 75 million households through the mobilization of PSU banks. This time the sudden demonetization of 80% of India’s circulating currency is intended to shock people out of their bad cash habits and remove the primary instrument that facilitates much of the daily economic life of the average Indian[1]. But unless comprehensive structural reforms that should have preceded this demonetization are implemented swiftly, this “bold move” will only have an oblique, if any, impact on the much deeper issues that continue to plague the Indian economy.

Three broad themes underlie demonetization: first, the existence of a large informal economy that employs most of India’s working population; second, the parallel consolidation of a cash-based economy beyond the purview of legal supervision and taxation and third, the long-term move to a cashless economy. Let us address these in turn.

More than 80% of India’s workers are employed in the informal sector, which means they are not subject to protection from labor laws or entitled to benefits[2]. People employed in the services sector – from rickshaw pullers to domestic help to daily-wage laborers – are all compensated in cash on informal terms. A vast majority of these workers don’t have bank accounts, a situation no doubt encouraged by the preponderance of the cash economy. Many of them do not possess valid photo IDs either – a requirement for exchanging old 500 and 1000 rupee notes at post offices and bank accounts under the new measures[3]. So their only option is to wait for their employers to obtain the new forms of legal tender or pay them in smaller denomination notes, both of which will require a considerable amount of time to obtain.

If demonetization was a step towards the long-term transition to a formal economy that would legally protect the rights of these workers, this could be a short-term cost worth bearing. However, there is nothing in the policy logic that would suggest that the latter will naturally follow. The deepening of mass enfranchisement in the form of widespread banking services, verifiable and valid photo identification for all and official records of employment contracts engaged in by individuals are prerequisites for the suppression of cash as an agent of the informal economy. Unfortunately, none of these conditions have materialized. The administrative burden of such a large-scale state-led mobilization is evidenced in the performance of the Pradhan Mantri Jan Dhan Yojna. A landmark expansion of banking services, it has yet to make a significant dent in this regard: a significant number of newly created accounts lay dormant and nearly a third of “new” depositors already have access to a bank account. It is ill-advised to leap ahead with demonetization when financial inclusion has only taken a few tottering steps.

Hence, for most of the working poor the demonetization will be just another heavy-handed short-term “inconvenience” that will not lead to any material improvement in their lives. The argument that trumpets the plausible long-term advantages of this strategy, should they materialize, betrays the traditional contempt and callousness with which the political and financial elite view the underclasses – as subjects who must be coerced or goaded into accepting a change they didn’t demand but from which they will supposedly benefit…in the long-run. If the money isn’t lost in between and used well. Yeah, right – that story is as old as independent India itself and convinces nobody, except those who continue to believe in the “if only we have the right person in power” trope.

Another structural issue where dangling the carrot for long periods of time is a superior alternative to a painful smack of the stick is the cultural attitude of Indians towards banking and cash. Although the demonetization of large value notes has its ostensible parallels in similar measures proposed in the US and the Eurozone for the $100 bill and 500 euro note respectively, these are fundamentally different measures. As cash use has dwindled in the developed world, large monetary transactions are almost always carried out electronically; ATMs in the US often only dispense $20 notes. Thus, their limited use naturally encourages the pariah status of large denomination notes.

However, while 500 euro bills are called “bin Ladens” in Europe for their specific association with money laundering and criminal enterprise, the 500 and 1000 rupee notes are ubiquitous in India’s money supply. Contrary to claims made by the political leadership, removing them from circulation is far from a surgical strike. These notes are used by the entire strata of the working population from wage-level workers to well-compensated executives. When a large proportion of the population decides to line up at ATMs instead of going to work, what happens to the economy? Targeting large-denomination bills will not isolate a few select, suspicious individuals from the rest of the population; the process will be more akin to searching for a few needles in a giant haystack. Thus, the government is using a cannon to make sure it gets the bull’s eye but it risks decimating the entire target in the process.

For the reasons discussed above, demonetization will not constitute any significant step towards a cashless economy. Although there are reservations about the replacement of cash by electronic transactions regarding privacy and security[4], there are definite benefits in the Indian context*, especially in having the ability to transparently and efficiently transfer subsidies and developmental funds to beneficiaries. It is important to remember, however, that cashless economies impose both monetary and administrative costs on people, including gaining access to the requisite technology and maintaining a bank account. Thus, the cashless paradigm must be demonstrably superior to the status quo to make a compelling case for transition. Without the infrastructure that makes cash use the exception rather than the rule of everyday life, i.e., regularly used banking services and electronic money transfers for everyone, cashless society remains a pipe dream.

The move to a more transparent, equitable economy where people can parlay on economically equal terms is not something that can be accomplished at the stroke of midnight. It is a function of systemic issues that the Indian state has consistently failed to resolve in its seventy years of existence. The people have often looked up to their leaders for grand initiatives that have often succeeded only in accruing to them political capital whilst foreclosing the possibility of genuine reform. Hopefully, demonetization is just one step in a larger comprehensive program which has at its heart the extension of formal banking services to the unbanked and rural masses. If the past is any indication, however, I won’t be holding my breath.


I am grateful to Harsha Goel for providing ideas, motivation and proofreading for this piece.

[1] By value; see:
[2] See:
[3] See:
[4] As evidenced by the recent ATM hacks:

*Those benefits are only worthwhile in the present convention of funds dispersed via a hierarchical, centralized apparatus which provides numerous avenues for “leakages”, ensuring that little, if any, of the intended money reaches beneficiaries. The validity of this approach is itself questionable and demands critical attention, perhaps as the subject of a future post.


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