Dr Marek Porzycki Chair for Economic Policy Monetary Law and Monetary Policy 5b. Demonetisation of high-denomination banknotes in India Current matter – announced on 8 November 2016 Dr Marek Porzycki Chair for Economic Policy

Role of high-denomination banknotes in India’s economy Cash-based economy Limited use of foreign currencies; foreign exchange restrictions Rs 500 and Rs 1000 notes (equivalent to ca. 6.5 EUR and 13.5 EUR respectively) constituted ca. 85% of cash in circulation High level of tax evasion „black money” and its role on corruption and financing of election campaigns terrorism financing by counterfeit high- denomination banknotes

Surprise announcement On 8 November 2016 India’s PM Narendra Modi announced that Rs 500 and Rs 1000 banknotes would cease to be legal tender effective at midnight 8/9 November. New Rs 500 and Rs 2000 banknotes to be introduced Low denominations of Rs 100 and below to continue as legal tender A limited time to be provided for old demonetised notes to be deposited on banking accounts or exchanged Cashless payments to continue unaffected

Exchange facilities for demonetised banknotes Until 31 Dec 2016 old banknotes can be used for deposits on banking accounts without an upper limit as regards the amount; any deposits above a certain threshold (reported to be Rs 2,50,000) would attract the attention of tax authorities ATM withdrawals limited to Rs 2000/Rs 4000 per day; withdrawal in bank branches to Rs 10.000 per day/Rs 20.000 per week During the initial 72 hrs old banknotes can be used for payment at a limited number of state-run places; later extended to another 72 hrs Old banknotes can be exchanged for cash in any bank or post office only up to Rs 4000 per person until 31 Dec 2016; after that exchange will be possible only in RBI branches until 31 March 2017. Valid ID required.

Purpose of the demonetisation Cutting out the „black money” kept in cash Curbing tax evasion Curbing terrorism financing by counterfeit Rs 500 and Rs 1000 notes Encouraging cashless payments

Adverse results Nationwide chaos Huge queues at banks and ATMs Need to recalibrate the ATMs – about half of ATMs are unable to dispense new banknotes for the first 2-3 weeks Cash crunch – existing Rs 100 and Rs 50 notes are hoarded; even those holding new Rs 2000 notes are sometimes unable to spend them, as merchants struggle with giving change Freeze for most businesses – non-essential purchases are deferred; those essential kept to a minimum A hit for tourism – huge inconvenience for foreign visitors without Indian banking accounts; moneychangers have insufficient cash to exchange foreign currencies into rupees. Low-denomination notes (Rs 100 and below) traded above par value Some merchants continue unofficialy to accept old notes on temporary basis; sometimes with a discount (e.g. Rs 500 banknote as Rs 400)

Unlikely winners Children (unless their piggy banks are raided by parents…) Beggars Temple hundi (religious funds using temple donation boxes)

Sources Legal basis – notification of the Minister of Finance: http://finmin.nic.in/172521.pdf (scroll down for English) PM speech: http://www.ndtv.com/india- news/read-entire-speech-of-pm-modi- announcing-large-notes-banned-1622990 Reserve Bank of India announcements: https://www.rbi.org.in/scripts/bs_viewcontent.asp x?Id=3270 Ministry of Finance announcements: http://finmin.nic.in/ Wikipedia https://en.wikipedia.org/wiki/Indian_500_and_1000 _rupee_currency_demonetisation