Will demonetization cause cash shortage?

Will demonetization cause cash shortage? -?Dr. Kishore Nuthalapati*

Demonetization is an economic tool Governments use to avoid counterfeit notes, tackle black money issues, improve security features, etc. This tool need to be used rarely and only when justified.

The economic history also reveals the same. In June 2019, as public trust for Zimbabwe currency was lost, its Government had demonetized local currency and later replaced with Zimbabwe dollars after a brief bitter experience with using foreign currencies. In November 2016 India demonetized notes of Rs. 1,000 and Rs. 500 denominations. In year 1999, Malaysia had demonetized its currency Ringgits and replaced with new notes. In year 1987 Myanmar had demonetized its 25, 35, and 75 Burmese Kyat notes. In year 1984, Nigeria demonetized 50 and 100 Naira notes. In year 1982 Ghana had demonetized its currency, Cedi. Singapore had demonetized its currency twice, in year 1980 and earlier in year 1970. In year 1953, South Korea had demonetized its currency.

Almost all the countries that have demonetized their currencies had objectives of arresting black money, combating corruption, confiscating counterfeit currency notes, punishing tax evaders, and avoiding terrorism, etc. Interestingly, in December 2016, after announcing demonetization of 100 Bolivars, Venezuela withdrew its drive due to the protests on increased economic crisis.

Regardless of the officially claimed success, it is a common knowledge that those who could amass and hoard the currency notes would also manage to convert their demonetized notes into new notes. This was proven in almost all the demonetization drives, and in India as well. If this was not the case, the newly issued Rs. 2,000 notes need not be demonetized within a short span of 5 years.

Demonetization exercises have significant costs such as printing cost of new notes, administrative costs, costs associated with the physical movement of people to convert the old notes, etc. Ideally, except for the time inconvenience to exchange the old notes with new notes, there should not be any economic loss for the common public. But as economies do have embedded shadow markets, undesirable and distressing impacts will arise. They include sudden shortage of other notes as hoarding of Rs. 2,000 notes would be replaced with hoarding of Rs. 500 notes. The trickle-down impact will create cash shortage in the markets. The sectors such as unorganized trade, real estate, sub-wholesale distribution businesses, gig service sector, tourism, entertainment, food & beverage, hospitality etc., may see notable impact.

To minimize such adverse impacts, Government should ensure fool-proof tracking of depositors, strict KYC filings, note-series tracking, matching of income tax returns with bank deposits, rigorous and daily monitoring of note-exchanges, and strict surveillance on the banks, petrol bunks, small currency accepting businesses, etc.

In the absence of consolidated objective efforts, the demonetization exercise may only remain as a political tool leaving common public with procedural disturbances and delays. The learnings from the previous demonetization should be relied upon to make the current demonetization exercise appreciable.

* Disclaimer: Dr. Kishore Nuthalapati is the CFO of BEKEM Infra Projects Pvt Ltd. Views are personal and do not reflect those of any of the organizations he is or was associated with.