Your Rs 500 and Rs 1000 notes will no longer be legal tender starting November 9. In a surprise address to the nation on Tuesday, Prime Minister Narendra Modi announced that India would be demonitising the notes in an effort to address corruption and the spread of black money in the country. Citizens will get a few months and many opportunities to trade in their notes for legal tender, but the government is hoping that by the start of 2017, Rs 500 and Rs 1,000 notes will no longer be in circulation.
"We have felt for many years that corruption and black money, poverty and terrorism are holding the country back," Modi said, as he was announcing the decision to demonetise the high-value notes.
This isn't the first time India has demonitised its currency. In 1946, the Reserve Bank of India actually banned Rs 1,000 and Rs 10,000 notes, primarily to deal with unaccounted money. These were then reintroduced with a Rs 5,000 note in 1954, before they were once again demonitised in 1978.
The idea behind the effort, as Modi suggested in a long preamble before his announcement, is to attack corruption and make black money harder to use. The decision may not have been a complete bolt from the blue: The State Bank of India had said in April that the cash surge in the country, which then RBI Governor Raghuram Rajan was blaming on elections, may actually have been owing to rumours of demonetisation.
The aim of taking the Rs 500 and Rs 1,000 notes out of circulation is to reduce the amount of illicit money in the economy. Simply put, many economists believe that high-value notes make it much easier for black money to move around the country, without necessarily being beneficial for law-abiding citizens or the poor.
Former Standard Chartered chief executive officer Peter Sands wrote a working paper earlier this year that called on countries around the world to demonetise their high-denomination bills.
"By eliminating high denomination, high value notes we would make life harder for those pursuing tax evasion, financial crime, terrorist finance and corruption . Without being able to use high denomination notes, those engaged in illicit activities – the “bad guys” of our title – would face higher costs and greater risks of detection. Eliminating high denomination notes would disrupt their “business models”.
Mint's Ajit Ranade made the same argument earlier this year, pointing out that the role of cash is diminishing in most countries, meaning those with illicit money are disproportionately benefiting from the use of high-denomination bank notes. Harvard's Kenneth Rogoff has in fact called for countries to completely phase out the use of paper currency.
That image – of a cashless economy – would be a mirage in an India where digital products are still limited to a very small urban elite, and the financial network still has miles to go before it covers the majority of Indian citizens.
Black money has been one of the key political planks that the Bharatiya Janata Party campaigned on, with Modi promising to bring back massive amounts of cash from abroad, and even being criticised for seeming to promise Rs 15 lakh to every Indian. That said, as the government has attempted to crack down on black money held in accounts abroad, it has become increasingly clear that most of the illicit money is here in India, most likely kept in high-value notes.
This effort now attempts to make it much harder for people to use illicit money, since they will have to find other ways to store their cash. As Sands explained,
"Eliminating high value, high denomination notes would not entirely eliminate tax evasion, financial crime and corruption, but would raise the costs and risks of such activities significantly... Without high denomination notes, it would simply be more difficult for criminals to make payments, to move money and to store it. It would be more expensive and the detection risks would be greater."
Of course, actually implementing this is something of a mammoth task. Modi explained how the country is planning to carry out this massive operation over the next few months, as millions of Indians will attempt to exchange their old notes.
It will stretch the capabilities of the financial system, which already does not extend across the country, and the interim period will also see many attempts by those holding on to black money to turn their cash into legal tender. The effort also depends heavily on Indian authorities actually delivering on the promise to make it easy for people to turn their old currency into smaller denominations. After this, the government plans to reintroduce a new Rs 500-denomination note, with limited circulation.
That said, it is a massive move from a government that is reaching the mid-way mark of Modi's tenure – and something of a gamble ahead of elections in Uttar Pradesh and Punjab, where one might expect much cash to be flying around. It follows Modi's financial inclusion scheme, an income declaration scheme and a special investigation team aimed at cracking down on black money, and suggests an actual attempt to deliver on the black money promises made in the BJP's campaign. How successful this will be, however, remains to be seen.