The Indian demonetisation fiasco

More than a month ago, on November 8th, in a nationally televised speech, Indian Prime Minister Modi announced that from that midnight onwards 85% of value of cash in circulation in India will become invalid. The two higher denomination currency notes of Rs 500 and Rs 1000 which were withdrawn from circulation formed the bulk of cash in use. Government gave time till December 30 to exchange or deposit old invalid notes, but put heavy restriction on the amount of withdrawal of new notes from Banks.

The stated reason for such a drastic move was to curb black money, eliminate counterfeit notes and to reduce terrorism.  Looking back after a month it seems the move failed in all counts while putting ordinary people, especially the poor to severe hardships. Moreover it opened new avenues of corruption with involvement of bank and income tax officials.

Most economists were very critical of the move. Here are some excerpts of the criticisms.

Only an authoritarian government can calmly cause such misery to the people — with millions of innocent people being deprived of their money and being subjected to suffering, inconvenience and indignity in trying to get their own money back.”

Telling the public suddenly that the promissory notes you have, do not promise anything with certainty, is a more complex manifestation of authoritarianism, allegedly justified — or so the government claims — because some of these notes, held by some crooked people, involve black money. At one stroke the move declares all Indians — indeed all holders of Indian currency — as possibly crooks, unless they can establish they are not.

the intended targets know how to avoid the trap: “It is hard to see how. This will be as much of a failure as the government’s earlier promise of bringing black money stacked away abroad back to India (and giving all Indians a sudden gift — what an empty promise!). The people who are best equipped to avoid the intended trap of demonetisation are precisely the ones who are seasoned dealers in black money — not the common people and small traders who are undergoing one more misery in addition to all the deprivations and indignities from which they suffer.”

Amartya Sen , economist and Nobel Laureate

Image Credit - Times of India

Image Credit – Times of India

Demonetization was ostensibly implemented to combat corruption, terrorism financing and inflation. But it was poorly designed, with scant attention paid to the laws of the market, and it is likely to fail. So far its effects have been disastrous for the middle- and lower-middle classes, as well as the poor. And the worst may be yet to come.

When the government announced demonetization, it also justified the measure as a way to curb terrorism financing that relies on counterfeit rupee notes, as well as to dampen inflation.

Both these justifications are flawed. Catching fake notes already in circulation neither helps trap the terrorists who minted them nor prevents more such money from being injected into the economy. It simply inconveniences the people who use it as legal tender, the vast majority of whom had no hand in its creation.

There also is no evidence that black money actually is more inflationary than white money; nor in theory should it be. Black money is just money held by people instead of the government. It’s an excessive money supply that tends to create inflation; whether that money is white or black makes little difference.

Kaushik Basu, Chief Economist of World Bank

Image Credit - Huffington Post India

Image Credit – Huffington Post India


Demonetisation may have been seen as a “big-bang” measure that would enhance the regime’s credibility in fighting black money and divert attention from its perceived failures. The informal economy accounts for 80 per cent or more of the workforce and nearly a half of total output. It has been grievously stricken by the government’s woefully inadequate preparation and complete failure to anticipate the impact of the move it has unleashed. This has been the inevitable consequence of the massive reduction in liquidity visited on an economy that conducts nearly 90 per cent of its transactions in cash. It has not only meant a great deal of avoidable distress, including deaths, for the mass of the people but also a devastation of the economy in the short and medium terms, with no guarantees for a revival subsequently. The advice to ordinary people to go digital in a context of poor bank and internet penetration is not only insensitive and gratuitous, but positively appalling.

Venkatesh Athreya

Former Professor of Economics, Bharatidasan  University, Tiruchi



The demonetisation policy, at best, is a one-time tax on black money that is stored in the form of cash. But only around 5-6 per cent of undisclosed income is held in cash. Therefore, even if all of it gets targeted by this measure, it will not be an effective way to go at the existing stock of black money. Moreover, black money generation is a continuing process that involves evading taxes and regulations, and engaging in corrupt and criminal activities. These cannot be tackled with a one-time measure. They will continue unabated with the new currency notes. Ironically, this reform may even increase the stock of black money held in cash in the future by facilitating hoarding in currency notes of a higher denomination (the Rs 2000 notes).
Even if the effectiveness of the policy in curbing black money will be minimal, the cost will be very high. Other than the direct cost of printing new notes, given that the affected currency notes constituted 86 per cent of the total volume of cash in the country, this policy effectively led to a much higher drop in liquidity than even the drop in the money supply (about 30 per cent ) that the US Fed is criticised for doing during the Great Depression. The informal sector is largely cash-dependent and alone accounts for 40 per cent of the GDP and employs 80 per cent of the workforce. It, along with the rest of the economy, is suffering perhaps the biggest policy-induced recessionary shock in post-Independence India. Add to it the physical hardship imposed on ordinary citizens in terms of standing in line, and strain on the capacity of the banking sector, which have resulted in deaths. This may go down in recent history as the biggest example of firing cannonballs to kill mosquitoes (granted that these were causing the malaria of corruption), with huge collateral damage.

Maitreesh Ghatak

Professor, The London School of Economics and Political Science, London

Image Credit- The Indian Express

Image Credit- The Indian Express


If demonetisation is to work as an attack on black money, it will only work if it is done repeatedly to any means of settlement that is used for illegal activities, and illegality is of course, not limited to cash transactions. No form of settlement is then safe from the arbitrary fancies of those in power. This is far from either a “surgical strike” or a “dose of strong medicine”. It is quackery. Worse, it is authoritarian quackery that cannot help but do deep damage to the basic institutional understandings that underpin our society.

Arjun Jayadev

Associate Professor, Azim Premji University, Bengaluru



As regards the policy mix, clearly demonetisation of the type undertaken is neither necessary nor sufficient. First, the policy will not impact the incentives for, nor deter, the earning of illegal incomes and evasion of taxes. The principal sources of the black economy in activities like political funding and election expenses, real-estate transactions, construction, tax evasion and bureaucratic corruption will continue. Second, the stock of black economy does not get affected much for, only a small portion of black money is held in currency. Much of it is stashed abroad or held in real estate, and gold and foreign currency.
It is obvious that the shock therapy of such a magnitude cannot be implemented by the banking system. Over 30 per cent of the people employed in India are casual labourers who receive their wages and pay for their purchases in cash, and they have been put to severe hardships. With trade, tourism and construction activity coming to a standstill and with agricultural sectors requiring but unable to get cash for purchasing seeds and fertilisers at a time when rabi sowing is on, the GDP in the economy will decelerate significantly. This is a typical case of throwing the baby out while retaining the bathwater!

M. Govinda Rao

Professor Emeritus , National Institute of Public Finance and Policy, New Delhi



The question of whether the human cost is acceptable would be hard enough to answer if the move were somehow successful in addressing its supposed aims. In fact, there is every reason to believe that it will be unsuccessful, which makes the avoidable human cost a tragic consequence of a cavalier or even cynical political calculation, or of poor economic ideas compounded by incompetence. The loss of trust in the currency and in the ability of the government to manage the economy has, ironically, also dealt a blow to the confidence of the domestic and foreign private investors whom the government is otherwise keen to please. Despite its debacle, the government and its faithful, some pliant economists among them, will likely assert that it has advanced its aims, as it can always claim that things would have been still worse. In such a case, there is no better recourse than common sense.

Sanjay G Reddy

Associate Professor, The New School of Social Sciences, New York


India may bounce back fighting this Modi made catastrophe, but at a severe cost.

Sources :

The Indian Express

New York Times



Comments welcome

This site uses Akismet to reduce spam. Learn how your comment data is processed.