How RBI Tried to Reduce Liabilities by Bringing Demonetization
Introduction
On November 8, 2016, the Indian government, led by Prime Minister Narendra Modi, announced the demonetization of Rs. 500 and Rs. 1000 currency notes. This meant that these notes were no longer considered legal tender, and people had to exchange them for new currency through banks. The main goal of this move was to tackle issues like black money, fake currency, and corruption. The Reserve Bank of India (RBI), as the country's central bank, played a crucial role in executing this decision.
One of the lesser-discussed reasons for demonetization was the idea that if a large portion of the old notes did not return to banks, the RBI’s liabilities would decrease. But did this actually happen? Let's break it down in simple terms.
Why Did RBI Want to Reduce Liabilities?
The Reserve Bank of India is responsible for printing and managing currency in the country. Every currency note that the RBI issues is considered its liability, meaning that the RBI is legally responsible for honoring its value.
The idea behind demonetization was that if a significant amount of currency did not come back to the banking system, those notes would become worthless. This would reduce the total amount of money that the RBI owed to the public, effectively decreasing its liabilities. Here’s how the government and RBI expected this to work:
- People with black money would not deposit their cash – Many people had large amounts of unaccounted (black) money, which they wouldn’t deposit due to fear of being caught by tax authorities.
- Fake currency would become useless – Counterfeit currency in circulation would automatically become invalid, reducing illegal money.
- Less cash in the system would push people towards digital transactions – The government wanted to move towards a cashless economy by encouraging people to use digital payment methods instead of cash.
What Actually Happened? Did It Work?
Now, let’s look at whether demonetization actually helped the RBI reduce its liabilities.
1. Almost All Money Came Back
One of the biggest surprises was that almost all the demonetized money returned to the banking system. According to the RBI’s 2018 Annual Report, 99.3% of the banned currency notes were deposited back into banks. Out of Rs. 15.41 lakh crore worth of demonetized currency, Rs. 15.31 lakh crore was returned. This meant that the RBI’s liabilities did not reduce as expected. People found ways to deposit their cash, even if it was black money, by using loopholes in the system.
While Rs. 15.31 lakh crore was returned, Rs. 10,720 crore worth of demonetized currency did not come back to the RBI. This amount, though small in comparison to the total demonetized currency, was considered an actual reduction in liabilities. The non-returned money could have been:
Cash held by individuals who could not deposit it due to lack of access to banking services.
Fake currency that got destroyed or was never brought back.
Money hoarded by individuals who feared tax investigations and thus let their cash become worthless.
Currency lost due to accidents, destruction, or being abandoned.
2. Increase in Cash Circulation
Another goal of demonetization was to reduce the amount of cash in circulation and encourage digital payments. However, in the following years, the total amount of cash in circulation actually increased. By 2022, more cash was in use than before demonetization. This showed that people still preferred cash transactions despite the government’s push for digital payments.
3. Black Money Was Not Eliminated
A major reason for demonetization was to eliminate black money. However, most black money is not stored as cash but is instead kept in assets like gold, real estate, and foreign accounts. Since almost all cash returned to banks, it showed that people with black money managed to convert it into legal money through different means.
4. Economic Disruptions
Demonetization caused significant problems for businesses and workers, especially in the informal sector, which relies heavily on cash transactions. Some of the major effects included:
- Slowdown in economic growth – The GDP growth rate declined in the quarters following demonetization due to reduced consumer spending.
- Job losses – Small businesses, traders, and daily wage workers faced severe losses, leading to many people losing their jobs.
- Cash shortages – For several months, there was a shortage of new currency, causing long lines at banks and ATMs.
5. Boost to Digital Payments
One of the positive outcomes of demonetization was the rise in digital payments. More people started using mobile wallets like Paytm, Google Pay, and UPI transactions. However, this trend was also influenced by other factors like increasing smartphone usage and better internet connectivity. Over time, cash usage rebounded, meaning the shift to digital payments was not permanent for everyone.
6. Total Expenditure on Demonetization
Demonetization also came at a cost. The RBI had to spend a significant amount on:
Printing new currency notes.
Managing logistics for exchanging old currency.
Strengthening banking infrastructure to handle the sudden increase in deposits and withdrawals.
According to RBI data, the total cost of printing new currency notes alone was around Rs. 7,965 crore in 2016-17, which was a sharp rise from Rs. 3,421 crore in 2015-16. Additional costs were incurred in bank operations, ATM recalibration, and other administrative expenses.
Conclusion: Was Demonetization a Success or Failure?
If we look at demonetization from the perspective of reducing RBI’s liabilities, it was not successful. The expectation that a large amount of money would not return did not happen, as almost all old notes were deposited back into banks. This meant that the RBI’s liabilities remained the same, with only a small reduction of Rs. 10,720 crore.
On the other hand, demonetization did help push digital transactions to some extent, but it also caused economic disruptions, job losses, and hardships for small businesses. While the intent behind the move was bold, the actual impact was different from what was expected. The long-term effects on India’s economy are still being debated, but from the viewpoint of reducing liabilities, demonetization did not achieve its goal.
