Role Of RBI And Finance Ministry In Demonetization

On 8th November 2016, our Hon’ble Prime Minister Shri Narendra Modi, announced the demonetization of all ₹500 and ₹1,000 banknotes of the Mahatma Gandhi Series. The primary reason was that the action would curtail the shadow economy and crack down on the use of illicit and counterfeit cash to fund illegal activity including terrorism.  The decision has been a huge one as, RBI estimations suggested that 16.5 billion and 6.7 billion notes of 500 and 1000 respectively were floating in the economy and all the cost that went on to print these had gone sunk which cannot be undermined (around ₹3 for printing one ₹1000 note). But the amount of collection of black money that govt. was expecting was definitely a lot more than that as almost 84% of the cash was in the notes of 500(45%) and 1000(39%).

The Reserve Bank of India had initially stipulated a window of fifty days until 30 December 2016 to deposit the demonetised banknotes as credit in bank accounts. The banknotes could also be exchanged over the counter of bank branches up to a limit that varied over the days. Initially, the limit was fixed at ₹4,000 per person from 8 to 13 November. This limit was increased to ₹4,500 per person from 14 to 17 November. The limit was reduced to ₹2,000 per person from 18 November. All exchange of banknotes was abruptly stopped from 25 November 2016. It is evident from the data known to us that over the period of the whole process RBI changed the guidelines several times. One of the major issues that RBI faced was the fact that the ATMs needed recalibration because the sizes of the new notes were not compatible with the old calibration. Finance Minister Arun Jaitley said ATMs had not been calibrated before the announcement to demonetise Rs 500 and Rs 1,000 notes to maintain secrecy. “It is a massive operation, it will take time.”Re-calibration of ATMs involved multiple agencies – banks, ATM manufacturers, National Payment Corporation of India (NPCI), Switch Operators, etc., and multiple activities making it a complex operation requiring immense coordination among these agencies. With a view to providing direction and guidance in this regard, it decided to set up a Task Force under the Chairmanship of Shri S. S. Mundra, Deputy Governor, Reserve Bank of India. Consequent to the announcement of withdrawal of Legal Tender status of banknotes of Rs 500 and Rs 1000 denominations from the midnight of November 8, 2016, the Reserve Bank of India also made arrangements for exchange and /or deposit of such notes at the counters of the Reserve Bank and commercial banks, Regional Rural banks and Urban Cooperative Banks.

According to sources, 97% of the demonetised bank notes have been deposited into banks which have received a total of ₹14.97 trillion ($220 billion) as of December 30 out of the ₹15.4 trillion that was demonetised. This is against the government’s initial estimate that ₹3 trillion would not return to the banking system. Of the ₹15.4 trillion demonetised in the form of ₹500 and ₹1000 bank notes of the Mahatma Gandhi Series, ₹9.2 trillion in the form of ₹500 and ₹2000 bank notes of the Mahatma Gandhi New Series has been re-circulated as of 10 January 2017, two months after the demonetization.

Legal framework behind the step:

“What gives the government the powers to declare legal tender illegal?”

Section 26 (2) of RBI Act gives these powers:

(2) On recommendation of the Central Board the [Central Government] may, by notification in the Gazette of India, declare that, with effect from such date as may be specified in the notification, any series of bank notes of any denomination shall cease to be legal tender 2 [save at such office or agency of the Bank and to such extent as may be specified in the notification].

What is the Central Board? It is the main body of RBI which governs the central bank and has 21 members. These directors are divided into official and non-official:

·         Official Directors

o    Full-time : Governor and not more than four Deputy Governors (which means 5 members)

·         Non-Official Directors

o    Nominated by Government: ten Directors from various fields and two government Official (10 + 2)

So before any decision is taken, the Ministry of Finance had an important role to play in case of the recent demonetisation. According to NDTV reports, Prime Minister Narendra Modi handpicked a trusted bureaucrat, little known outside India’s financial circles, to spearhead a radical move to abolish 86 percent of the country’s cash overnight and take aim at the huge shadow economy. Hasmukh Adhia, the bureaucrat, and five others privy to the plan were sworn to utmost secrecy, say sources with knowledge of the matter. They were supported by a young team of researchers working in two rooms at Prime Minister Modi’s residence, as he plotted his boldest reform since coming to power in 2014. And that’s how the whole plan was charted secretly and the suddenness of the feat was accomplished.  This has been a special case where depending on the need of the situations, guidelines had been changed. Overall we can say, the step to a certain extent was a well calculated one but the execution didn’t go smooth.  The banking officials worked tirelessly day and night, and with a bit of sacrifice from our fellow countrymen, this feat was achieved.