RBI recent move to withdraw all currency notes

The central bank did specifically say there was no reason to get into a panic about bank notes printed before 2005 getting phased out. So naturally, a lot of people have done exactly that. That's an exaggeration of course, but it has to be said that there is consternation among large sections of the people.

The Bharatiya Janata Party fumed that the poor and the illiterate will be badly hit by the move. Meanwhile, some shopkeepers and cab drivers are looking askance at currency notes without the year of printing on the back.

Experts said gold and real estate prices may increase while individuals could face difficulty making transactions, leading to the mushrooming of agents to facilitate note swaps.

All these and more could be among the unintended consequences of the Reserve Bank of India's decision to swap currency notes that went into circulation before 2005 with new ones.

RBI governor Raghuram Rajan seems resigned to facing a barrage of questions over the move. Even Central Bureau of Investigation director Ranjit Sinha wanted to know whether the timing of the announcement on Wednesday had anything to do with the general election that's coming up. "I feared that this question will be asked," Rajan said in Delhi on Thursday. "The decision to withdraw pre-2005 currency notes after March 31 is not guided by politics and elections. It was a long-standing demand of the finance ministry. There are security factors attached with the decision."

Rajan was delivering the RN Kao memorial lecture. Incidentally, the governor's father had worked closely with Kao, founder of India's external intelligence agency, the Research & Analysis Wing.

"This is not an attempt to demonetise," Rajan insisted. "It is an attempt to replace less effective notes with more effective notes. I understand people are making different interpretations. Unfortunately that should not be the interpretation." Some RBI officials said that with many security features having been introduced since 2005, it made sense to withdraw currency without these to weed out counterfeits, which was possibly what the governor meant by "more effective notes".

Still, Sinha's question was legitimate. Black money with businessmen, politicians and elements beyond the pale of the law may chase real assets ahead of the polls on fears that come April they'll face uncomfortable questions from the income tax department even though in theory, unlimited amounts of currency could be exchanged without disclosing the source of income.

While that may act as boost to an economy in a prolonged slump amid a cut in government spending, a price rise would run counter to what policymakers are trying to achieve.

Veteran bankers remember what happened in 1977 when the Janata Party government of Morarji Desai demonetised notes of higher value to curb black money. But the intended effect was undone by a weakness in the system -- it moved to Nepal instead where the currency had the same status as in India.

"In 1977, RBI had withdrawn currency and called it demonetisation with a focus to curb black money hoarding,'' said Sunil Pant, a banker who retired from the State Bank of India recently. "We used to wait for customers to walk in with the notes, but it hardly happened. Pressure on undeclared currency could result in black money moving into other near cash assets like commodities.''