The scope of the scheme was equally significant and should have given adequate hints about the government’s thinking on what it wanted to do a few months later. It had outlined plans to provide access to financial payment services to every citizen along with the ability to conduct card or digital transactions, digitize government collections by equipping each collection point with a method to accept card or digital payments and migrate payment transactions currently dominated by cash to non-cash modes. The government wanted to incentivize people to use card or digital transactions and disincentivize the use of cash-based transactions. Steps were taken to strengthen the infrastructure for acceptance of cards or digital transactions and encourage companies, institutions and merchant establishments to facilitate card or digital payments. Different departments of the Union government were given specific responsibilities to achieve both the short-term and medium-term goals—the short-term goals were to be realized in one year and the medium-term goals in two years.
For instance, the Ministry of Road Transport and Highways and the Ministry of Urban Development were asked to facilitate the use of existing open-loop systems issued by a bank for multipurpose use, including for making transit payments with a dedicated application like toll fees, metro rail ride or bus services. This was essentially aimed at facilitating the payment of toll fees through cashless instruments. The Department of Financial Services in conjunction with the RBI was expected to ensure that each eligible account holder under the PMJDY should be provided access to the digital financial services in addition to the RuPay card. The Department of Electronics and Information Technology was entrusted with the task of formulating an action plan wherein all government departments and organizations introduced infrastructure for acceptance and collection of all revenues, fees and penalties through card or digital means, beyond a specified threshold, through electronic platforms or ‘PayGov India’, which it must develop as a single unified portal across Central and state governments as well as their public-sector undertakings for collection purposes.4
Similarly, the Department of Financial Services and RBI were expected to take steps to rationalize merchant discount rates (MDR) on card transactions and formulate a differentiated MDR framework for key transaction segments such as utility payments and railway ticketing by examining the matter holistically in consultation with the stakeholders. A detailed plan for creating infrastructure for accepting such digital payments was outlined. This included the introduction of adequate numbers of point-of-sale or POS terminals or mobile POS terminals for card payments and a review of the requirements under the Prevention of Money Laundering Act and rules to bring uniform know-your-customer norms based on an authorized identity for all payment systems.
The message from the government was unmistakably clear. There was an attempt to reduce the preponderance of cash in all transactions in the economy, although cash in itself did not always represent black money. There was also an attempt at greater formalization of the economy, bringing more people under banking coverage. The presence of credit card companies and their desire to expand their business also helped in this push towards non-cash transactions. In retrospect, it seems the government had made up its mind on the massive attack it would launch on high-denomination currencies in circulation a few months later. It is clear that the government was building the infrastructure where transactions could be made in non-cash modes once the crackdown on cash was announced.
Taken together with Finance Minister Arun Jaitley’s Budget announcement on a crackdown on black money and a tax compliance window, which gave taxpayers a final chance to declare their undisclosed income after paying a penal rate of tax at 45 per cent, the finance ministry’s office memorandum on the same day completes a full circle. The government had by then made up its mind on a crackdown on cash. It is also possible that because the government was not sure how successful its drive would be against black money in terms of declaration of undisclosed income, it had begun exploring alternative methods to reduce the preponderance of cash. How and when that would happen was perhaps left to a smaller group of people in the government, including, of course, the prime minister. But it would be wrong to assume that demonetization was a disruption that the government caused without much thinking or prior planning. It was kept a well-guarded secret till its announcement on 8 November 2016. But it would not be incorrect to assume that the government had been toying with the idea of demonetization from as early as February 2016.
What Went On behind the Scene
Sometime in February 2016, the government of Narendra Modi had initiated a highly secret conversation with the then RBI governor, Raghuram G. Rajan.5 His views on demonetization were sought and Rajan told the government that although there might be long-term benefits, the ‘likely short-term economic costs would outweigh them’. More importantly, Rajan told the government that there were potentially better alternatives to achieve the main goals that it sought to achieve. The government did not stop there and asked the RBI governor to prepare a note on demonetization.
According to Rajan, the RBI prepared a note and submitted that to the government. What did the note contain? Rajan writes in his book, I Do What I Do, that the note ‘outlined the potential costs and benefits of demonetization as well as alternatives that could achieve similar aims’. And if the government, after weighing the pros and cons of the move, decided to go ahead with demonetization, Rajan’s note explained in detail what kind of advance preparations the government needed and how much time such preparation would require. The note also pointed out the consequences of inadequate preparation before the rollout of demonetization.
It is after receiving that note from Rajan that the government set up a committee to consider the issues that would arise out of demonetization if such a decision were to be taken. Rama Subramaniam Gandhi, the deputy governor in the RBI, in charge of currency, attended the meetings held by the government. While it is true that the government did not ask the RBI to take a decision on demonetization while Rajan was in charge of the RBI till 3 September 2016, the issue of demonetization did come up in a media interaction with the governor earlier in 2014. Rajan said at the annual Lalit Doshi memorial lecture in August 2014: ‘I am not quite sure if what you meant is demonetize the old notes and introduce new notes instead. In the past, demonetization has been thought of as a way of getting black money out of circulation. Because people then have to come and say how do I have this 10 crore in cash sitting in my safe and explain where they got the money from. It is often cited as a solution. Unfortunately, my sense is, the clever find ways around it.’6
In a detailed report in the Hindustan Times, Rajan was quoted further to say the following:
Black money hoarders find ways to divide their hoard into many smaller pieces. You find that people who haven’t thought of a way to convert black to white, throw it into the hundi in some temples. I think there are ways around demonetisation. It is not that easy to flush out the black money.7
Elaborating further, the report added, Rajan said that a fair amount of unaccounted cash is typically in the form of gold and, therefore, even harder to catch. Rajan explained that his approach would be to crack down on incentives that led to generation and the retention of black money. Black money expert Arun Kumar, however, disagreed with Rajan’s views on black money hoarders. According to him, neither do most of them keep black money in gold nor do they throw their unaccounted wealth in the hundi in temples.8
Nevertheless, what the above indicated was that Rajan had to deal with the demonetization issue even during his public speeches almost one and a half years before the matter was even broached with him by the government in February 2016. For the government and the RBI, also, demonetization as an idea was not something that just sprang up one fine morning. There were discussions, meetings and debates within a small group of officers, which were, of course, kept secret and confidential. Within the government, a handful of officers in the PMO and the finance ministry were aware of the government�
�s plan to demonetize eighty-six of the currencies in circulations. And within the RBI, except the RBI governor, Rajan, his deputy governor in charge of currency management, R. Gandhi, and a few of their trusted lieutenants, nobody had any inkling of the disruption that was awaiting the nation.
Urjit Patel was at that time the deputy governor in charge of monetary policy and one whose reports on a new monetary policy framework and an inflation-targeting mechanism mandated by law were receiving serious attention within the RBI and the government. This would eventually pave the way for a new regime from September 2016. The new monetary policy framework meant a departure from the existing practice in which the RBI governor would decide on the monetary policy review, after consultation with his senior team and a clutch of technical advisers, whose advice, however, was not binding on the head of the central bank. In the new system, the monetary policy review exercise would be undertaken periodically by a committee to be chaired by the RBI governor. But the monetary policy committee will have two other members from the RBI and three members from outside the central bank. And the appointment of these three members would be made through an official search committee, to be headed by the cabinet secretary and the RBI governor would only be a member.
Similarly, a law was being framed to set an inflation target of 4 per cent, based on the movements in the consumer price index, with a range of 2 per cent either way. If the RBI failed to adhere to that inflation target, the governor would be obliged to explain to the government why such deviation took place.
This was going to be a new regime, where the RBI governor was made more accountable to a committee system of reviewing the monetary policy and a legally mandated inflation target. Urjit Patel as the deputy governor was a key player in framing the contours of this new regime. Little did he know then that he would be the next governor, succeeding Rajan from 4 September 2016, implementing the new system from the very first monetary policy review exercise that he undertook as the new governor. He was also completely unaware of the other big move that was being initiated by the government and the RBI. Patel had no idea then that more than the new monetary policy regime, he would have to handle the biggest disruptive event that any RBI governor had done in the past.
In 1946, before India became independent, currency notes of Rs 1000 and Rs 10,000 were removed from circulation. This had little impact on the people as their circulation was very low. But later in 1954, both these were reintroduced along with Rs 5000 currency notes. Twenty-four years later, the first demonetization took place in independent India. That was in 1978. Prime Minister Morarji Desai wanted to crack down on black money and decided to demonetize currency notes of Rs 1000, Rs 5000 and Rs 10,000. However, the governor of the RBI at that time, I.G. Patel, disagreed with that strategy. That left Desai with no option other than getting an ordinance on demonetizing these notes promulgated. Subsequently, he followed that up with the passage of the High Denomination Bank Notes (Demonetization) Act in Parliament. But the impact of that demonetization on ordinary people was relatively small as the share of these high-denomination currency notes in the total currency in circulation was less than 1 per cent. In 2016, Prime Minister Modi opted for a new route for demonetization. He sought recourse to Section 26 (2) of the RBI Act, 1934, under which the government, on the basis of recommendations from the RBI, could declare that bank notes of any denomination would cease to be legal tender. Thus, unlike Desai, Modi did not need an ordinance for demonetization. An RBI board meeting recommending demonetization to the government was good enough.
Coincidentally, both in 1978 and 2016, when demonetization took place, a Patel was at the helm of the RBI—I.G. Patel in 1978 and Urjit Patel in 2016. Also, both the prime ministers behind the two demonetization plans hailed from Gujarat. Demonetization in independent India has a strong Gujarat factor!
Where the 2016 demonetization stood out in contrast was the manner in which the decision was implemented. The question that arose was if a good number of people in the RBI and the government knew of the demonetization plan, certainly the preparations that should have been undertaken before implementing it were inadequate. It is possible to argue that the exigencies of keeping the move a secret did not allow larger dissemination of the information and necessary action to be undertaken for a glitch-free implementation. The disruption may have been sudden and the decision process was kept secret. But a few people in the government and the RBI knew of the steps that were being planned. They were also presumably aware of the consequences of those steps and what preventive measures and safeguards needed to be taken or put in place to manage the disruption and minimize its impact. Yet, the adverse consequences to the economy in the wake of demonetization, as outlined in a later section, brings out another stark failure of those who planned this massive disruption. Even after being involved with the planning before demonetization, these important players in the government system underestimated its actual impact. The failure to manage the disruption, clearly, accentuated its adverse impact on the economy and society.
CHAPTER 23
THE HAND OF THE RBI AND MODI
Rama Subramaniam Gandhi, a postgraduate in economics, joined the RBI in 1980 and rose pretty fast in the hierarchy to become its executive director in 2011. Barring a short stint at the Securities and Exchange Board of India (SEBI), the mild-mannered Gandhi spent the bulk of his working life at the central bank. So, when on 3 April 2014, Gandhi became the deputy governor, it was hailed as the rise of an in-house officer of the RBI to occupy a board-level position in that august organization. In the three years that he occupied that post, Gandhi handled a wide range of portfolios—regulations of banks, non-banking entities and cooperative banks, financial and operational risk management, financial stability, management of foreign-exchange and external reserves, payment systems, information technology, financial market regulation and currency management. Gandhi retired from the RBI in April 2017. But of all the various portfolios he handled as deputy governor, the one pertaining to currency management will remain deeply etched in his mind.
Not without reason. In February 2016, Gandhi was summoned by RBI Governor Raghuram G. Rajan and asked to assist the government in examining the pros and cons of a move to demonetize high-denomination currencies in the system. It was a top-secret assignment. Nobody in the RBI system apart from Gandhi and RBI Governor Rajan knew of the plan. Even within the government, there were not too many who had any information on why the government was seeking information on what steps needed to be taken if a large number of currencies were to be replaced with new ones. A note had also been prepared by Rajan on what the short-term and medium-term consequences would be if all high-denomination currencies were to be declared invalid and what preparations needed to be made if the government still went ahead with the proposed demonetization. Like Rajan, Gandhi too was not comfortable with the idea of such a disruptive measure, even though the problem of counterfeit currency was getting worse, though its incidence was a very tiny proportion of all the high-denomination currency notes in circulation at that time. But the solution for that was not demonetization, but a more concerted attack on fake currencies and bringing in new currency notes with better designs and more robust security features.
Work on bringing out new currency notes and changing their designs started as early as in February. The PMO and the RBI were in close consultation over the design and new features of the new currency notes to be circulated. Gandhi was in charge of the entire operations from the RBI’s side. The procedures were elaborate and followed while maintaining utmost secrecy. As many as eighteen designers worked on the new currency notes at the Mysuru currency printing press of the RBI and they took about forty-five days to complete the design work. An official at the RBI printing press at Mysuru would travel to the PMO in New Delhi and get the designs approved. In a digital age, no emails or postal correspondence was undertaken. Instead, all the processes followed a physical drill, in a bid to ensure secrecy. By May 2016, the matter was referred to th
e RBI board, which then cleared the introduction of currency notes with a value of Rs 2000.
In June, the printing presses at Mysuru and Salboni in West Bengal were told to undertake no more fresh printing of currency notes of Rs 1000 and Rs 500 value. This was probably the most significant pointer that the government had by then decided about its demonetization plan. Raghuram Rajan was at the helm of the RBI at that point in time. While Gandhi implemented that decision and got a clear sense of the government plan, Rajan too must have realized by then that demonetization was in the offing. On 18 June 2016, Rajan announced his decision to return to the academia and not continue as the RBI governor beyond the completion of his three-year tenure on 4 September 2016. This was almost two and a half months before his tenure was due to end and discussion was on with the government on the nature of his next term. Rajan made public his letter to his colleagues in the RBI on that Saturday morning. Recounting his achievements as the governor, Rajan also noted the fresh challenges that he would have liked to tackle in the coming days. These challenges included the operation of the new monetary policy framework, the tasks of completing the clean-up of bank balance sheets by resolving their stressed assets and a few potentially risky international developments.
The Rise of Goliath Page 34
