The Rise of Goliath

by AK Bhattacharya

  Rajan noted in his letter to his colleagues:

  While I was open to seeing these developments through, on due reflection, and after consultation with the government, I want to share with you that I will be returning to academia when my term as Governor ends on September 4, 2016. I will, of course, always be available to serve my country when needed.1

  For Gandhi, however, the resignation announcement made little impact on his work schedule in the next few months. By mid-September, 2016, Gandhi made sure that the printing of the new Rs 2000 notes had begun. Simultaneously, the printing of the new Rs 500 notes too had begun in other printing presses in Dewas in Madhya Pradesh and Nashik in Maharashtra. Urjit Patel had become the governor of the RBI on 4 September 2016. And the new notes thus bore the signature of Patel.

  The challenge of maintaining secrecy over the currency note exercise was proving to be formidable. A report in a Hindi publication, Dainik Jagran, on 28 October,2 seemed to have revealed it all about a fortnight before the decision on demonetization was made public. Brijesh Dubey, a business journalist based in Kanpur, wrote that the government was likely to soon issue new currency notes of Rs 2000 value with high-security features to curb black money. The report also said that in a bid to curb fake currencies, a serious view was being taken on the existing currency notes of Rs 500 and Rs 1000 value. It was significant that the board of the RBI under its new Governor, Urjit Patel, held its meeting at Kanpur on 20 October. Within days of Dubey’s report in Dainik Jagran, a WhatsApp picture of the new Rs 2000 note became popular, raising questions on what the government was planning to do with a new currency.

  On 30 October, a Sunday, Diwali was celebrated across the country. The government weighed the pros and cons of advancing the decision on demonetization to pre-empt further leakage of information. Eventually, it opted for 8 November 2016 to be the big day. The schedule for advance preparations for managing the consequences of demonetization certainly suffered. But the embarrassment of further leaks was avoided.

  Gandhi told Gopika Gopakumar of the Mint about a year after demonetization that the government went in for Rs 2000 notes to keep a check on the circulation of high-value currency notes. ‘We had to ensure that a minimum value of new notes was available before the government went ahead with demonetization. Hence we decided to introduce Rs 2000 notes,’ Gandhi said. As early as in 2014, the RBI had mooted the idea of printing currency notes of higher denomination, but the finance ministry agreed to the idea of printing only Rs 2000 notes. An area of concern was over the pace of the printing of these new currency notes, which later became a major headache for the government and the RBI as demonetization was rolled out.

  But the government’s concern over fake and counterfeit currency was real in many ways. A sharp surge in the detection of counterfeit notes had been noticed since 2008. They more than trebled from 1,95,000 pieces in 2007–08 to 6,32,000 in 2015–16 and most of these notes came from across the border in Pakistan. The sophistication in the way these counterfeit notes were produced in printing presses in Pakistan was a major worry and this put more pressure on the RBI to come out with a new series of currency notes, particularly with higher denominations.3 Since then the government and the RBI kept consulting each other on the new currency series that needed to be issued to counter the menace of counterfeit currency notes. This also raised the awareness level among banks and people about the menace of fake and counterfeit currency notes. Also, thanks to the rapidly spreading technology of currency note counting and sorting machines, the rate of detecting counterfeit notes improved dramatically increasing the reported incidence of the menace.

  A few more steps were explored by the RBI to address the problem of counterfeit currency. In 2013, the central bank explored the idea of switching over to printing of plastic currency notes as these were difficult and also expensive to counterfeit. Another big move was taken in 2014, when the RBI issued a circular saying that all currency notes printed before 2005 would have to be phased out and a three-month window was given during which such old notes could be exchanged with the new ones. This created uncertainty and even fear among the people if this was a veiled demonetization being introduced by a different name. The RBI quickly issued clarifications to quell such fears and the window of exchanging such notes was extended till 31 December 2016.

  Gandhi also made sure that necessary steps were taken to build the capacity of the Indian government to print sufficient numbers of currency notes within the country. In 2013, the Bank Note Paper Mill India Private Limited was set up in Mysuru as a subsidiary of Security Printing and Minting Corporation of India Limited and Bharatiya Reserve Bank Note Mudran Private Limited. The objective of this move was to reduce the country’s dependence on imported paper for printing currency notes. According to reports, an estimated 18,000 tonnes of paper was produced by the Bank Note Paper Mill between April and December 2016—a period of just eight months. This is much higher than its estimated capacity of producing 15,000 tonnes of paper for currency notes. In addition, another 30,000 tonnes of paper for printing currency notes was imported by the end of December 2016. All this to help the RBI to manage the consequences of demonetization and meet the demand for new currency notes after 8 November 2016.

  For Gandhi, 8 November 2018 was not an ordinary working day. He had come to Delhi by the morning flight to attend a meeting of the RBI Board to be held the same afternoon. It was the 561st meeting of the Central Board of Directors of the RBI. No specific reasons were cited why the Board met at New Delhi. One of the Mumbai-based directors of the Board, Natarajan Chandrasekaran, who at that time was the CEO and managing director of Tata Consultancy Services and later became the Chairman of Tata Sons, could not attend the meeting. The board granted leave of absence to Chandrasekaran. After the customary signing of the minutes of the previous meeting of the RBI’s Central Board (the 560th held in Kanpur less than a month ago on 20 October), Gandhi placed before the Board a memorandum from the RBI’s Department of Currency Management.

  The speculation and suspense over why a Board meeting had been convened got over. Gandhi’s memorandum recommended the ‘withdrawal of the legal-tender status of bank notes in the denomination of Rs 500 and Rs 1000 of existing and any older series in circulation’.4 Along with the memorandum, Gandhi also presented a copy of a finance ministry letter of 7 November 2016 along with a draft scheme for implementing the withdrawal of the legal-tender character of existing Rs 500 and Rs 1000 bank notes. These were submitted before the RBI Central Board for its consideration and commending to the Central Government under Section 26 (2) of the RBI Act, 1934. Section 26 of the RBI Act pertains to the legal-tender character of currency notes in circulation. And Clause 2 of Section 26 says that on the recommendation of the RBI 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’.5 The RBI Central Board was now required to recommend to the government to annul the high-denomination currency notes.

  The RBI Board was also informed about the sharp rise in the circulation of bank notes in the denomination of Rs 500 and Rs 1000 in the five-year period between 2011–12 and 2015–16. The Board was informed that while the Indian economy in these five years grew by 30 per cent, the bank notes in the denomination of Rs 500 and Rs 1000 grew by over 76 per cent and 109 per cent, respectively, in the same period. This was an instance of a flawed use of statistics and, therefore, a weak and poor argument to justify demonetization. The 30 per cent economic growth figure was measured at constant prices, without adjusting for inflation during this period. The nominal economic growth (including the impact of inflation) in these five years would be about 57 per cent and the gap between the nominal economic growth and the increase in the high-denomination currency notes would have, therefore, shrunk considerably.

  The government’s argument presented before the Board touched upon a few othe
r issues. It cited the Finance Ministry’s White paper on Black Money to note the following:

  Cash has always been a facilitator of black money since transactions made in cash do not leave any audit trail. The White Paper also quotes the estimate made by the World Bank in July 2010 wherein the size of the shadow economy for India has been estimated at 20.7 per cent of GDP in 1999 and rising to 23.2 per cent in 2007. Incidence of counterfeiting is also on the rise in these two denominations. The total counterfeit currency in the country is estimated to be around Rs 400 crore.6

  Present at that meeting of the Board were RBI Governor Urjit Patel, his two deputy governors—R. Gandhi and S.S. Mundra, and five other directors—Nachiket Mor, a former executive director of ICICI Bank whose second tenure as director was cut short a little after one year in September 2018, Bharat Doshi, a senior finance professional who worked in various capacities in the Mahindra group, Sudhir Mankad, a retired IAS officer and a former chief secretary in the Gujarat government, Anjuly Chib Duggal, an IAS officer who was then secretary in the department of financial services in the finance ministry, and Shaktikanta Das, an IAS officer who was then secretary in the department of economic affairs in the finance ministry and later in December 2018 was appointed the RBI governor. There is no documentary evidence on who all among the RBI Directors responded to the memorandum that was put up for the Board’s recommendation. But some of those observations suggested that the memorandum did not have an easy passage at the Board meeting.

  Three critical observations, which were recorded in the Board meeting’s minutes, deserve to be recounted here:

  The growth rate of the economy mentioned is the real rate while the growth in currency in circulation is nominal. Adjusted for inflation, the difference may not be so stark. Hence, this argument does not adequately support the recommendation.

  While any incidence of counterfeiting is a concern, Rs 400 crore as a percentage of the total quantum of currency in circulation in the country is not very significant.

  Most of the black money is held not in the form of cash but in the form of real-sector assets such as gold or real-estate and that this move would not have a material impact on those assets.

  There were also comments that supported the demonetization move, though these too had struck a note of caution and sought an assurance that the concerns over the adverse impact on the economy would be addressed. These comments ran as follows:

  It is a commendable measure but will have short-term negative effect on the GDP for the current year.

  Exemption provided to medical stores can be extended to private medical stores as well.

  Arriving domestic long-distance travellers, who may be only carrying high-denomination notes will be taken by surprise at railway stations/airports for payment to taxi drivers and porter charges and hence put to hardship. It would also have an adverse effect on tourists.

  The Board was assured that the matter has been under discussion between the Central Government and the RBI over the last six months during which most of these issues have been considered. Apart from the stated objectives, the proposed step also presents a big opportunity to take the process of financial inclusion and incentivizing the use of electronic modes of payment forward as people see the benefits of bank accounts and electronic means of payment over the use of cash.

  The Board was assured that the Government will take mitigating measures to contain the use of cash.

  The RBI management was extremely reluctant to make public the minutes of the 561st meeting of its Central Board. For months together, requests for releasing these minutes made under the Right to Information Act were turned down. It was only under the directives of the Chief Information Commissioner under the RTI Act that the RBI released those minutes in March 2019. What these minutes clearly show is that the decision on recommending demonetization was not an easy and smooth affair. Serious concerns were expressed over the impact and hardships that demonetization would create. The directors seemed to have recognized the inevitability of the decision on demonetization, but spared no efforts in seeking as much assurance as possible to help mitigate the adverse impact of annulling 86 per cent of the country’s total currency in circulation. The minutes also established that the government and the RBI were in consultation with each other on the plan for demonetization for about six months. A puzzling development during the Board meeting was the presentation of a finance ministry letter dated 7 November 2016. It is not clear what the contents of this letter were. The RBI Act clearly mentions that the government can annul currency notes of any denomination on the recommendation of the RBI’s Central Board of Directors.

  What was the finance ministry letter doing in that Board meeting? Under what sections of the RBI Act was that letter written and sent? There is no clarity on this as yet. Was the RBI Board being guided by the finance ministry to recommend the declaration of high-denomination currency notes invalid? Such questions must have troubled many of the Board members on that day. But in the end,

  [the] Board considered the memorandum and after detailed deliberations concluded that in larger public interest, the balance of advantage would lie in the withdrawal of legal-tender status of Rs 500 and Rs 1,000 currency notes currently in circulation and passed the following resolution: Resolved that the proposal of the Deputy Governor recommending withdrawal of legal tender of bank notes in the denomination of Rs 500 and Rs 1,000 of existing and any older series in circulation, is hereby considered and commended by the Central Board of Directors for forwarding the same to the Central Government.

  The 561st meeting of the Central Board of the RBI began at 5.30 p.m. on 8 November 2016. Going by the minutes of the meeting, the meeting could not have lasted very long. But it was not an easy meeting for the RBI Board to hold. The Board had been advised by the government to consider a proposal that some of its directors were not comfortable with. The resolution that was adopted and used to convey the RBI’s recommendation for demonetization put the ball in the court of the RBI. Official records would show that it was after all a proposal of the RBI deputy governor that recommended demonetization. The consent of the RBI board was communicated back to the government. Having received the RBI recommendation, Prime Minister Modi held a Cabinet meeting to announce his plans and secure its approval before he started his address to the nation at about 8 p.m.

  Even as Prime Minister Modi began his address, Gandhi kept his fingers crossed, busy checking if all the preparations were in order. ‘I was busy going through my checklist over and over again to be sure that the RBI was ready with the action plan to stem the blow of the announcement,’ Gandhi told Gopika Gopakumar in late 2017 while recalling the developments more than a year earlier.7

  The Miscalculated Surgical Strike

  The first five-odd minutes of Modi’s address to the nation on 8 November 2016 were spent on how the government had improved the country’s economic situation, reviving growth in spite of two years of severe drought—an economic performance that was hailed not just domestically but also by institutions such as the World Bank and the IMF. The prime minister also reiterated his government’s commitment to development for all—Sab Ka Saath, Sab Ka Vikaas—and listed out the major schemes to uplift the poor and spread fruits of economic growth among larger sections of people, which included a drive to open bank accounts for the poor and increase financial reach and inclusion (Pradhan Mantri Jan Dhan Yojana, PMJDY); a scheme to widen the coverage of insurance for the poor (Jan Suraksha Yojana); a programme that provides loans to small entrepreneurs (PMMY); a scheme providing financial assistance and guidance to the Dalits, tribals and women (Stand-Up India); and a scheme providing cooking gas connection on easy terms to homes of people from economically weaker sections (Pradhan Mantri Ujjwala Scheme) among others.

  After outlining these developments, the prime minister drew attention to the growing menace of black money and corruption, in spite of the many attempts his government had made to eliminate both the economic ills. Was it then a clear
admission by the prime minister that because the earlier schemes to unearth black money had failed to secure the desired results, the government decided on demonetization?

  A third ill that the prime minister added to the list of economic challenges was that of terrorism, which he said was holding the country back in its development march. He even mentioned how many terrorists were apprehended with fake currency notes of Rs 500 and Rs 1000, which were seized from them. Modi now reminded the nation how his government had launched a frontal attack on black money, corruption and terrorism. He listed some of them as well: Setting up the Special Investigation Team, headed by a retired Supreme Court judge, passing a law in 2015 for disclosure of foreign black money, signing of agreements with many countries, including the US, that compelled the signatories to share banking information among themselves, a strict law to curb benami transactions used to deploy black money earned through corruption and a scheme allowing the declaration of black money after paying a penal rate of tax.

  At this stage of his speech, it became quite clear that the prime minister’s announcement was not going to be about any external threat but about measures against black money, corruption and terrorism. Giving credence to such expectations were Modi’s statement that the government had till then succeeded in bringing into the open about Rs 1.25 lakh crore of black money. He posited the fight against black money as a fight on behalf of honest citizens and poor people, who were harmed the most when black money prospered and corruption remained unchecked. He also noted how high circulation of cash boosted the hawala trade, which was connected to black money and illegal trade in weapons. No less worrying for him was the role of black money in elections.