The role of cash notes is to facilitate an instant way to trade, pay and complete the transaction at the lowest cost. A vendor gives goods or services and gets paid instantly in cash notes. The transaction is verified and completed instantly without any wastage of time. Electronic payment is no doubt a product of convenience for the affluent, but it costs significant amount in fees. If you spend Rs. 1 lakh in a year, at 2% you will be paying Rs.2000 in fees! At 5 minutes for each ePayment transaction for 240 transactions in a year, it costs the customer 1200 minutes i.e. 20 hours in time. This is far more expensive both ways than using cash notes. The cash note therefore, is the most cost effective way for small value transactions.

The process of issuing currency notes by the Government is, in simple words, the sale of pieces of printed paper by the Government for real money in the Bank. It is a process of creating money in the Bank. The cost of printing the note is a fraction of its value, thus the Government actually makes a profit by issuing notes. However there is a limit set by prudential norms for the printing of notes and requires strict control. In India this is a function of the Reserve Bank of India. The Reserve Bank controls the issue of cash currency required by the banks to meet their withdrawals from bank accounts. Reserve Bank ensures that every Rupee of cash given out by the bank is against a reduction of the rupee from the bank balance, so that there is no inflationary effect.

However, in a growing economy like India, there is a real requirement of increase in the quantum of cash notes with increase in population and with growing per-capita income. Reserve Bank assesses such requirement and the Government spends that amount additionally as deficit financing. With more Government spending, additional notes are needed by the banks for withdrawal which adds to the currency in circulation. This liberty of deficit financing with the additional printed notes may be of the order of 3% of Revenues of the Government in a country like India or perhaps even more. The increase of cash money supply is equal to the increase in the inventory levels of cash currency (i.e. stock of notes) with the people. This additional release of printed notes helps for smooth running of the economy without any inflationary effect. But, the issue of these additional cash notes adds significantly to the financial resources of the Government.

When a bank gives out a currency note, the value of the note is reduced from the customer’s account and credited to the bank’s account. Thus real money with the bank increases. A mandated fraction of which is put into the Reserve Bank to maintain its Cash Reserve Ratio (CRR).  So the withdrawals from bank accounts in the form of cash notes by its customers result in the bank adding to its bank balance and to that of the Reserve Bank. It is the opposite when the customer brings cash notes to deposit them in the Bank account, the Bank credits real money to his Bank account against his paper notes. For the Bank, this deposit increases cash-on-hand of the Bank and reduces the bank balance of the Bank. Excess cash-on-hand of the Bank is deposited by the Bank into Reserve Bank which results in Reserve Bank paying the Bank the value of these paper notes by crediting real money to the account of the Bank. In short, by pulling out currency notes from the public, Government loses, the money in the Treasury reduces, whereas by issuing currency notes, the balance in the Treasury increases and the Government gains.  

Now let’s come to demonetization. The Government in it’s wisdom, made the high value notes no longer a legal tender overnight on the 8th Nov. 2016. That meant that people could no longer use these notes for paying for goods and services. But they could deposit these notes in their bank accounts upto 30th December 2016. Consequently, within a period of 30 days, almost 90% of the cash notes came back into the banks, swelling bank deposits of customers and reducing the bank balances of the bank and increasing the cash-on-hand of the banks. The excess cash-on-hand was deposited by banks into Reserve Bank against credit of real money to the account of the respective banks. The Reserve Bank got worthless paper in their vaults for shelling out real money to the banks. The balance of real money with the Reserve Bank i.e. in the treasury has fallen drastically. Thus Government got worthless printed paper as it gave out real money in its exchange. The real money with the Government was transferred to the people in their bank accounts. This is a major loss of money from the treasury of the Government of India. In mid December 2016, this loss was huge; about Rs 8 lakh crores! The notes with the Reserve Bank are not a legal tender and therefor their value is nil for accounting purpose. It may perhaps take bending of the established accounting practices for the Reserve Bank to survive this loss.

The result of demonetization without adequate supply of paper currency was that the Government purchased the worthless pieces of printed notes at their face value at a great loss to the Treasury. This would have been avoided if the banks had enough new printed paper currency to pay out, by giving paper for paper. Instead, the banks gave out real money for worthless paper.  Due to paucity of new paper notes, the banks were unable to let the customers withdraw any amount of cash notes from their own money in their own bank accounts. The banks caused hardship to their customers, defaulted in their function, greatly shaking people’s faith for keeping money in their Bank account. 

The Government then started a crusade-like campaign for cashless transactions with smartphones using eWallets and such apps. They aimed for cashless economy. But the plight of the poor sections of society could not be redressed by such payment systems. They needed cash notes to earn their livelihood which had disappeared. The Government has now become aware of this hardship.

Analysing the above scenario, my conclusion is that though the Government has temporarily deprived the country of adequate amount of paper currency resulting in loss of income for the daily wagers, marginal farmers and cottage industry. But it has created a situation for a great boost to the Government revenues and economic growth in the future. Not because country will become cashless society but because it will soon become a cashrich economy. The faith of people in the banking system has eroded as they could not withdraw their own money from their Bank account as and when they needed it. The restriction on withdrawal of their own money by the people from their bank accounts has invoked an unending appetite for the paper currency. This will create an insatiable demand for cash notes by the people. The people will withdraw more cash than they need to build a reserve of cash notes in their cupboards. As a result, crores of people will keep a much larger amount of cash with them at home.

The cash build up will go on till the appetite of the people is satisfied. Nothing can stop it now. The cash notes in circulation in India therefore may go up from the pre-demonetization amount of Rs.14 lakh crores to perhaps an astronomical amount of Rs.20 lakh crores! With this remonetisation, the Government will be selling new printed paper as currency notes for real money. The Government coffers will gain substantially, Treasury will fill up greatly. The increased cash in the economy will be a big boost to the GDP. The Government will have learnt the benefits of cash notes in the economy and will not attempt to thwart it again as it will be socially unjust, economically unwise and politically inexpedient. But the Government will find other methods to ensure tax compliance, so tax-evaders beware. As for the general public and poor people, they may rest assured that cashflow will return with a vengeance and demonetization will end up doing good for them after all.

My conclusion is therefore that demonetization done without adequate stock of new paper money will whet insatiable appetite for cash money and eventually lead to a cashrich economy, good for India and the World.