Need to bury memory of demonetisation

Almost one and a half years after the demonetisation fiasco the country has just witnessed a mini reenactment of long queues in front of ATMs running dry and bank branches limiting cash withdrawals. The cash shortage which started in Andhra Pradesh and Telengana in February and spread to eight States was not fully gone even by late April. This disruption will take its toll, particularly on those working in the cash-dependent unorganised economy.

Several disturbing questions pop up. Was there a glitch in an otherwise well thought out system to meet the economy’s cash needs while, over the longer term, discouraging the use of cash? Or is there a systemic flaw which, if not corrected, will lead to relapses of the same affliction over time? And if that be so, has the economy developed a new vulnerability which was not there before the late 2016 demonetisation?

The reasons trotted out for the cash crunch are — demand for cash abruptly increased, possibly because of several upcoming Assembly elections and the kharif marketing season. Notably, the highest denomination notes, ₹2,000, widely used during election campaigning, seemed to have mostly disappeared.

But even before this demand spurt, the Reserve Bank of India was unwittingly tying its hands behind its back in the matter of raising supply. Early last year it cut down on orders for supply of raw materials to print new notes, printing ink and security thread, and by June it was cutting down on note printing orders per se. So the RBI ceased to have the usual 8-12 months of back-up currency stock .

Stubborn queues

Despite government assurances and RBI upping supplies, the stubborn queues before ATMs persisted. This is because those who were earlier happy to live with a certain amount of cash, seeing there was some kind of a shortage, went out and tried to get some more. When they met with difficulties, their urge to hold cash increased, as did the length of queues.

Obviously, such sentiment feeds on itself and what we have seen is a bit of financial panic and miniature run on banks. The fact that panic and run subsided bears testimony to the soundness of the system. But the fact that there was a run in the first place highlights the need to look at systemic issues, not simply glitches.

First glitch. For its cash management, the RBI needs to keep an eye not just on historical cash-GDP ratios but also on elections that are heavily cash driven.

Second glitch. The mountains of unverified cash still lying around in currency chests have to be examined and accounted for immediately.

Third glitch. The disappearing ₹2,000 notes. The government possibly tried to staunch their outflow keeping the upcoming elections in mind. The attempt to curb the use of black money in electioneering is welcome. But what prevented the government from making an upfront announcement that there will be an attempt to curb the use of ₹2,000 notes? This gives rise to the speculation that the ruling party wanted to catch the Opposition by surprise and hit them hard.

Systemic issues

Now two systemic issues. One, the public seems less tolerant today to a perception of an emerging cash shortage, no matter how temporary, than before demonetisation. But more crucially the public today seems to quickly lose faith in banks being a safe place to keep their savings — again, a post demonetisation phenomenon.

So the government needs to convince people that, one, they will get enough cash whenever they need it and two there is absolutely no need to think at the first sign of a cash shortage that one’s money is not safe in banks. To regain credibility, the government needs to tell people : We are sorry we botched up demonetisation.

Restoring people’s faith in the banking system is far more difficult. But the government can make a beginning by taking two decisions. One, raise the level of deposit insurance from the present ₹1 lakh, fixed in 1993 after the Harshad Mehta scam, to take care of the rise in per capita nominal GDP between then and now. This will take depositors back to where they were a quarter century ago.

But more importantly the government needs to reassure the public that in case a troubled bank’s creditors need to take a haircut, that process will not include depositors, specifically saying that any provision of ‘bail in’ in the Financial Resolution and Deposit Insurance Bill will not apply to bank depositors. Once these actions are taken, we can hope that panic withdrawal of cash will become a bad memory which will not return.

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