Demonetisation
8th November 2016 is probably the most remembered demonetization date in India.
Prime Minister Narendra Modi had declared in a television broadcast that Rs.500 and
Rs.1,000 notes would cease to be legal tender. He also announced the issuance of the
new Rs.500 and Rs.2,000 banknotes.
Remember the year 2016, when it was announced overnight that the currency notes of
the face value 500 rupees and 1000 rupees will no longer be functional? This left the
citizens of India frenzied and confused, not to mention the long queues that were
formed at the banks to get the currency changed. There was a lot of confusion between
people as to why this decision was made and while a majority of people supported it,
there were also some who condemned the act. However, there were also a lot of us
who had heard the term “demonetisation” for the very first time that year and had no
idea what this term actually entails and why it is so important in an economy.
Although it is something that most of you must have learned because of what happened
in India five years back, the term demonetisation is not at all new to the world and it has
its roots deep in the world’s economic history. Therefore, to understand this term a little
better and know why some of the largest economies have undergone the process of
demonetisation, let us have a look at the basic concepts behind this term and its role
around the globe as well as in our country.
What is Demonetisation?
The term demonetisation refers to the act of stripping a currency unit of its status as
legal tender. In simple terms, you can say that when demonetisation of a currency
occurs, the currency loses its face value and is no longer of the status to be used as
legal money for any kind of transactions. This usually happens when there is change of
any national currency, which involves withdrawal of the existing form or forms of money
that is currently being circulated and replacement of those forms with new notes or
coins. Rarely, it may happen that a country will entirely replace its old currency with new
currency.
Demonetisation is often considered as a drastic intervention in the
country’s economy as it involves removing the legal tender status of the currency and
can affect the day to day business activities in the economy. If demonetisation goes
wrong, it can cause a chaos or serious downturn in an economy. The chances of this
happening are even more when demonetisation is announced suddenly, without any
prior warning. The process that is opposite to demonetisation is called remonetisation
which refers to the act of restoring a payment form as a legal tender.
Demonetisation is often believed to bring stability to a country’s currency and used as a
tool to fight inflation, facilitate trade and give the economy a better access to
the markets which will allow it to push informal economic activities into becoming more
transparent and get them away from black and grey markets.
Why is Demonetisation used by a country?
The act of demonetisation can be used by an economy for various reasons. It is mostly
used as a tool to make the country’s currency more stable which will give more stability
to the economy and possibly fight inflation. Some countries even use demonetisation as
a solution to facilitate trade and have better access to the markets. Another reason why
demonetisation is used is to provide more transparency to informal activities and push
them away from the black or grey markets. One of the most important reasons as to
why a cash-dependent developing economy may use demonetisation is to combat
corruption and crime that often happen in the form of counterfeiting or tax evasion.
Understanding Demonetisation around the Globe
As we have already discussed above, demonetisation is used by economies for various
reasons that they find valid for the progress and development of their nation. Although
demonetisation can be harmful if gone wrong, it has also proved beneficial many times
when used across the globe by different countries and their economies.
The Coinage Act, 1873 in the USA, demonetised silver as its legal tender and fully
adopted gold standard. This was done to fight disruptive inflation which was as
significant as the new silver deposits discovered in the Western America. The act
suspended the circulation of various coins, including two-cent piece, three cent piece
and half dime. This act that removed silver from being circulated in the economy led to
contraction of money supply which in turn contributed to the downturn of the economy
throughout the country. This is the reason why silver was remonetised as a legal tender
through the Bland-Allison act in the year 1878. This remonissation was done in an effort
to put an end to recession and political stress that was going around among farmers
and silver miners.
Another example of demonetisation is when in the year 2015, the government of
Zimbabwe demonetised its dollar. This was done to fight the hyperinflation in the
economy. Zimbabwe demonetised the Zimabawean dollar and removed it from the
country’s financial system. It then fixed the Botswana Pula, the U.S. dollar and the
South African Rand as the country’s legal tender to stabilise its economy.
There are some countries that use demonetisation as a tool to facilitate trade or
establish currency reunions. This kind of demonetisation which is done for business
purposes was done by the countries under the European Union, when they formally
started using Euro as their daily currency in the year 2002.
Demonetisation in India
In the year 2016, demonetisation occurred in India. This was tried and used as a tool to
modernise the developing cash-dependent economy and to fight crimes like corruption
that involve counterfeiting and tax evasion. The Indian Government demonetised the
two most prominent denominations in its currency system— 500 rupees and 1000
rupees notes, which accounted for 86% of the country’s circulating cash. On November
8th, 2016, the Prime Minister of India announced that these notes will have no value.
This was done with no prior warning, but the citizens were allowed to change these
notes with the newly introduced currency of 2000 rupee notes and 500 rupee notes by
the end of the year.