‘A very rare opportunity to tackle fake notes, terrorist financing and black money’

In a 7-page note submitted on December 22 to the Department Related Committee of Finance, the RBI said its Central Board that met on November 8 noted that the proposal to withdraw the legal tender status of high-denomination bank notes could not have come

Preparation

Though no firm decision was taken initially, whether to demonetise the high denomination notes or not, preparations still went on for introduction of new series notes, as that was needed in any case.

Besides, the RBI had earlier in October 7, 2014, suggested to the government the need for introduction of higher denomination notes of Rs 5,000 and Rs 10,000, keeping in view the inflation since the introduction of Rs 1,000 denomination in October 2000 and the need for facilitating payments and managing the currency logistics. The government considered the same, and after deliberations, advised on May 18, 2016, their in-principle decision to introduce notes in a new denomination of Rs 2,000.

Accordingly, the RBI, on May 27, 2016, recommended to the government that new series of notes with new designs, sizes, colours and themes including notes in the new Rs 2,000 denomination be introduced. The government gave its final approval on June 7, 2016, and accordingly, the presses were advisedinjune2016toinitiateproductionofnew series notes.

Decision

On November 7, 2016, the government advised the RBI that to mitigate the triple problems of counterfeiting, terrorist financing and black money, the Central Board of the RBI may consider withdrawal of the legal tender status of the notes in high denominations of Rs 500 and Rs 1,000. It was advised in that letter that cash has been a facilitator of black money since transactions made in cash do not leave any audit trail. Elimination of black money will eliminate the long shadow of the ghost economy and will be positive for India’s growth outlook. They also observed that in the last five years, there has been an increase in the circulation of Rs 500 and Rs 1,000 notes with an increasing incidence of counterfeiting of these notes. There have been widespread reports of the usage of the Fake Indian Currency Notes (FICNS) for financing of terrorism and drug financing. The FICNS have their origin in the neighbouring country and pose a grievous threat to the security and integrity of the country. Hence, the government has recommended that the withdrawal of the legal tender character of these notes is apposite. The government advised the RBI to place these matters of immediacy before the directors of the Central Board of the RBI for consideration intermsofandaspertheprovisionsofsection 26 (2) of the Reserve Bank of India Act, 1934.

The Central Board of the RBI met on November 8, 2016 to consider the government’s advice. The Board noted that a summary measure with high and lasting impact in the form of withdrawal of legal tender character of these high denomination bank notes to contain the menace of counterfeit notes is proposed by the government. It was observed that such a proposal could not have come at a more opportune time than coinciding with the introduction of the MG (New) series of notes: with these, the existing banknotes can be summarily withdrawn, and the new design notes with more counterfeit resistance features be introduced.

It was considered that the action as proposed by government would result in nonavailability of these denominations for the public for transaction and store of value purposes; it might not immediately be possible to replace these notes fully in terms of both value and volume on one to one basis, within a specific time. However, the stock of Rs 2,000 denomination were arriving in RBI offices and were being dispatched to currency chests across the country and that could enable meeting a significant critical portion of the physical demand therefrom in value terms. Besides, electronic means of transaction were expected to take another part of the transaction load hitherto met from physical currency. Further, the available stock of other denominations at RBI and currency chests would also help meet demand. Further, Rs 500 banknotes in MG (New) Series was also being introduced. With these measures in place, it was considered that the transition from old series to new series in the context of withdrawal of legal tender character of Rs 500 and Rs 1,000 could be managed. It was also noted that the implementation phase would be closely monitored and necessary corrective actions could be taken as and when necessary.

After deliberations of the proposed scheme, the Board decided to recommend to Central Government that the legal tender status of the banknotes in the high denominations of Rs 500 and Rs 1,000 be withdrawn as per the Scheme. Government considered the recommendations and decided to withdraw that the legal tender status of the banknotes in thehighdenominationsofrs500andrs1,000. The Gazette Notification dated November 8, 2016 contained this decision and the Scheme.

Impact on RBI’S balance sheet

The withdrawal of legal tender status of thespecifiedbanknotes(sbn)willbeimpacting the balance sheet of the RBI in the following ways. To the extent, the SBNS are exchanged with other legal tender notes, there will be no impact on any components of the balancesheet.however,totheextentthesbns are deposited and value thereof has been credited, the notes in circulation component of the balance sheet will get reduced and the deposits by commercial banks component will get increased by an equal amount. Further, to the extent the SBNS do not get returned to the RBI, there will be no change in the balance sheet, as such notes will still remain the liabilities of the RBI. Thus on net basis, there will be no net impact on the balance sheet of the RBI because of withdrawal of the SBNS.

Rationale

Government of India, on the recommendations of the Central Board of the RBI, withdrew the legal tender status of banknotes of Rs 500 and Rs 1,000 denominations effective midnight of November 8, 2016.

In the last few years, the RBI, in consultation with the Government of India, had been working on introduction of new series of banknotes. It included improving existing security features, introduction of new security features and new design features including new color scheme and new sizes, besides a new theme. Primary objective behind this entire exercise is to secure our banknotes against counterfeiting.

In parallel, Government of India had been taking several steps to curb black money and combat terrorism. There were reports by intelligence and enforcement agencies that availability of high denomination banknotes made it easier for black money hoarders and counterfeited notes in high denominations were being used for terrorist financing.

It occurred to Government of India and the RBI that the introduction of new series of notes could provide a very rare and profound opportunity to tackle all the three problems of counterfeiting, terrorist financing and black money by demonetising the banknotes in high denominations of Rs 500 and Rs 1,000 or by withdrawing legal tender status of such banknotes.