ECONOMYNEXT – India’s rulers suddenly demonetised larger rupee notes on November 08, making them valueless, supposedly to draw ‘black money’ back to the economy, showing once again why people around the world trust currencies such as the US dollar.

This is a path Sri Lanka has trod on the past but should never again follow if it wants to be financial centre.

India’s Prime Minister Narendra Modi on November 08 suddenly said 500 and 1000 rupee notes are no longer legal. Reports said bank cash deposit machines clogged up and businesses refused to accept the larger bank notes.

Delhi taxi driver Anu Choudhury was quoted by Reuters saying his boss called to say he should not accept 500 or 1,000 rupee notes from customers.

"This is not a good step for business. The prime minister did not think about people like us," he said.

Banks are expected to accept the old money as deposits from November 10 in return for new money and time will be given to change notes.

Any notes not changed by December will be worthless.

For the moment 500 and 1000 rupee notes will be accepted at government hospitals, pharmacies, railway stations government airlines, state oil companies, crematia on ‘humanitarian grounds’ Modi had said.

Trust in the US dollar

Despite the faults of the US Federal Reserve, acts by developing country rulers to resort to demonetization shows why currencies like the US dollar are trusted by millions around the world more than their own national currencies.

These included people in authoritative or socialist regimes where there are foreign exchange shortages, and countries like Sri Lanka where the central bank operates unstable soft-pegs and suddenly devalues it currency or imposes exchange controls.

Criminals and mafia types also use US dollars.

The US specifically demonetised a silver ‘trade dollar’ struck for export to China in 1876 after silver prices fell (under old coinage laws, silver or gold holders can ask the government to strike their metal into coins).

But a Coinage Act of 1965 has effectively re-monetised all notes and coins issued by the US government.

There is also a view that US law effectively prohibits demonetization due to a section in the law which says:

"All coins and currencies of the United States (including Federal Reserve notes and circulating notes of Federal Reserve banks and national banking associations), regardless of when coined or issued, are legal tender for all debts, public and private, public charges, taxes, duties, and dues."

But of course the Congress can at any time introduce new laws, if people do not understand the damage caused by demonetisation.

This is just one reason why the US continues to lead Europe in economic power and the US dollar remains the globally preferred currency.

Sometimes it is not big things that rulers do that makes countries great, but things they do not do.

Political Gimmick

The trick of demonetization was invented not by backward developing countries. India first demonetised in 1946 while it was still a part of the British Raj.

The notes were remonetised later and again demonetised in 1978.

Although demonetisation inconveniences and may result in losses to citizens who for some reason or another fail to convert by the deadline, its touted reason of bringing ‘black money’ back into circulation is doubted, although it is a favoured by rulers who have power over citizens.

I G Patel, Reserve Bank of India Governor in during 1978 in his book Glimpses of Indian Economic Policy: an Insider’s View, had said that the idea that black money was held in suitcases is naïve, and there will be little useful effects on reducing corruption or the black economy.

The current RBI Governor, appointed by Modi, has called the latest demonetization a ‘bold move’.

However, the damage to the trust in the currency will last. It will also spread into neighbouring countries, where the rupee had some convertibility.

Misplaced Trust

The hardest hit are Indian rupee users abroad who foolishly placed their trust in a ‘third world’ currency, not knowing the dangers of such a move.

Citizens of Sri Lanka, who may have held some rupee notes in their hand after travelling to India, will no longer do so in the future. Nepali citizens who hold Indian notes will also be in difficulty.

After central bank reforms in 1991 made the Indian rupee more acceptable abroad.

In Asian cities, including Colombo, currency dealers used to readily accept Indian rupees in the recent years.

But currency dealers in Asian cities who used to take Indian rupees were no longer accepting the paper, underling the danger of using a third world currency.

The day after the shock announcement "more than the usual number of Indian customers turned up frantically looking to exchange their Indian bank notes," Reuters reported. But they went away empty handed with many dealers showing ’00’ on their boards.

In Hong Kong’s Chungking Mansions, there were no takers for Indian rupee, with several currency dealers displaying "0.00" on their counters.

"This is really frustrating and we had no time to act," Gurpreet Kaur a Hong Kong resident of Indian origin was quoted as saying.

Before the money printing that followed after independence from Britain with the nationalization of the Reserve Bank of India, the Indian rupee was the ‘dollar’ of Asia and the Middle East. Countries like Sri Lanka was pegged to the Indian rupee and several Middle Eastern countries used the rupee as their national currency.

Sri Lanka has also demonetised in the past, probably following the bad example of India.

None of that has done any good to the country or produced any startling spurts of growth in either country.

Demonetisation is a political gimmick that undermines the trust in a currency and its economy, and disrupts the lives of citizens, including law-abiding ones.

India’s pretentions to be a world power, garnering the trust of world citizens and its own, will not be furthered by such ‘naïve’ gimmicks. (Colombo/Nov09/2016 – This column has been updated and the headline changed since first published)