'It is like bombing a building with 200 people to kill 5 terrorists.'
It is 60 days and counting since the demonetisation of Rs 500 and Rs 1,000 notes was announced by Prime Minister Narendra Modi on November 8, 2016.
During this period, the Reserve Bank of India's role and certain flip-flops have been questioned.
Former RBI deputy governor K C Chakrabarty tells Joydeep Ghosh that the RBI's focus should have been on keeping more Rs 500 notes in circulation, as Rs 2,000 were rendered useless for the millions of transactions that take place every day.
There were reports suggesting the government had approached the RBI in the past to demonetise high value currencies. However, the apex bank did not approve of this measure.
What, according to you, was the key reason for the RBI's discomfort?
It was discussed many times, both formally and informally, in the past.
Since 1978, when it was done for the first time, demonetisation has been discussed. But in the past, RBI has been uncomfortable with it, as rough estimates suggest only 6% to 8% of black money is in cash.
And it does not make sense to hurt 90% people, especially the poor and underprivileged, for such a small percentage of black money.
It is like bombing a building with 200 people to kill five terrorists.
Also, the people with money have more clout. They can hide black money in many other ways.
Ultimately, the poor and underprivileged suffer.
The government can, of course, make such decisions. And the central bank would have to comply because ultimately, the central bank is accountable to the government in our country.
For a central bank to be truly autonomous, it should only be answerable to Parliament, and not the government of the day.
With the ban on 86% of currency in stock, how badly do you think the economy will be impacted?
There are various numbers -- from 15 basis points to 2 percentage points -- showing the impact on the gross domestic product (GDP) in FY17.
Only an astrologer will be able to say how badly the economy will be impacted.
It depends entirely on how quickly the RBI and the government can take corrective action.
And as of now, nothing concrete seems to be have been done, in terms of corrective measures, except efforts to bring back currency in the system.
If the global economy does well, the GDP numbers will become better.
If the global economy does not do well, we may be impacted even more.
Everyone is saying there will be short-term impact (less than one year), but there will be benefits in the long term.
But I don't think anyone is sure about the long-term benefits unless there is a structural shift in our behaviour of making financial transactions.
Just when there were expectations that the economy will start turning around, the government and RBI implemented the ban on Rs 500 and Rs 1,000 notes.
How badly will this impact consumption demand? Do you see deflationary pressure?
In India, consumption is more affected by supply side factors. So I don't see deflationary pressures.
Yes, there could be some adverse impact on farmers' perishable produce. But that may not be significant.
The RBI's role has also come under question during this exercise.
Its silence in the initial period and some flip-flops have been disconcerting for both banks and customers.
Should the RBI have been more proactive and helped in soothing nerves?
The RBI's consistent view, in the past, has been against demonetisation.
However, once the decision was taken to do so, the preparation could have been better.
One basic calculation went wrong -- the number of the new Rs 500 notes available in the system. No one is asking this question.
One should know how many Rs 500 notes were in the system on November 10 (when the banks opened) and how it has increased over successive weeks.
The acute shortage of the Rs 500 notes is the main reason for the non-functioning of the rationed cash distribution and the resultant chaos and suffering of the people.
If there were, say, 15 billion notes of Rs 500 in circulation before November 8, the RBI should have been ready with at least 30% to 40% more notes of Rs 500.
With Rs 1,000 going out of the system, the demand for Rs 500 would have been immense for all kinds of small transactions.
In the absence of Rs 500 notes, Rs 2,000 notes are completely useless for the millions of transactions that happen every day.
This is a fundamental mistake that has happened.
I feel this issue needs to be examined at length, if any exercise of fixing accountability of bad implementation is ever made.
Do you think a trust deficit between banks and its clients has been created because of demonetisation?
I think there will be a tremendous issue of trust deficit.
I think once the economy is remonetised and banks have cash, account holders, especially the poor, might actually want to hold more cash with them instead of keeping it in their accounts because of the trust deficit created.
Also, I don't know whether banks can legally refuse to give money to its account holders.
Is it not a breach of contract between banks and their account holders?
Suppose, you don't have enough balance and you issue a cheque, the bank charges you a penalty.
Similarly, if a bank is unable to pay the money that you have kept, should there not be a penalty?
A number of countries, including Australia, Europe and Venezuela (though it has been put on hold now), are talking about demonetising high-value currency.
Do you think central banks have the luxury to implement such measures in the current environment?
Most countries, which are planning to do so, are facing hyper-inflation or currency depreciation.
It is important to remember that black money is a byproduct of faulty tax administration and its compliance.
Improving the efficiency of tax administration is more important than an exercise like demonetisation because generally, these measures don't work.
For a central banker, it depends on the pressure on them to take such a step.
Usually, the poor use more cash, but they are smaller denomination notes, while more illegal cash transactions take place in higher denomination notes.
Withdrawal of high-value currencies definitely reduces the scope of utilisation of high-value notes in unlawful transactions. But it increases the cost of currency management.
Steps like one-time currency withdrawal of high-value notes are a very blunt measure, which work in very limited number of situations.
IMAGE: Reserve Bank of India Governor Dr Urjit Patel.
'The government can, of course, make such decisions. And the central bank would have to comply because ultimately, the central bank is accountable to the government in our country,' says former RBI deputy governor K C Chakrabarty.
'For a central bank to be truly autonomous,' he adds, 'it should only be answerable to Parliament, and not the government of the day.'