Treading a tightrope

In November 2016, the Indian government announced the demonetisation of all Rs 500 and Rs 1,000 banknotes. The government claimed that the move would curtail corruption, encourage digital transactions and reduce the use of counterfeit currency. The Diplomat (November 15, 2016) commented, "India witnessed a truly historic moment on November 8, 2016, when the government took the remarkable step of demonetizing Rs 500 and Rs 1000 notes. Prime Minister Narendra Modi, in his address to the nation, stated one of the reasons for this policy was to counter the rising menace of fake Indian currency notes'. However, despite the promise to reduce cash transactions, the value and volume of notes in circulation has continued to increase since November 8, 2016. Between November 8, 2016 and October 29, 2021, the notes in circulation in value terms increased by 64 per cent.

Rise of counterfeit currency

The total number of Fake Indian Currency Notes (FICNs) of all denominations detected in the banking sector increased to 2,30,971 pieces. According to the RBI annual report, the number of fake currency notes of Rs 500 denominations, detected by the banking system, more than doubled to 79,669 pieces in the fiscal 2021-22 over the previous year. The number of counterfeit notes of Rs 2,000 denomination was 13,604 pieces during 2021-22, up 54.6 per cent from the preceding financial year. The report also said that the total expenditure incurred on security printing during April 1, 2021 to March 31, 2022 was Rs 4,984.8 crores as against Rs 4,012.1 crores in the previous year. Moreover, the disposal of soiled banknotes increased by 88.4 per cent to 1,878.01 crore pieces during 2021-22 from 997.02 crore pieces in the previous year, reported The Hindu.

As per a report by Economic Times, fake Indian currency, seized by security and intelligence agencies, has increased each year since 2017. Data on the fifth anniversary of demonetisation showed that there was a 190 per cent jump in 2020, compared to the previous year.

In 2016, the year when demonetisation was launched, 6.32 lakh counterfeit pieces were seized across the country. In the next four years (including the year 2020 till October), a total of 18. 87 lakh pieces of fake notes were seized across the country in various denominations, according to the RBI data, reported Moneycontrol. Currency in circulation, according to the RBI data, increased to Rs 24.2 lakh crore in March 2020, from Rs 16.4 lakh crore in 2016, Volume of currency notes have increased to 11.6 lakh pieces in 2020 from 9 lakh pieces in 2016.

Reacting to this massive increase in fake currency during the last five years, Congress leader Rahul Gandhi tweeted, "The only unfortunate success of demonetisation was the torpedoing of India's economy." It may be recalled that in November 2016, former Prime Minister Manmohan Singh, reacting to the demonetization decision, said that its implementation was a "monumental management failure" and a case of "organised loot and legalised plunder."

West Bengal Chief Minister Mamata Banerjee was among the leading voices of protest against the demonetisation move. Soon after the Prime Minister's announcement, she had termed the decision "draconian" and called for its withdrawal. Targeting the Prime Minister, she had said the move was a "drama" to "divert his failure" because he couldn't get back black money from abroad as promised during elections.

It must be remembered that demonetization is required when a new currency is to be introduced either to combat inflation or to discourage a cash system or to combat corruption. This process involves either introducing new banknotes or coins of the same currency or completely replacing old currency with new currency. The question may be raised whether demonetization was just a gimmick or a calculative move to change the entire monetary transaction process of the Indian economy — from cash to digital currency?

In a detailed study (2015) on the impact of counterfeit currencies on the economy, the Reserve Bank of Australia observed, 'Currency counterfeiting is costly for society. Law enforcement agencies allocate substantial resources to deter, detect and prosecute counterfeiting operations, households and businesses suffer a direct loss to counterfeiters and undertake costly prevention measures, and Central banks spend considerable resources upgrading and improving the security of banknotes. Without these prevention efforts, there is a risk that the public could lose confidence in the currency and reduce its use relative to costlier payment alternatives'.

It seems that the main cause of stagflation of the Indian economy is the demonetization of major currencies in 2016 which had destabilised millions of micro small and medium enterprises which are the backbone of India's manufacturing sector. Demonetization, followed by the introduction of GST and unplanned prolonged COVID lockdown, shattered the MSME sector. Reduced supply of goods, and increased circulation of currency due to huge supply of fake notes in the economy have resulted into runaway inflation. With a very high rate of unemployment, India has slipped into stagflation.

Rise in digital payment

Post demonetization, India has witnessed simultaneous increase in cash in circulation and rise in digital payments!

According to a report, UPI (Unified Payment Interface) payment volume stood highest in FY20 at 1,251.86 crore up from 91.52 crore in FY18 among all digital or contactless payment channels. UPI transaction value also went up from Rs 1.09 lakh crore to Rs 21.31 lakh crore during the said period. Total digital payments, in terms of volume, have gone up to 3.4 lakh in 2020 from 70,466 in 2016, reported Moneycontrol. The volume of digital payments in India increased by 33 per cent year-on-year (YoY) basis during the financial year (FY) 2021-2022. A total of 7,422 crore digital payment transactions were recorded during this period, up from 5,554 crore transactions seen in FY 2020-21, said the Ministry of Electronics and IT.

Cryptocurrency

A cryptocurrency is an encrypted data string that denotes a unit of currency. It is monitored and organized by a peer-to-peer network called blockchain, which also serves as a secure ledger of transactions. Bitcoin and digital currencies are based on the idea of a distributed trust mechanism called the "blockchain", a way of keeping track of trusted transactions in a distributed fashion. The definition itself indicates the complexities of this mechanism.

Unlike physical money, cryptocurrencies are decentralized, which means they are not issued by governments or other financial institutions. Cryptocurrencies are created (and secured) through cryptographic algorithms that are maintained and confirmed in a process called mining, where a network of computers or specialized hardware such as application-specific integrated circuits (ASICs) process and validate the transactions. The process incentivizes the miners who run the network with the cryptocurrency. Bitcoin, Ether, Litecoin, and Monero are popular cryptocurrencies.

For our convenience, the cryptocurrencies can be broadly divided into two categories. First, those which are not regulated by the government. Bitcoin and Litecoin fall under this category. The second type of cryptocurrency, like the Digital Yuan, is a Central bank digital currency (CBDCs). These have recently emerged as a hot topic in the financial space. Banks, Institutions, and governments are performing research and analysis on the economic and technical feasibility of introducing a new form of digital money and its impact on monetary and fiscal policy.

If a country issues a CBDC, its government will consider it to be legal tender, just like fiat currencies; both CBDC and physical cash would be legally acknowledged as a form of payment and act as a claim on the Central bank or the government.

It is claimed that a Central bank digital currency increases the safety and efficiency of both wholesale and retail payment systems. On the wholesale side, a central bank digital currency facilitates quick settlement of retail payments. It could improve the efficiency of making payments at the point of sale or between two parties (p2p). In simpler terms, CBDC is an electronic form of central bank money that citizens can use to make digital payments and store value. A CBDC has three main dimensions: (i)A digital currency (ii) Issued by the central bank, (iii) Universally accessible.

The journey of cryptocurrency started with the publication of a paper titled "Bitcoin: A peer-to-peer Electronic Cash System" in 2008, by a pseudonymous developer with the name Satoshi Nakamoto. Two years later, the first sale of an item using Bitcoin took place with someone swapping 10,000 Bitcoins for two pizzas. This attached a cash value to cryptocurrencies for the first time. Soon enough, other cryptocurrencies such as Litecoin, Namecoin and Swiftcoin began to emerge and the digital asset started gaining traction.

One of the stated missions of the World Economic Forum is to 'ensure that blockchain securely decentralizes the transfer of information in ways that reduce corruption, increase trust, and empower users to work with partners and members to guarantee that everyone, including the most marginalized members of society, can benefit from both blockchain and the cryptocurrencies that are potential gateways to new wealth creation'.

Klaus Schwab, the founder of the World Economic Forum, in his book 'The Fourth Industrial Revolution', published by the World Economic Forum in 2016 (before demonetization in India in November 2016), mentioned that by 2015, the total worth of bitcoin in the blockchain was around USD 20 billion, or about 0.025 per cent of the global GDP of around USD 80 trillion. He also mentioned that by 2025, it was expected that 10 per cent of global gross domestic product (GDP) would be stored on blockchain technology.

The mission statement of WEF clearly flags that blockchain and the cryptocurrencies are 'potential gateways to new wealth creation'. Against this background India demonetized its high value currencies in November 2016.

Cryptocurrency in India

Since 2013, the Indian government is seriously contemplating to frame a policy on cryptocurrency. As crypto exchanges including ZebPay, Pocket Bits, Coinsecure, Koinex, and Unocoin began springing up in India, the Reserve Bank of India (RBI) issued a circular, in 2013, warning users of the potential security-related risks pertaining to the use of virtual currencies.

In the first month, immediately after demonetization in November 2016, out of about 20 bitcoin start-ups, India's bitcoin trading platforms — ZebPay, Unocoin , and Coinsecure — registered a surge in new users willing to experiment with the cryptocurrency as an alternative asset class. Forbes reported that in a mere 18 days after the demonetisation speech of Prime Minister Narendra Modi, the price of bitcoins on ZebPay, which claimed to have over 1,30,000 users, had surged from USD 757 to USD 1,020 (per bitcoin) whereas in the US (the benchmark market for most cryptocurrencies), bitcoins were trending at USD 770 apiece, marking a clear premium on the Indian bitcoin exchanges.

In an elaborate story, Moneycontrol has reported that the increased preference for digital payments brought about by the demonetisation experiment gave an unintended boost to crypto investments, driving tech-savvy customers to the virtual asset. The Indian banks continued to allow transactions on cryptocurrency exchanges pushing the RBI to release another circular in 2017 conveying its apprehensions regarding virtual coins. Finally, by the end of 2017, a warning clarifying that virtual currencies were not a legal tender, was issued by the RBI and the finance ministry.

In March 2018, a draft scheme for banning virtual currencies was submitted by the Central Board of Digital Tax (CBDT) to the finance ministry and just about a month later the RBI came out with a circular — restraining banks, NBFCs and payment system providers from dealing with virtual currencies and providing services to virtual currency exchanges. This dealt a heavy blow to crypto exchanges, and trading volumes fell by 99 per cent. Reacting to the ban, the crypto lobby commented, "banning cryptocurrency to fight black money would be like setting fire to the forest in order to smoke out a few sheep."

On November 1, 2018, ten years after Nakamoto's paper, Nischal Shetty, Founder of WazirX, started the #IndiaWantsCrypto campaign for the positive regulation of crypto in India. Meanwhile, crypto exchanges had filed a writ petition in the Supreme Court against the ban on cryptocurrencies. In March 2020, the ban was ultimately struck down, declaring the RBI circular unconstitutional. Cryptocurrency exchanges, thus, sprung back to life and the SC ruling came at the best possible time, coinciding with the crypto boom.

On Jan 29, 2021, the Indian government announced that it would introduce a bill to create a sovereign digital currency and subsequently put a blanket ban on private cryptocurrencies. In November 2021, the Standing Committee on Finance met the Blockchain and Crypto Assets Council (BACC) and other cryptocurrency representatives and concluded that cryptocurrencies should not be banned but regulated. In early December 2021, Prime Minister Narendra Modi also chaired a meeting on cryptocurrencies with senior officials.

In March 2022, the Indian Parliament passed the Finance Bill 2023, which introduced a new levy of 30 per cent on virtual digital assets (cryptocurrencies) from April 1, 2022. Though the announcement did not make crypto legal, it gave official recognition to these digital assets, bringing the much-needed legitimacy to the sector, reported Deccan Herald.

Recently (May 31, 2022), the economic affairs secretary Ajay Seth said that the government will soon finalise a consultation paper on cryptocurrencies with inputs from various stakeholders and institutions, including the World Bank and the IMF. He also underlined the need for a global response to deal with issues concerning crypto currencies as these operate in the virtual world, reported Telegraph.

Notwithstanding the uncertainty around the future of cryptocurrencies in India, investments in the unregulated digital asset, especially Bitcoin, has shown a breath-taking upward trend since 2020. Data from various domestic cryptocurrency exchanges suggest that more than 1.5-2 crore Indians have invested in the asset class, hitting the USD 10 billion mark in November 2021. The growing number of cryptocurrency adopters suggests a shift in the investment paradigm in the country that is known to invest more frequently in gold and other safer assets.

Conclusion

It appears that the Indian government's efforts to check counterfeit currency have miserably failed. People are losing confidence on fiat money and are opting for "relatively costlier payment alternatives". If the circulation of counterfeit currencies increases at the current rate, the entire monetary system may collapse. To prevent such a situation from unfolding, will the Modi government opt for another demonetization exercise to flush out fake currencies? Or would the government change the entire system of monetary transaction by introducing cryptocurrency?

Whatever option the government takes, any form of demonetization will have a severe adverse impact on the economy and citizens. Economic history is replete with such instances. It may be mentioned that under the Coinage Act of 1873, silver was demonetized as the legal tender of the United

States, and the gold standard was adopted fully. The withdrawal of silver from the economy resulted in a shrinking of the money supply, which was followed by a five-year economic depression throughout the country. The Bland-Allison Act remonetised silver as legal tender in 1878 due to the terrible situation and pressure from farmers and silver miners.

Transition to any new system is painful and abrupt changes, like unplanned demonetization, create disaster. The Reserve Bank of India has already expressed its concern that cryptocurrencies may impact financial stability of the economy, as reported by Business Standard. They have suggested to prohibit all private cryptocurrencies in the country and create a framework for an official digital currency.

Unregulated cryptocurrencies may be more disruptive than fake currencies in destabilizing the financial system. Hope, Indian policy makers will learn from past experiences and refrain from taking any hasty decision on currency management.

Views expressed are personal