India’s Demonetization One Year Later: A Failed Tool to Combat Corruption

One year ago, in an unscheduled live televised address, India’s Prime Minister Narendra Modi announced that within weeks the ₹500 and ₹1000 banknotes would become worthless. Prime Minister Modi framed this so-called “demonetization” policy as part of the battle against corruption and illicitly-obtained “black money,” which had “spread their tentacles” through the India economy. The Prime Minister identified two ways that demonetization would combat corruption. First, the surprise devaluing of currency would leave criminals, including corrupt officials, with millions of rupees’ worth of currency that would suddenly become worthless, and those holding large stashes of black money would be unwilling or unable to exchange it without having to explain where the money came from. Second, going forward, demonetization would make it more difficult to hold, transport, or exchange large quantities of cash (particularly since the Indian government was demonetizing the two largest notes in circulation); as the Prime Minister emphasized, “[t]he magnitude of cash in circulation is directly linked to the level of corruption.”

One year out, it is increasingly clear that India’s demonetization experiment imposed tremendous social and economic costs but failed to achieve either of these objectives (see here, here, and here). A closer examination of the reasons for this failure may help us understand both the potential and limits of demonetization as a tool to combat corruption and the underground economy.

Consider first the Indian government’s hope that surprise, rapid demonetization would flush black and counterfeit money out of the system, leaving corrupt officials and other criminals stuck with piles of worthless illicitly-obtained cash. This clearly failed: The Reserve Bank of India recently reported that almost 99% of the demonetized currency was returned to the banks, vastly exceeding the amount the Indian government expected would be returned. Moreover, less than 0.0007% of the cash returned was counterfeit, also eliminating the prospect that demonetization would expose large sums of counterfeit currency. There are three main reasons that India’s demonetization failed in its objective of flushing existing stocks of illicit money out of the system:

  • First, the Indian government overestimated the black economy’s reliance on the large demonetized bills. In fact, less than 10% of India’s black money is stored in cash, with much more stored in property and gold.
  • Second, the government underestimated the ability of black economy operators to exchange black money for white money and to take money out of India’s robust informal economy, thus effectively sanitizing their money without having to deal with the government. Within days of Prime Minister Modi’s announcement, the phrase “How to Convert Black Money to White Money” was a top search on Google in India. Those holding large piles of cash that they didn’t want to report found a variety of ways to dispose of this cash without having to deposit it in banks, for example by giving loans to poor people, buying gold and property, and making use of organizations like the “banknote mafia.”
  • Third, and perhaps most importantly, the government underestimated the ability of black market operators to devise complex money laundering schemes to formally deposit their black money into banks through money mules, certain basic banking accounts, and cooperative banks.

Next consider the second way in which demonetization was supposed to suppress corruption and other illegal transactions, by making it more difficult to hold, transport, or exchange large amounts of cash. Here the government seems—ineptly and inexplicably—to have undermined its own policy objectives: After announcing the withdrawal of the ₹500 and ₹1000 notes from circulation, the government decided to print a new version of the ₹500 note and to introduce a new ₹2,000 note. Not only did the Reserve Bank of India spend billions of rupees printing these notes, the new ₹2,000 note provided black economy operators an even better opportunity for storing illicit cash. Instead of making it more difficult to operate in large denomination notes, the government made it easier. India’s former Finance Minister aptly described the decision to introduce the ₹2,000 note as a “puzzle,” rightly asking, “How [is] the purpose of demonetization of high denomination notes [] served if a new and higher denomination note is introduced?” I’ve not seen the Indian government offer any satisfactory answer to this simple question.

To be clear, on this point, the idea behind demonetization may well be sound, and could even be effective if implemented sensibly. For example, the European Central Bank (ECB) has decided to phase out the €500 note—one of the highest-value circulating notes in the world. This is not quite “demonetization” in the same sense as India’s policy, as even after the phase-out, existing notes in circulation would still be legal tender. But the motivation for the phase-out is at least partly the same, as phasing out the €500 note will make it more difficult to conduct large-scale transactions in untraceable cash. The ECB has taken a number of steps to smooth the transition and avoid hardship on citizens and businesses: the phasing out of the bill will take place over a two year period, and

On that note, it’s also worth observing—as many others have—that India’s demonetization policy imposed enormous social and economic costs on everyday citizens. The burden of the rapid and surprising removal of the ₹500 and ₹1000 notes fell less on corrupt officials and criminal organizations than on cash-dependent small businesses and poorer citizens, many of whom had to wait hours in line to deposit and exchange their notes. In fact, the sudden demonetization increased unemployment amongst poor laborers and resulted in the death of over 100 people, as hundreds of millions of citizens rushed to banks and ATMs to exchange their money. And perhaps unsurprisingly, declaring roughly 85% of India’s currency worthless—in an economy where 97% of retail transactions occur in cash—decreased the country’s GDP by more than two percentage points.

It appears that India’s demonetization has been a colossal failure as an anticorruption tool. That’s not to say that some forms of demonetization might not be a useful component of an anticorruption strategy. Efforts to remove large-denomination notes from circulation do indeed make illicit, unrecorded cash transactions harder to execute, and can be implemented in a way that minimizes disruptions to the legitimate economy. But the Indian government’s clumsy design and implementation of its policy maximized its disruptive effect while failing to meet its stated objectives. Perhaps part of the problem was the impulse to fight corruption with dramatic, headline-grabbing new policy initiatives, rather than through a sustained, multifaceted, long-term campaign. As one astute critic observed: “Public policy for rooting out corruption calls for a systemic approach, with carrots and sticks to motivate cultural, institutional, and behavioral change in the long term. Silver bullets, such as drastic demonetization don’t work.”

13 thoughts on “India’s Demonetization One Year Later: A Failed Tool to Combat Corruption

  1. Great follow-up on the demonetization effort. I wonder, however, the extent to which demonetization has driven the recent surge in mobile banking in India? And whether or not there is a correlation between black market transactions and the % of transactions done via mobile money? I understand that mobile transaction systems must comply with certain anti-money laundering and anti-terrorism finance laws, but I wonder whether you know of any studies that address the relationship between corruption and banking on your cell phone.

    • Thanks for the comment Michael. You bring up a great point. There were likely secondary benefits to demonetization (including an increasingly digital economy and a larger tax base) that could serve important anticorruption purposes. As you mention, moving to a digital economy could make transactions both more efficient and transparent, and it seems that the Indian government was aware of this benefit. I think it’s still important to assess whether it was worth the social and economic cost of demonetization for the secondary benefit of combating corruption through digital banking, and whether there are more effective government programs that promote digitization. Here is an interesting blog post ( and a paper ( about the nexus between corruption and mobile banking in Kenya.

  2. It would have been more interesting if the author has delved also on how demonetization affected, if not the India’s relationship with neighboring countries like Nepal, the poor people in Nepal, holding demonetized currency out side formal banking channel. Due to free boarder, near convertibility of Nepali rupee and Indian rupee and millions of Nepali workers working in India sending cash remittances, demonetization affected their savings.

  3. Great post Harmann. Everyone seems to be bemoaning demonetization on its anniversary and yet the BJP bandwagon marches on in India! ( I guess another takeaway which indirectly flows from the post is the critical need for the Indian government to enhance transparency of data on these efforts. Much of what we discuss here remains speculative at a certain level unless the government shares its data on what it saw were the problems and what is its assessment of the current position.

    • Hi Abhinav! I agree that our analysis of the effectiveness of demonetization is tied to the transparency and availability of relevant data. That said, it seems that the government has controlled the narrative of success despite overwhelming consensus among economists and experts that demonetization failed to achieve its anticorruption objectives. Given this existing consensus, do you think additional data—unless it rebukes the existing data demonstrating the failure of the policy—would change the minds of citizens who believe that demonetization was successful in combatting corruption? As the article you cite notes, the approval of Indian citizens demonstrates a disconnect between good economics and good politics, and I’m unsure if additional data would bridge this disconnect (particularly since many citizens supporting the effort were directly and negatively impacted by the policy). That said, I do agree that additional data and transparency around the effects of demonetization would be beneficial in analyzing the policy.

      • I absolutely agree that the need for transparency here is critical in analyzing the impact of the policy here, but that brings up two operational questions – (1) the quality of the data and (2) literacy of what the data is saying. I wonder, to Maddie’s point below, and to both of your points about the popularity of this policy, if the popularity reflects a misunderstanding of what any data reflecting results really mean. In short, I am skeptical that transparency of data in India (or anywhere) is the lynchpin for success in any policy, including this one.

  4. I think we touched on this point a bit in our class discussion, but a fascinating angle to me is how Modi’s popularity has endured, despite the massive problems that this policy has caused. I was recently read this article that tries to examine why this may be the case: It’s a bit outside the scope of your argument here, but it gives an interesting look into the political dynamics playing out from this policy.

    • Hi Maddie! That’s an interesting read and touches on some of the points made in the article Abhinav cited in his comment above. The politics of demonetization is fascinating. For example, the government recently deemed November 8 “Anti-Black Money Day” in an effort to celebrate the demonetization policy. It is certainly interesting to see how Prime Minister Modi has been able to control the narrative of success despite the overwhelming consensus among economists and experts that the policy failed.

  5. It is a good effort no doubt. I am bit disappointed because Mr Singh could not bring anything new which has not been discussed in the Indian media and some economists at least in India. Indeed, no one could disagree with Mr Singh when he critiqued the government’s move to bring 2000 rupee notes. Hit the nail. As a media person and as a researcher, his three points look bit weak…
    1. Indian businesses were under strain since 2012 or 2013 onwards when non-performing assets (of state run banks) ratio gone up dramatically. As a result, economic activity on the ground was strained ever since because small businesses could not get loan from banks. But strangely, the macro outlook was promising. This is bit odd. So, businesses undergoing trauma is not due to demonetisation alone. It had a history and demonetisation could be a final push.
    2. Economists and data are so inseparable that sometime, they mislead. This 99 per cent money coming back is one such issue. Unless one goes deep into the details and “thrill of observation” it is difficult to analyse this 99 per cent money coming back. Can you imagine people queuing up to deposit into their accounts the money taken from others (black money) and deducting a percentage from it and return it after a couple of months. This happened across the country. When society as a whole join hands to convert black into white no government could do anything.
    3. Yes, poor planning bad implementation could be seen everywhere.
    4. I would say: not appointing a Lok Pal, country’s top most post, Ombudsman set up to check corruption government is a bad intent of government to check corruption.
    5. After demonetisation, elections happened in India where we suspected money being spent by political parties including the ruling party which opted for demonetisation. So, it clearly shows the government lacks intent to stop corrupt practices.
    Therefore, demonetisation alone cant be read and interpreted in isolation…

  6. I agree with your thoughts that the demonetization was a failure and lack of preparation. The Government should have prepared very well in curbing corruption using demonetization. A few rich only get trapped in this sudden announcement. However, a lot of middle class and poor people trapped too in this sudden decision by the government.

    • Thanks for your thoughts. As you mention, the burdens imposed by the policy fell far more on the middle class and poor than on the rich; not only because the rich have more options (both legal and illegal) to convert their notes, but also because they are more likely to be “cashless” in the first place, with money stored in gold, land, and other assets. My guess is that there were not many rich people standing in the hours-long lines to exchange their notes.

  7. Demonetization seemed more like a political gimmick to me. BJP is a corrupt party, so its fighting corruption didn’t seem honest to begin with. Also it is well known the RE sector is where money laundering is done.

    Meanwhile London is called the world’s greatest laundromat.
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    ‘It’s not the bureaucracy, it’s not the police, it’s not the politics but what is corrupt is the financial capital’

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