Will a targeted demonetization work?

The road to hell is paved with noble intentions. So it was a bunch of unintended consequences – many bad ones and a few good ones – that characterized the large-scale currency demonetization that took place in India almost three years ago. (Read: “Demonetization: “objective” matters,” published October 23, 2019).

The debate on ending corruption keeps popping up some novel ideas in Pakistan. One such idea that has been circulating lately is to place expiry dates on currency notes. The idea is cuckoo in nature, in that it makes the assumptions that i) all or most illicit stash is held in cash and ii) continuous currency replacement would be sustainable. Several rounds of tax amnesties have continued to underscore the fact that it is really hard to bring informal, illicit cash and other assets into the formal system.

The recent government directive to the public to convert savings in Rs40,000 prize bonds by early next year is yielding some results, but going after other shady assets may be hard to crack. However, there must be something that can be done to curb the growth and flow of black money. In that respect, a case exists for a targeted intervention that learns from the Indian experiment and is clear-headed about the main goal and the core objectives.

Let’s start with a main goal: reduce usage of cash in the economy. And the objectives are: i) to bring informal cash into the formal system through digital alternatives and ii) to grow bank deposits in order to channelize more savings into the private sector. The following hypothetical scenario can meet the above-mentioned goal and objectives, with a reduction in growth of black money and assets a likely by-product.

Imagine that the central bank wakes up one day and announces that all currency notes (of all denominations) will expire after six months. The public can start replacing the now-old currency notes with fresh ones by opening an account with a bank (if they don’t have one already) or by opening a mobile-wallet account with a branchless banking service provider. Because the back-end preparations have been made in time (a critical assumption that must be met for this adventure to succeed), ATMs (including an expanded fleet of mobile ATMs) all across the country, will start dispensing new currency notes

This will initially cause some panic, but in a week or so people will realize that it’s not as bad as they thought. They will flock to the banks, and to branchless banking agents, who will be ready to meet the surge in customers and liquidity. Why? Because they have been trained for exactly this scenario in the prior months! The customer traffic will smooth out over time – after all, the sunset is six months later, not six to seven weeks as was the case in the Indian experiment that had expired the currency overnight.

As the goal is to reduce usage of cash in the economy, there may be daily and weekly limits on cash withdrawals from bank accounts. Folks and businesses who have to do large transactions will find that there are no limits on value transfer through cheques, bank drafts, pay orders, online and mobile banking, and m-wallet based funds transfer, whereas taxes on bank transactions have been done away with or reduced to very small amount That way, people will realize that they can keep some cash to meet daily necessities, but they are also at liberty to use formal channels to make or receive large payments.

At this stage, dirty money will start getting queasy. After all, there are restrictions over the next six months on cash-based purchases of property, equity and debt instruments, vehicles, foreign currency, gems and jewelry, and other hard, valuable assets. There will, of course, be legitimate buyers of such assets – they can get what they want as long as they make the payment through a banking instrument.

This way, illicit cash will have little choice but to find its way into the banking system, where it risks scrutiny. Another key assumption to make this adventure successful is that FBR’s analytics wing is up and running - which it is not at the moment – so that they solid access to bank account datasets.

The illegal wealth already stored in hard assets may not have much of an incentive to liquefy amid the general march to the bank. That will, in a way, create a stock of hidden wealth, a sort of legacy, which will remain there but not grow as much as it would have in normal times. If such an asset holder felt nervous and decided to divest some shady investments, e.g. in foreign currency or real estate, remember, the buyer can only make a large payment in these six months through a banking instrument. That money will go into a bank account, where it will be subject to limited withdrawals, and hopefully, some KYC, too.

What about the high-volume, low-value swathes of business transactions taking place in the informal, cash-dependent wholesale and retail markets and in agrarian heartlands? For that, m-wallets may be the answer. This scenario assumes that the central bank has created a robust supply-side infrastructure that seamlessly integrates the back-ends of banks and telecom operators so that people can send and receive payments instantly and at low cost through a unified mobile payment interface.

The above scenario has a lot in it to be branded as ambitious and idealistic. But ideas drive action. Recognizing that there is no such thing as a perfect idea, nor is this one, it is important to talk about these issues. These are lean economic times – perhaps these days are ideal for a mass drive towards formalizing a cash-dependent economy, if the idea is to cause minimum disruption and achieve objectives within a reasonable amount of time. From what it looks, it is Pakistan’s supply-side of payments that needs a shock; the demand-side, resilient as it is, will probably take care of itself.