Remember the year 2016, when it was announced overnight that the currency notes of the face value 500 rupees and 1000 rupees will no longer be functional? This left the citizens of India frenzied and confused, not to mention the long queues that were formed at the banks to get the currency changed. There was a lot of confusion between people as to why this decision was made and while a majority of people supported it, there were also some who condemned the act. However, there were also a lot of us who had heard the term “demonetisation” for the very first time that year and had no idea what this term actually entails and why it is so important in an economy.
Although it is something that most of you must have learned because of what happened in India five years back, the term demonetisation is not at all new to the world and it has its roots deep in the world’s economic history. Therefore, to understand this term a little better and know why some of the largest economies have undergone the process of demonetisation, let us have a look at the basic concepts behind this term and its role around the globe as well as in our country.
What is Demonetisation?
The term demonetisation refers to the act of stripping a currency unit of its status as legal tender. In simple terms, you can say that when demonetisation of a currency occurs, the currency loses its face value and is no longer of the status to be used as legal money for any kind of transactions. This usually happens when there is change of any national currency, which involves withdrawal of the existing form or forms of money that is currently being circulated and replacement of those forms with new notes or coins. Rarely, it may happen that a country will entirely replace its old currency with new currency.
Demonetisation is often considered as a drastic intervention in the country’s economy as it involves removing the legal tender status of the currency and can affect the day to day business activities in the economy. If demonetisation goes wrong, it can cause a chaos or serious downturn in an economy. The chances of this happening are even more when demonetisation is announced suddenly, without any prior warning. The process that is opposite to demonetisation is called remonetisation which refers to the act of restoring a payment form as a legal tender.
Demonetisation is often believed to bring stability to a country’s currency and used as a tool to fight inflation, facilitate trade and give the economy a better access to the markets which will allow it to push informal economic activities into becoming more transparent and get them away from black and grey markets.
Why is Demonetisation used by a country?
The act of demonetisation can be used by an economy for various reasons. It is mostly used as a tool to make the country’s currency more stable which will give more stability to the economy and possibly fight inflation. Some countries even use demonetisation as a solution to facilitate trade and have better access to the markets. Another reason why demonetisation is used is to provide more transparency to informal activities and push them away from the black or grey markets. One of the most important reasons as to why a cash-dependent developing economy may use demonetisation is to combat corruption and crime that often happen in the form of counterfeiting or tax evasion.
Understanding Demonetisation around the Globe
As we have already discussed above, demonetisation is used by economies for various reasons that they find valid for the progress and development of their nation. Although demonetisation can be harmful if gone wrong, it has also proved beneficial many times when used across the globe by different countries and their economies.
The Coinage Act, 1873 in the USA, demonetised silver as its legal tender and fully adopted gold standard. This was done to fight disruptive inflation which was as significant as the new silver deposits discovered in the Western America. The act suspended the circulation of various coins, including two-cent piece, three cent piece and half dime. This act that removed silver from being circulated in the economy led to contraction of money supply which in turn contributed to the downturn of the economy throughout the country. This is the reason why silver was remonetised as a legal tender through the Bland-Allison act in the year 1878. This remonissation was done in an effort to put an end to recession and political stress that was going around among farmers and silver miners.
Another example of demonetisation is when in the year 2015, the government of Zimbabwe demonetised its dollar. This was done to fight the hyperinflation in the economy. Zimbabwe demonetised the Zimabawean dollar and removed it from the country’s financial system. It then fixed the Botswana Pula, the U.S. dollar and the South African Rand as the country’s legal tender to stabilise its economy.
There are some countries that use demonetisation as a tool to facilitate trade or establish currency reunions. This kind of demonetisation which is done for business purposes was done by the countries under the European Union, when they formally started using Euro as their daily currency in the year 2002.
Demonetisation in India
In the year 2016, demonetisation occurred in India. This was tried and used as a tool to modernise the developing cash-dependent economy and to fight crimes like corruption that involve counterfeiting and tax evasion. The Indian Government demonetised the two most prominent denominations in its currency system— 500 rupees and 1000 rupees notes, which accounted for 86% of the country’s circulating cash. On November 8th, 2016, the Prime Minister of India announced that these notes will have no value. This was done with no prior warning, but the citizens were allowed to change these notes with the newly introduced currency of 2000 rupee notes and 500 rupee notes by the end of the year.
