De-monetisation update 5: promise to pay

A friend wrote to me last last night (or, early hours of today) what he had from a former RBI staffer:

The RBI reportedly cannot write off currency just like that. It may declare a series to be no longer legal tender but they have to exchange the old note when presented. (During the 1978 demonetization, the RBI did not write off notes earlier.)

That is, even if the old Rs500/1000 is no longer medium of exchange, it is still store of value. The RBI’s promise to pay the bearer does not really come with any qualification. Seems they can inform IT of the exchanger’s PAN but not refuse the claim themselves.

The PM’s speech has said that the RBI will exchange notes upto March 31. However, the RBI has not announced a cut-off date in its circular. It is legally very doubtful if it can impose it.

This accords with what Ms. Usha Thorat, former Deputy Governor of RBI, had written in ‘BusinessLine’. She had pretty much said the same thing on the legal status of ‘Promise to pay’. The promise remains forever.

The message above and Ms. Thorat’s article deal with the legal status of the currency notes that have been demonetised. In my previous two blog posts, I had dealt with a different question: whether the ‘Currency in circulation’ as an item in RBI’s balance sheet does really come down at all. My answer was NO. It does not and, therefore, there was no case for a special dividend to the Government of India.

Also, imagine the nightmare scenario for liquidity and interest rates if the central bank really believed that both legal tender and ‘promise to pay’ features have been irrevocably cancelled on the currency notes that some private citizens did not surrender. If it cancelled its ‘currency in liabilities’ accordingly and proceeded to sell government securities to raise cash and pay a dividend to the government. It would suck the liquidity out of the system so thoroughly that most economic activity would cease. It would be such a near-fatal blow to the economy.

Unfortunately, due to the logistics of the exercise, that seems to be happening already. We will deal with that in the next post.

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