Ban in India – Pain in Nepal

On evening of November 8, 2016, the Prime Minister of India Narendra Modi announced that the currency notes of INR 500 and 1000 circulating until that date would no longer be legal tender effectively from midnight of that same day. The announcement sent shockwaves, not only across India but also in its neighbouring countries like Nepal, where the financial system is accustomed to accepting the Indian Rupee as a second legal tender in addition to the local Nepali Rupees. All of a sudden after the demonetization announcement, currency notes held by people with so much esteem had become only a piece of paper. A currency note is nothing but a promissory note or ‘I owe you’ (I.O.U) paper issued by a monitory authority backed by a sovereign state making it a legal tender for commercial transactions. The currency note turns into a simple worthless piece of paper when the state withdraws its backing as the legal tender. So, the demonetization of a currency note means state backing out from its promise to pay the bearer equivalent to the denomination of the note. The Indian state backing out from its promise to pay equivalent of INR 1000 and INR 500 to the bearers of IC banknotes of Rs. 1000 and Rs. 500 should be a subject of no concern to the nationals of an ‘Independent’ and ‘Sovereign’ Nepal. But reality is different. Nepali nationals seem to be as affected as Indians, if not more. In the good old days, when there were no banks and currency notes, people would simply barter their rice with salt or use some precious metal like gold or silver as means of exchange. With the increase in commerce, the promissory note issued by a well known merchant started to be accepted as payment for goods delivered. As time progressed, the state overtook the job of issuing promissory notes and made it binding for subjects to accept the promissory note issued by it or on its behalf. The phrase ‘This note is legal tender for all debts public and private’ printed on every US dollar bill amply illustrates this situation. You cannot demand anything else for a debt that is owed to you. The growth of international trade meant that some currency bills, especially those issued by larger economies gained acceptance beyond national boundaries. The US dollars, Euros, Yens and Pounds have become international currencies, accepted all over the world. The states under whose sovereign jurisdiction these currency notes are issued allow free movement of these currencies (of course, within reasonable limit for individuals to avoid money laundering). They are traded openly in various money markets to ascertain their values against other similar currencies. The prices of goods and services traded across national borders are fixed in these currencies, most of it in US dollars. Ditto is the case with cross border financial deals. Most transactions now a days are made by simple debit and credit entries in books of accounts, and do not involve the physical movement of the currency notes; but some physical movement is inevitable, especially for small denomination transactions. Governments all over the world are trying to reduce the use of currency notes and increase the use of plastic (debit and credit cards) and electronic transfer as it is possible to follow money trail avoid tax evasion and money laundering in such transactions. Usage of paper currencies is higher in under developed countries where much of the transaction is still outside official purview. Although the currencies of our immediate neighbours - China and India, have not yet become fully convertible and are not as widely accepted as other international currencies, we have been trading with India in Indian Rupees and to some extent with China also in Chinese Yuan or RMB. The Indian and the Nepali governments allow their nationals to carry Indian banknotes of up to Rupees 25,000 in either direction. Tourists and pilgrims coming from India travel to Nepal with Indian banknotes. Nepali migrant workers working in India also bring in their earnings in Indian Rupees. Similarly, Nepali travelers to India for purposes ranging from health check-ups to pilgrimages take Indian banknotes with them. Further, Indians working in Nepal take their earnings back to India in Indian Rupees. We may have stopped keeping books in two currencies (during the Rana Regime government books of accounts used to be kept in two currencies: those issued by British-Indian authorities and those by the Nepali authorities), nonetheless, the Indian currency was and is still in circulation for all practical purposes. The Indian Rupees were freely accepted in Nepal from large departmental stores to vegetable hawkers. Its use was more rampant in bordering areas and poorer hinterlands of the Mid-Western and Far-Western regions of Nepal, where a substantial population migrate to India for seasonal work. In these areas, people kept their savings in Indian rupees. Nepal faces a huge deficit in trade and current account dealings with India; Indian currency has been in short supply for the last few years. Banks in Nepal would not change enough Indian notes when people wanted to exchange. The Central Bank encourages people to use banking channels (cheques, drafts and bank transfers) for making payments. Unofficial trade was and is financed through cash or hundi payments. Hence, there is sort of a premium on Indian currency notes in the open market. So whenever any Nepali found themselves in possession of Indian rupees, he or she would not go to the bank and change them to Nepali Rupees (as required by Nepali law), but would keep them for future needs or to be sold at a premium at a later date. There is no official estimate of the amount of Indian currency with the Nepali public. But one thing is certain, it is not in millions but in billions, and most of it is outside the formal banking system. Yet, the formal movement of Indian 500 and 1000 notes across the border was not allowed till not long ago. It was only since January 2015 that these notes were allowed into and back from Nepal. This good gesture, which came after innumerable requests of Nepali authorities and Prime Minister Modi’s friendly’ gesture,’ turned out to be a curse when India demonetized its notes. When a state backs off from its promise through demonetization of its currency, it is similar to expropriation of the wealth at disposal of the citizen. The citizen looses the asset worth of the demonetized currency held. The currency issuing authority simply writes off its liability. Any person literate enough about the balance sheet can tell that liquidation of a liability is as good as acquisition of assets. In its true sense, the withdrawal of the 500 and 1000 rupee notes in India is not demonetization in its true sense as Indians are allowed to convert them to bank deposits provided they can prove that the money was legitimately earned. So Indian authorities write off the liability of only those banknotes which do not come back to the system; in other words, only this portion is truly demonetized. What will be the case with Nepalis (non-citizens of India) holding these notes? Authorities in both countries are saying that they are in continuous touch with the other side and will come to some sort of solution. But, what can be the solution? The first option most Nepalis will favour is, of course, that Indian authorities allow Nepali monetary authorities to accept the notes, which will then be accepted by the Indian Central Bank. However, such a development is highly unlikely as Nepal may then turn into a conduit for illicit operators in India looking to turn their ‘black money’ into ‘white’ defeating the whole purpose of the demonetization. The next best option for Nepal would be a limit, say 25,000 Rupees per person, (the official limit an individual can carry as per the Reserve Bank of India’s rule) to be converted. But, there is no such rule in Nepal. The question arises should the rule set by RBI be enforced by the authorities in Nepal. If so, what will be the criminality of the person not abiding by that rule? The third option, and the most likely, is that the RBI will accept old notes up to a certain amount being deposited by the Central Bank in Nepal. The Indian officials in their press briefings have been saying that the issue will be resolved through an agreement between the two governments. The Central Bank in Nepal may even open a short window for Nepali nationals to deposit their Indian Rs 500 and 1000 denominated notes in banks in Nepal with a caveat that they show the proof that they obtained the notes legitimately. However, as the dealings between the two countries are made through unofficial channels only, very few citizens can prove the legitimacy of their Indian earnings. Even those who collected Indian notes by using their cards in Indian ATMs may not be able to prove it. Most people travel to India without passports. Even those carrying passports do not get their passport stamped. The casual labourer who works in India and who brings back Indian currency does not possess proof of employment or receipt of the wages. Small business operators, who readily accepted Indian rupees as payment for goods or services, do not have the ability to prove the legitimacy of their holdings. Hence, their holdings, most probably, have become worthless after the announcement of demonetization (if they have not already converted the notes at a very high discount through currency smugglers). The impact of demonetization will be felt not only by those holding Indian notes, but also by the wider public. As latest report suggests, trade between two countries has severely dwindled. Indian tourist numbers are going down. The government may be hoping that traders from now on will be bringing goods at true prices as they can pay for the goods through banking channel. But there is a flipside; the prices may go up as they will have to pay duties and charges on the basis of the true price and not on the under-invoiced price. All said and done, Nepalis are going to lose from India’s demonetization. The gainers will be either unscrupulous currency change racketeers who buy demonetized notes at heavy discounts and then get that changed into legal money using their own ingenuity, if unofficial channel were to be used as we have been accustomed to, or the Indian State which gets its liability reduced. The second development is a typical case of taxation without representation. ‘No taxation without representation’ was the main slogan of the American Revolution, which led to the independence of the United States of America. The colonists - British subjects of the day - in the 13 colonies of Britain in North America revolted against the taxes imposed by the parliament in far away London where they did not have their representatives as MPs. The issue was so widely discussed at that time that many including the noted economist Adam Smith proposed to include some representatives of the colonists as MPs in the British Parliament. Similarly, we never elect the government in India, neither do we have any say on how it is run. We may not formally be a colony of India, but we suffer from whatever they do within their borders. The question worth pondering now is, how we can ensure ‘No taxation without representation’ in our case?

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Dr Hemant Dabadi is a Senior Fellow at Samriddhi, The Prosperity Foundation, well-known expert writing and researching on economic aspects of federalism in Nepal.