The widespread corruption in Nepal remains unchecked, and the government seems clueless about the situation. Some high-profile politicians often suggest banning high-value banknotes such as Rs 1000 and Rs 500 to address the problem.
They appear to be under the misguided belief that prohibiting high denomination notes (so-called demonetisation) is the solution to rampant corruption. While demonetisation can reduce illegal transactions involving black money in the short run, it has potential long-term harm that far outweighs its short-term benefits.
It is crucial to understand that most of Nepal’s population relies on an informal economy and is financially vulnerable. As high as 80 per cent of workers in informal employment are paid in cash, making them particularly susceptible to the negative impacts of demonisation.
Small business owners, shopkeepers, farmers, manual labourers, and others contributing to Nepal’s shaky informal economy cannot digitise quickly. They depend on cash to perform the everyday transactions that support their families. Banning their primary payment method could bring life to a standstill, potentially eroding social stability. More than that, this idea could prove to be dangerous, as it could cause structural damage to Nepal’s already fragile economy, a prospect that should deeply concern us all.
Therefore it is time to delve into whether so-called demonetisation is a suitable policy for Nepal and underscores the urgent need for a more effective solution to combat the country’s relentless corruption.
Takeaways from India’s demonetisation experience
India’s experience with demonetisation in 2016 is very relevant to the current discussion in Nepal. The Indian experiment indeed offers many valuable insights into the matter. The original idea behind the demonetisation scheme was that criminals with illegally earned black money would refuse to declare their funds, resulting in a loss for the corrupt. However, in reality, it appears to have only caused a short-term inconvenience for those who held the illegal money. A report by the Reserve Bank of India in 2017 showed that 99 per cent of demonetized notes were returned back to the banking system, indicating only 1 per cent of the black money was not exchanged. This suggests a gross failure of the much-hyped demonetisation. Former Finance Minister P Chidambaram even questioned whether the demonetisation scheme was designed to convert black money into white.
Empirical research has further uncovered many adverse effects of India’s demonetisation policy. The National Bureau of Economic Research (NBER) study notes that demonetisation caused a decline in the quarterly growth rate of employment, economic output, and bank credit. The GDP contracted by about 2 per cent ( from 7.5 to 5.7) within the second quarter of the implementation, leading to billions in economic losses. The shock and awe impact of demonetisation execution was primarily felt by those in agriculture and daily wage construction labourers rather than the actual corrupt targets, resulting in significant job losses for low quarters of the population. This affected the most vulnerable groups, which predominantly conducted cash transactions. Small businesses and marginalized communities without access to formal banking were disproportionately affected, exacerbating inequality. The destitution and lost earnings were much more significant than even the most optimistic predictions of temporary declines in corruption.
Besides controlling corruption, India’s demonetisation was meant to modernize the economy into a digitized system. Accordingly, in the aftermath of India’s demonetisation in 2016, digital payments experienced a surge in popularity, as expected. However, within a few years, the cash-to-GDP ratio had returned to a level very close to what it was before the policy was implemented (12.2 per cent in 2016 to 11.23 per cent in 2019). This implies that simply forcing people to use digital tools without improving digital infrastructure, accessibility, or financial literacy could lead to the exclusion of vulnerable populations from financial services.
Another critical research revealed that criminals quickly adapted to the liquidity shortage, using alternative methods such as land, gold, foreign bank accounts, alternative paper currencies, and cryptocurrency. They found their way into other shady channels to manage their illicitly earned money. Therefore, India’s experience serves as a cautionary tale for Nepal, highlighting the potential pitfalls of such a drastic measure.
Lessons from other countries
According to a study published in 2017, many other countries have attempted to use demonetisation as a monetary tool to combat corruption. Among them, richer countries with established infrastructure that do not rely on informal economies, such as the United States and Australia, have successfully implemented demonetisation and were able to see tangible results. In the US, a 100-dollar bill is still the highest-value note available on the market.
However, other less developed countries such as Nigeria, Zaire, Zimbabwe, North Korea, Pakistan, and Venezuela have failed to implement the demonetisation. The Venezuelan government was even forced to reverse its decision due to public chaos. The North Korean government publicly apologized for the gross mismanagement of the demonetisation that ultimately exacerbated inflation in the country. The study indicated that the Pakistani experience was a total mess with a lot of hardship for the common people.
Demonetisation cannot be an option for Nepal either
Tackling Nepal’s deep-rooted systemic corruption through shock therapy is a difficult task. The aforementioned research findings and prior experiences from other countries unequivocally suggest that banning large currency bills, known as ‘shock therapy,’ does not pass a fundamental cost-benefit analysis. As discussed, there is sufficient evidence that demonetizing high-value notes against sophisticated corruption channels that continuously adapt and find alternative ways to maintain illegal transactions is ineffective after a short period, especially in developing countries.
Furthermore, unlike the Reserve Bank of India, Nepal’s central bank lacks extensive research and resources to base its executive decisions. It remains uncertain whether Nepal can even execute a ‘shock and awe’ kind of demonetisation execution that could potentially devastate its weak economy. Additionally, the cost of printing new notes of lower denominations to replace the higher denominations, adapting to new infrastructure, and managing the transition far outweighed shock therapy’s benefits in curbing corruption.
Therefore, banning Rs1000 and Rs500 cannot permanently solve Nepal’s corruption problem. Instead, we should focus on implementing structural reforms emphasizing accountability, transparency, and modernization of payment systems to combat persistent corruption.
Policy ideas for Nepal
Policy ideas tested and proven based on international experiences are still the best choice for Nepal to combat corruption more effectively than demonetisation. These ideas aim to establish robust prosecution frameworks, enforce existing laws, provide adequate resources to watchdog organizations like the CIAA, implement strict information disclosure requirements, use civic technology, launch sustained public awareness campaigns, and increase public access to governance activities through digital transparency portals and accountable contracting processes. It is important to note that controlling large monetary transactions rather than large denominations is more sensible.
Likewise, citizens must be empowered to report corruption through effective whistleblowing mechanisms to promote a culture of integrity. It is also crucial to share best practices and resources with other countries fighting corruption, encourage secure and accessible digital payment platforms, and ensure inclusive access to prevent marginalisation.
Thus, to achieve tangible results, policymakers must prioritize transparency and accountability by implementing genuine reforms to eradicate corruption while safeguarding prosperity for low-income people. Severely ingrained corrupt practices in Nepal will not be resolved by mere currency removal when underlying accountability norms have been badly broken. The notion of demonetisation, which has been shown to do more harm than good, is not the solution for Nepal’s struggling informal economy.
