Money has three functions.
It acts as:
1. a medium of exchange
2. a unit of account
3. a store of wealth.
On every Indian 500 Rupee note it states “I promise to pay the bearer the sum of Five Hundred Rupees.” It is signed by the Governor of the Reserve Bank of India (RBI). This allows Rupees to perform these functions.
On November 8th, 2016, in an unscheduled speech in parliament, the Prime Minister of India, Narendra Modi, banned the old 500 and 1,000 rupee notes. These notes made up over 85 per cent of the notes in circulation in India. Modi urged Indians not to rush to banks, as they had until the end of the year to deposit the old notes in their accounts. However, queues formed immediately at the cash machines as people tried to exchange their higher value notes for 100 Rupee notes, or to deposit the old notes in their bank accounts. The queues lasted for months with many cash machines regularly emptied. People were unable to withdraw new notes to replace the old ones they had handed in.
Indians non-resident in India were in an even worse position. They were given until the end of the year to exchange their notes. That made it difficult for those who had no plans to be in India during that time. Some just gave their money to friends who were visiting rather than see it go to waste. However, the deadline for these individuals has now been extended to June 2017.
In effect, the RBI had reneged on its promise to pay the bearer. So why did the RBI break its promise?
The aim was to fight corruption and tax evasion. The hope was that many Indians would move from the cash economy into the formal taxed economy, perhaps increasing the use of electronic cash. But will it work? Only time will tell.
The idea was also to leave gangsters stranded with suitcases full of worthless money. But it appears that nearly all of the 15.4 trillion rupees taken out of circulation are now accounted for. So maybe there was less illegal money in the Indian economy than was originally thought. Or do the gangsters always know how to stay one step ahead?