There is more than meets the eye in demonetisation

It is the paradox of our time that on the day we were celebrating self rule, Madaraka Day, the breaking news was demonetisation of Sh1,000 note. In economics speak, it is the withdrawal of a currency from circulation.

The timing was perfect, during a holiday, and more so when celebrating self rule. Did this breaking news mean we are still struggling to self rule ourselves on the economic front, 56 years later?

Was the timing supposed to give us a weekend to digest the news? Or was it to stop a rush to banks and forex bureaus? Did the news catch us flat footed or we anticipated it after a similar move in India in 2016? That apart, does Central Bank of Kenya (CBK) have a museum of currencies?

Beyond the demonetisation of the Sh1000 note, we have new coins and notes. That is what the constitution demanded, new currencies without human portraits. The thinking supported by Murang’a Senator Irungu Kang’ata is that such portraits on the currency can be politically polarising.

Interestingly, even the US whose constitution we copied uses portraits of presidents on their currencies, but they must not be living.

Beyond constitutional requirements, why else are we changing the currency or demonetising?

One reason is counterfeiting. The new currency notes and coins are harder to fake. Seen Canadian notes? They are smaller and easier to carry and hopefully longer lasting. 

Two, the focus on the big note “ngiri” or “thau” is because of its alternative use. Not just as a medium of exchange. It’s an alternative “bank”. If you want to keep money at home or elsewhere, use this note. You need less space and less weight if carrying it around.

Have you noted the booming business in safes? The yellow pages showed very few safe dealers in the past. Today they are many. I doubt if we are buying safes to keep our exam certificates and title deeds only.

But let us be fair to ourselves, we keep money at home or office for a number of reasons. We prefer cash to “see the money” in transactions. I noted the other day that casual workers want cash, not M-Pesa. There is some pride in handling real cash. That is why mobile banking has not picked as fast as expected. We also keep cash for emergencies.

Illegal or shadow economy prefers cash. You can’t write a check when buying cocaine. Cash leaves no trail. That makes it hard for the taxman to get you or even the police.

It is not just the Sh1000 note that is popular in illegal business or underworld, the $100 note and 200 and 500 Euro notes are popular too. Lots of such notes disappear from circulation into underworld. Such big notes are popular in corruption deals. If you are getting a cut of Sh100m, cash would be preferred. Again no trail, no tax.

The new stringent CBK regulation might have inadvertently pushed lots of people into “ngiri” notes. Instead of answering so many questions in the bank when opening an account, why not just keep that money at home?

Did I hear a lot of Kenyans have opened accounts in the neighbouring countries because of our stringent banking regulations? While the target is fraudsters and terrorists, innocent businessmen and women are caught in between.

The CBK fined some banks for handling NYS money. That has made them implement the regulations to the letter, never mind the rising cost of compliance, both for banks and customers.

Demonetisation is more than meets the eye. Recent police raids have found lots of cash in a number of homes. There is a widely held belief that some people have bunkers full of money This is probably the money CBK is targeting.

Any money got through your sweat is likely to be banked for safe keeping and made available to the formal economy. It can be lent to investors or government through treasury bills and bonds. Hoarding money at home slows down the intermediating role of banks.

In general, demonetisation and introduction of new coins and notes is good in the long run. More money in the formal system will give our economy a much needed boost.
Less counterfeits will restore faith in our currency. We hope the noblest objective will be achieved, reducing corruption. Proceeds from corrupt deals and counterfeits could be used to fund terrorism or other activities that are a threat to national security.

Counterfeits and corruption discourage hard working and innovation which are critical to economic growth. If counterfeits lead to inflation, even the innocent suffer.  
Where do we go from here?

This policy shift despite its huge publicity affects few people. How many Kenyans carry Sh1000 note? In the countryside, getting change for such a note can be a tall order. But the few who keep such notes are influential and not always positively.

Expect vibrancy in some sectors as the few try to bring their money from the shadows. Real estate is one. Could lots of buildings start coming up? Could there be an explosion of generosity as such money hoarder’s reason it’s better to give than to lose? What of buying luxuries like cars or expensive perfumes? There is no limit to what one can do to “clean” money.

The amount of money held in Sh1000 note is about Sh218b; about 8 percent of the proposed Sh2.7 trillion budget. That might be a big boast to the economy and taxman. We anticipate no significant inflation as those hoarding that money try to get it into formal system.

Let’s face it; the effects of demonetisation of Sh1,000 notes might not be as severe as expected. Data from stock exchange does not show a big shift in the index. The exchange rate has not shifted significantly too. Could it be because we had the weekend to digest the news? Was the breaking news old news to some?

The financial sector is the nervous system of an economy. We hope the CBK reforms including demonetisation will make it more efficient. So far CBK has done an exemplary job in stabilising the exchange rate and inflation.

One joke I heard is that instead of throwing away the old notes, we can use them to pay our foreign debts. That is gross misunderstanding of how an economic system works. It’s akin to suggesting that we should print money, give it to everyone and declare an endless holiday. Money obeys the laws of supply and demand; we would end up with hyperinflation and your money would be of little use.

Zimbabwe shows what can happen if money supply is increased recklessly. South American nations had a similar problem in the 80s and so did Germany during World War II.

Finally, academics have a golden opportunity to study the effects of policy changes “live” without textbooks and their inert ideas. PhD students where are you? Where are behavioural economists?

-The writer teaches at the University of Nairobi. xniraki@gmail.com