Why phasing out of old notes won’t curb graft

This week, the Central Bank of Kenya (CBK) launched the new generation coins, in a move largely in compliance with the Constitution. This means the current generation of coins in circulation will cease to be legal tender (or become demonetised) after some time.

But a more pertinent issue that has dominated the street is the notion that an abrupt demonetisation of banknotes, especially the Sh500 and Sh1,000 denominations, can help wipe out illicit or ill-gotten money perceived to be warehoused in houses, especially the gated residences. Broadly, this notion speaks to the citizenry’s constant frustrations with high level corruption scandals, most of which get smeared across the front-pages in a classical “If It Bleeds, It Leads” fashion.

However, the success of such an undertaking can be unsuccessful and at the same time anecdotal. India has proved that it can be unsuccessful. In November 8, 2016, the government of Narendra Modi announced the demonetisation of all 500 and 1,000 Indian Rupee banknotes, a move that was aimed at cracking down on black money, terrorism financing and counterfeit currency. The success of that undertaking is now in doubt.

Indeed, in its latest annual report, the Reserve Bank of India shows that over 99 percent of the junked (or demonetised) 500 Rupee banknotes showed up in the banking system two years later. However, success was recorded in the crackdown on counterfeit currency.

Secondly, currency in circulation does not explicitly incubate or stimulate corruption. Japan has been known to have the highest usage of cash. In fact, Japan’s currency in circulation (C-i-C), as a share of its gross domestic product (GDP), stood at 19 percent in 2017, ranking it among the highest in the world. Kenya, on the flip side, had currency in circulation equivalent to just three percent of its GDP. However, according to Transparency International’s corruption perception index, which it says ranks 180 countries and territories by their perceived levels of public sector corruption as per experts and businesspeople, Kenya ranked 28 in 2017 while Japan ranked 73.

India, whose currency in circulation as a share of GDP stood at 10 percent in 2017 and making it to the list of Tier 1 countries in terms of cash usage in the economy, ranked 40. And if you think the two countries could be outliers, let’s try Nigeria.

In 2017, Nigeria’s currency in circulation as a share of GDP stood at just two percent but it scored 27 on the Transparency International’s corruption ranking.

This basically implies that the Japanese, as cash-heavy as they are, are still significantly less corrupt than the cash-lite Kenya, Nigeria and India. This underscores the fact that there is no direct correlation between the cash-heaviness of an economy and corruption levels.

Finally, asset allocation among the corrupt elite favours physical assets and offshore foreign currency investments, mostly through vehicles registered in tax-friendly and opaque territories and jurisdictions. However, there has to be a liquid component of the allocation — mostly in the form of cash (to a large extent). In fact, they are also faced with the same trilemma as your asset managers, namely liquidity, security and return. Consequently, any attempt to demonetise a currency with the aim of cracking down on illicit flow of money may not yield the desired results.