The market has reacted heavily to the news from the reserve bank of India (RBI) about the withdrawal of all pre-2005 bank notes in circulation after March 31st, 2014. The media has been saying this is an attempt to flush out black money in the system as well as the fake notes. It is our understanding the main reason is simply to phase out old notes, something the RBI has been doing secretly in the past. This time they have decided to inform the public in an effort to get some help, because all pre-2005 notes are easily identifiable since they do not have the date on the back of the note (please see the picture of a pre-2005 INR 500 note and post 2005 note with the date on the back side above).
We are currently not buying pre-2005 notes until the market stabilises. From April 1st, the public in India will be able to exchange their bank notes at the banks. From July 1st, anyone changing more than 10 pieces of 500 and 1000 rupee notes will have to provide proof of identity and residence to the bank. The banks in India will always accept these notes as legal tender so there is no need to panic. We will eventually starting buying pre-2005 notes (at a lower rate), but not until the system overcomes the shock and adapts to the policy properly.
With the inflation India has experienced it doesn’t make sense for people to keep large amounts of black money in cash, most of the black money would have already been converted to assets like property or commodities like gold, so the impact on black money will be limited. However, this will adversely affect the poor and illiterate who live in remote places and without a bank account. This policy could lead people to take advantage of their lack of knowledge and situation in general. For more information on this issue, please see the below video.
Update: The reserve bank of India announced all pre-2005 Indian rupee notes (without a date on the back) will be accepted by commercial banks until the end of June 2015. After which they can be redeemed at branches of the Reserve Bank of India. Since a large quantity are still in circulation there is chance there could be a further extension.