Demon(et)ization - Part 1

Ever since Prime Minister Narendra Modi announced on US Election eve that 500 and 1000 denomination notes would not be any longer legal tender, the issue of demonetization has been a topic of heated discussions. The response to the move has been varied and interesting. While some political parties like TMC immediately demanded a rollback, others waited to catch hold of some straws to beat the government on the issue.

There were multiple aims of this exercise-

1. Temporarily check flow of counterfeit currency which is used to fund terrorism, insurgency and drug cartels

2. Attack on black money hoarded in form of cash

3. Give a push to a less-cash society with better accountability

Most criticism has been around the preparation or the execution post the decision. Let's look at the stated goals and the criticism to evaluate the decision. For the first two goals, demonetization as a move is effective only when  it comes as a surprise and there is little time to make alternative arrangements.

There has been several reports as to how printing presses in Pakistan have been printing Fake Indian Currency and circulating it through multiple borders. Fake Indian Currency has flown through porous border with Pakistan, Nepal, Bangladesh, etc. It not only directly affects the country through terrorism and insurgency but also affects the economy by taking value out of country and fueling inflation. With a change of currency design and size, it would take time for counterfeiters to create a very similar copy that would be difficult to distinguish from the real notes. This means the security agencies could look out for suspicious activities and expose those indulging in counterfeiting. Imagine if the government had announced it in advance, the counterfeiters would have stopped printing old notes and tries ways to create copies from the day announcement would have been made. The result of this to some extent has been encouraging as the media reports show a reduction in stone-throwing crowds in Kashmir and the activities of Naxals.

The second point has been a key point in discussion. Officially people got a 4 hour window since the decision was announced around 8 and was to be effective since midnight. The government also announced some exceptions to  However, people didn't take time to find loopholes and ways to launder money. People bought jewelry and gold with a premium as high as 30%. Many sought relatives or acquaintances ready to deposit/exchange notes with or without commission. Some used force to get the same done. Some bought railway and air tickets only to cancel and get refunds. The Jan Dhan accounts showed a significant hike. Some probably were too baffled to burn notes, flush them away or throw them in dump yards. The question remains as to how much black money was actually in cash and what amount will not be laundered resulting in a write-off by the Central Bank.

It is to be noted that the decision comes as part of a series of measures to unearth unaccounted money. Starting with setting up SIT on Black Money, the central government has undertaken the following measures:-

1. Signing agreements with other countries for automatic tax related information exchange
2. Disclosure scheme for Foreign assets
3. Excise duty on gold and diamond jewellery
4. Income declaration scheme for domestic assets
5. Benami Transactions Act Amendment
6. Real Estate (Regulation and Development) Act
7. Renegotiation of double taxation avoidance treaties with Mauritius, Singapore, etc.
8. Declaration of PAN for transactions above 2 lakh

Along with these, the GAAR, GST, reducing exemptions for Corporation along with a lower Corporate Tax are all aimed to mainstream the informal economy which some believe could be as large as the formal economy. It is common knowledge that apart from cash, most unaccounted wealth sits in form of gold and property. Points 3, 5, 6 and 8 are aimed at tackling the same. The government with its two income declaration schemes (2 and 4) had given people to come clean. Points 1 and 7 are aimed at closing the route for laundering money abroad. Lowering exemptions, clearing statutes, increasing use of analytics by Income Tax department, GST will all restrict informal economy. As Prime Minister himself has said, this is just the beginning of his war against black money.

Another important contributor to black money is corruption. All this while, politicians, bureaucrats and government officials have amassed wealth through corruption. In this, they benefited some crony capitalists and law-breakers while the general public suffered. The current regime is a welcome change from the scam ridden dispensations of UPA. With focus on clear policies, auctions, increasing use of technology to harbinger transparency (including DBT), this avenue would also be restricted. Of course, politicians who have come to rely upon this channel to fund their election campaigns and influence voters (corrupting them) are likely to suffer. This also explains the huge noise made by politicians who want a rollback or are hiding behind the sufferings of common man to thwart success of this step.

Now, let's look at the sufferings of common man. Narendra Modi said, there will be some difficulties in seeing this to completion. People had to stand in queues to exchange notes, withdraw cash which was again restricted. Why did this happen? It's not easy to switch from notes which accounted for 86% of the transactions. New Rs. 2000 notes were in short supply and new Rs 500 notes did not even come into a circulation for more than 10 days. Could the government have printed these notes in advance to tide over the change? The government indeed printed some Rs 2000 notes whose pictures leaked some days before the decision but did people guess the impending move. No, by the records it came as a surprise to everyone. Why weren't the Rs 500 notes printed earlier? Well, if the images of new Rs 500 note got leaked, people would have realized that the old 500 notes are to be switched - a deadly signal to give to people who are waiting for any clue that could harm their unaccounted wealth. Was there a need to give people window to exchange notes and not deposit them in banks? While the government did  a great job in opening Jan Dhan account, the financial inclusion is not complete. The people excluded are poor and uneducated and hence the move was to avoid them any hassle. Of course, as has been the case, there is often a mismatch between the intended and actual beneficiary. This has been true for subsidies, ration shops and funds allocated for various schemes. People who had black money used agents and beguile people to launder money for them through exchange. The ATMs didn't work. Couldn't the government have envisaged this? There is a high likelihood that the government knew about it though they may not have guessed it perfectly. Even then, the government couldn't have prepared for reconfiguration of ATMs as it would have given costly signals to people that government is planning something.

There have been some unintended sufferings. Some people had difficulties with respect to marriages, health treatment, etc. Why did this happen? Most of the urban population have bank accounts and mobile phones - the means to transact in absence of cash. Unfortunately, there has been poor adoption of such means in various business transactions as people always felt the cost of transacting in cash was nil or very less as compared to alternate means. Thus, few people have been swiping their Debit/Credit cards or using e-wallets for almost every transaction. For any cashless transaction, both the parties should be willing. For educated middle and upper class, it had been easier to dole out cash for transaction than to ask/educate the counter-party regarding cashless transaction. Here comes the third goal of this exercise - to drive economy towards cashless transactions. It will have enormous savings for the economy. the cost of printing, distributing and maintaining supply of currency would reduce while the reconciliation would become easier. There are still come costs including the cost of switching and gaining trust with a new technology which would need to be overcome in order to ensure that the trust is maintained.

It is also interesting to note how some in the educated class have reacted to the aftermath. We have all find means of cutting off our interactions and transactions with government to a minimum. Aided by technology and agents in some cases, we hardly ever have to interact with the sloth-like bureaucracy. This also explains the general apathy where people in metros didn't go out to vote (before IAC) and prefer to express displeasure over sad state of affairs in private conversations or social media - which is an easy way out. As this exercise has forced many people to stand in queues of banks which they had all relegated to an unknown region in their brain, they are coming to terms first-hand with bank branches and as an extension, the way things operate in the country. It would be good if they realize that all this need to change and the processes need to be revamped, the people manning the processes need to get professional and we still have a long way at improving ease of doing business. This should hopefully also generate some genuine empathy towards the underprivileged who see this face of the so-called 'system' and help them see a better side.

Is the pain going to be over soon? Perhaps not. But it's not going to take as long as some people are predicting. The savings shift from lockers to bank account, some transactions become electronic and an increase in money multiplier would mean you don't need to print the same value of notes. Hasn't consumption been hit in short-term? Yes, but it's likely to recover as basic items are still bought with low currency notes, are less elastic with regard to the available purchasing power. Some discretionary spending has been hit but will come back probably with a bang as the overall spending trend and economic sentiment hasn't changed. So a 2% dip in GDP growth rate is wishful thinking from pessimists and people wanting the exercise to fail.

The demonetization has raised several interesting questions which are also being discussed in public. But any honest Indian hoping for a better economy and a better society should hope the move succeeds in its aims.