Since the past week with the
series of events since the demonetization in India including the cash crunch
felt at home to the social media messages that I have been reading, I have been
thinking of writing about the situation from my viewpoint – it is just my
opinion, my take on the situation and I am thankful to the constitution of this
great country that allows me the freedom to express them.
I come from a family which has
traditionally supported BJP because of its pro-development agenda but I have
always had a problem with BJP’s hindu conservative and dictatorial tactics and
had always looked for a third avenue to support (Congress not being an option because
of corruption, vote bank populist tactics, etc.). Unfortunately AAP did not
deliver and Kejriwal and his theatrical ways disillusioned all his followers
including me. Having said that, without digressing from the topic, I wish to
put forth some of my views on BJP’s latest act, i.e., demonetization of the 500
and 1000 notes, which has caused so much hue and cry that for the first time in
Indian history since Independence, Indian media almost gave the US Presidential
election a miss and has been doing so in its aftermath.
Being a doctor my view is more of
that of the general population but having done an MBA it allows me to view this
from the Macroeconomic lens too.
So, first let’s talk about what
is positive about this initiative. Demonetization of the 500 & 1000 notes
as an immediate response to fake currency and terrorism is an admirable move
but let me stress on the word “immediate” right now. This is not a long term
solution for any of the two topics at hand as has been touted by many including
BJP and its devoted supporters. What good has this step brought in then? It has
stopped the inflow of “fake currencies” creating a parallel economy and stopped
the “Hawala” flow of money for terrorism with immediate effect. But is this a
long term effect? No, if demonetization is not done at a frequent interval of 10
years or lesser making the development of fake currencies unsustainable,
eventually fake currencies of the current highest denomination,i.e., 500 and 2000 will gradually find their way
into the market and the same issues that the RBI is trying to battle right now
through this strategy will eventually arise. The last demonetization of the
notes of highest denomination (1000, 5000 and 10000) was done almost 38 years
back in 1978 giving the fake currency developers within the country and in
Pakistan ample time to run a profitable business. Now, had the imaginary "Nano GPS Chip (NGC)" been truly a part of the plan, it would have been a different ball game totally - a true master stroke - allowing much more stringent monitoring of tax evasion and fake currencies.
The other thing touted to be affected
is Black money that Modi and his passionate supporters have been pushing as the
major effect of this move. It is common knowledge that the black money
(undeclared money) amassed in cash by many rich will either be useless or will
have to be declared and deposited in the bank. Theoretically, this will help
the country to earn through taxes and interests on the deposits and interests
from the banks thus making it economically stronger. But that’s a theoretical
assumption which includes two assumptions that a large proportion of the
undeclared money is in the form of cash and that people will deposit the cash
in the bank. Realistically speaking people don’t stack black money in cash.
Rather, they stash it in the form of real estate assets in someone else’s name,
Gold and undisclosed accounts in Banks outside the country ,e.g., Swiss Banks.
Modi announced that the
nationalized banks received more than Rs 53,000 crore deposits in 2 days. It
sounds big when you hear that figure but let’s break it down further with a bit
of maths. We are a country of 127 crore population. Let’s assume that only 10
crore (around 8%) of that population, those that needed the cash immediately
went to the bank on the first 2 days for exchange, what amount did they each
deposit? Rs 5300 each. Is that an improbable figure? Would you or I or even a
fruit seller or poor farmer not hold that much money? So can that money be
equated to deposits from black money? Probably not. The ones with Black money
would either have tried to convert it to Gold or other assets or desperately
destroying or discarding it. Add a penalty tax to this scenario and destruction
of cash becomes the most likely choice. Destruction of this asset does not help
the economy in any way. The Ministry of Finance’s White paper on Black Money
suggests that excessive tax rates increase black money and tax evasion. When
tax rates approach 100 per cent, tax revenues approach zero, because higher is
the incentive for tax evasion, greater the propensity to generate black money.
Thus a penalty tax in this scenario will only lead to a destruction of the black
money instead of reaping the fruits of their deposits.
The Black money held by political
parties for the upcoming election will also be affected. In 2011, the MC Joshi
Committee on black money had found that the two major national parties (Congress
and BJP) claim to have incomes of merely ₹5 billion
(US$74 million) and ₹2 billion
(US$30 million). But this isn't "even a fraction" of their
expenses. These parties spend between ₹100 billion
(US$1.5 billion) and ₹150 billion
(US$2.2 billion) annually on election expenses alone. BJP may have had an
upper hand in this situation with time for the conversion of the undeclared
money into assets elsewhere but the demonetization action will still give
everyone an almost level ground during election as the cash distribution prior
to election for votes will decrease for all. During the 1978 demonetization in
the Janata Party regime under Morarji Desai, then-RBI governor I.G. Patel
disagreed with the measure and accused the Janata coalition government of
trying to cripple the corrupt predecessor governments instead of simply
eradicating black money. Thus the accusation from the current opposition on the
current measure too which will have a similar effect on the other political
parties including Congress.
Does this move result in deflation
and generate profits for RBI? It’s a complicated situation – our cash reserve
remains the same and that black money or fake currency was never a part of the
circulating economy and thus there will be no profits in the accounting books
and RBI will thus not be sending out dividends to your accounts and has been
stated in some speeches. Former Reserve Bank Governor, Rangarajan in his
article “Currency ban may cause meaningful wealth destruction” in Mint suggests
that the immediate effect will be that of a lower growth due to the adverse
effect on the heavy supply side sector like the transport industry. The real
estate and jewellery sector will also be affected because of an avoidance of cash
transactions. There will be a disinflation but eventually, once the cash
disbursement process normalizes, everyone will try to convert their cash into
assets including deposits (where the government will win) and real estate and
jewellery leading to an inflation again due to the increased demand.
Now let’s talk about the most
important effect of this move - the general public – 80% of the country agrees
to demonetization as a good effort floating on the anti-Pakistan, anti-terrorism
sentiments post-Uri attacks knowing that the move will affect the fake currency
inflow from Pakistan and the Hawala flow of money for terrorism but it is also
the same population which is exasperated having to stand in queue for hours
everyday for a few thousands and having to do so frequently because enough is
not being disbursed at one go. The timing of this move is also inappropriate as
it is harvest season, festival season and wedding season – all situations that
require heavy cash transactions. The hardest hit here are the farmers, the
small scale home-run businesses, the auto and taxi drivers and the street
vendors. With limited cash in hand, the buying power of the cash-strapped
general population is extremely low and limited or no transactions are occurring
with these vendors. Many of the farmers and street vendors do not have bank
accounts so neither can they sell nor earn through cashless banking.In Odisha,
Bali Jatra at this time provides an income avenue for hundreds of poor Odia
farmers post-harvest season wherein they sell organic small-scale household
items. This move at this time has almost ensured a sure loss for these vendors
who, in many cases, make one-fourth of their annual income in Bali Jatra. Their
plight is saddening and so is that of many farmers who are unable to sell their
produce. The effect of this is yet to be seen. Unfortunately there is no easy
measure of gauging this loss of economy and how it compares against the
probable profits (from deposits and interests) of this demonetization. Is there
a justification for this timing? Probably not. It was probably more politically
driven than strategically to affect the upcoming elections as was the case in
1978.
Let’s talk about the execution
now – the banks did not have enough cash and their ATMs had not been modified
to be able to hold the new 2000 notes. Firstly, no matter how covert the
operation, there could have been some notice to banks to ensure adequate amount
of 100 notes. Secondly, everyone knew of new 2000 notes being planned to be introduced
even if they did not know of the 1000 and 500 ones being replaced. At least
some effort should have been made to ensure that all the ATMs could accommodate
the 2000 prior to this notice. This would have ensured a smoother transition
ensuring smaller queues and lesser inconvenience.
In 1978, when the high
denomination notes of 1000, 5000 and 10000 were made illegal for transaction,
the buying power of the Rupee was much higher and families were able to sustain
with just 100 a month. Thus only the rich were affected but now, an average Indian
family earns and requires anywhere between Rs 10000 to 25000 in a month for sustenance
(Per capita income on purchasing power parity USD 5350). Thus people in every economic
strata poor, middle class and rich are affected.
So, to summarize my take on Modi’s
demonetization strategy – great move but needs to done frequently enough to
sustain its effect, bad timing – politically driven, execution not planned well
and thought through keeping the inconvenience to general public in view leading
to a sluggish phased implementation.
