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.