DEMONETISATION: A Big, Bold Move or Big, Bad Blunder?

True Tremors

Since November 8, 2016, a fierce debate is dominating public discourse in the country. Questions doing the rounds at many a round-table are:

“Will demonetisation (or, remonetisation, for technical accuracy) define India’s future? Or, will it destroy the economy?”

The answer most likely depends on your political affiliation, not on either your preferred mode for saving money for a “rainy day” or the impact of the demonetisation diktat on your personal wealth. Views are clearly polarised; opinions deep-rooted and convictions rock solid. Emotions no doubt are running high on both sides of the intellectual divide. So, to understand all the ramifications of the measure, I attempt a clinical, dispassionate assessment based on hard-nosed, economic considerations and not lily-livered, emotive compassions.

At the outset, is there money hoarding of cash in India at all?

Of course, it does not take a rocket scientist to intuitively and empirically know that the answer is a resounding “yes”. But, do cold facts back the view? My take follows.

All Economics; No Politics

The United States of America, with a GDP of about US$20 trillion, has “currency in circulation (CIC)” (the sum of all currency notes and coins out with the public) of about US$1 trillion, that is, about 5% of GDP. The US$ being a strong currency, it is a good hedge against future risks and uncertainties. Foreign bankers and investors alike prefer to stockpile it as a reserve currency. Hence, only about US$300 billion or 1.5% of GDP is the domestic CIC powering the US economy. This confirms that “money velocity” and “money multiplier”─ two CIC-linked measures that economists use to gauge economic health─ in the US economy are (as desired) high.

In contrast, India has a CIC of about US$0.3 trillion, which constitutes almost 15% of its GDP of a little over US$2 trillion. This is not only indicative of the presence of a significant cash-based, parallel economy, but also symptomatic of substantial tax evasion, money laundering and currency hoarding in India. High-denomination bills, of Rs.500 and Rs.1000, only facilitate the stashing of black money. Hence, the shock-‘n-awe of demonetisation presumably (temporarily, for sure) has driven a dagger right through the hearts of the black-moneyed and their activities.

It is well-settled in economic theory that high levels of money supply, specifically “currency in circulation” coupled with corruption and tax-evasion, are inflationary. The systemic onslaught of black money in the country has assumed endemic proportions. It has systematically eroded tax collections; created economic imbalances; impeded government spending on infrastructure and social sectors; and, led to burgeoning fiscal deficits.

Further, crime and corruption proceeds are typically channeled and laundered into certain cash-centrist sectors of the economy, such as, retail, real estate, restaurants, entertainment (films & the ilk). Excess (tax-evaded) cash─ chasing goods and services, particularly sin (viz., alcohol, tobacco, etc.) goods, luxury products, lifestyle services and high-end imports─ exerts inflationary pressure. Spiraling inflation leads to higher interest rates; it also dampens “consumer sentiment”, diminishes “real and discretionary incomes”, reduces “consumption”, drives down “industrial investment and job creation” and, potentially encumbers financial systems with “toxic loans and non-performing assets”. Further, it often creates a “residential investment” bubble.

Result: “Jobless growth”, which is detrimental to the economy in the long haul. It is these hollow, flawed fundamentals that have been a blemish on India’s growth story in recent times. Given this backdrop, a course correction to mitigate risks of an economic meltdown was surely kosher.

Some detractors of the bold move believe that demonetisation in India will fail to tackle black money. Demonetisation initiatives in Burma, North Korea, Nigeria, Zimbabwe, and even USSR are cited in support of the view. However, they gloss over the fact that in other countries, such as Australia where demonetisation was an anti-counterfeiting measure, it has been hugely successful.

The battle in India though is not just against black money, but also against several other economic ills and socio-political evils. Cash, as we know, is the lifeline of drug peddling, criminal activity, human trafficking, illegal betting, insurgency, Maoism, terrorist funding, hawala rackets, illegal chit-funds, usurious lending (mostly to lower strata of society), election campaign financing, etc. Given that corruption and tax evasion are prevalent in India, and the propensity of Indians to subvert the system, even if the “surgical strike” against black money fails, the downstream curtailment of other scourges, if not all, partly justifies the move.

Sound of the Death Knell

A few people hold the view that the measure was not well thought out. The evidence is in favour of just the opposite. Past moves of the government aimed at financial inclusion, such as, PM Jan Dhan Yojana, Aadhar-linked Direct Benefits Transfer, etc., were perhaps attempts to soft-land demonetisation. The amnesty afforded through voluntary income declaration schemes too was perhaps sugar-coating of the revolutionary move. Strengthening of the Benami Transactions Act, and notification of stringent rules thereunder, were also indications that demonetisation was a move conceived meticulously. Many surely thought it was business as usual, and hence, missed all the portents that forbore the drastic policy decision.

Conspiracy theorists have even speculated that bureaucrats, privy to the move, had leaked information and helped crony capitalists and politicians to proactively swap, deposit and convert hoarded cash. Demonetised currency holdings were surreptitiously converted or transitioned, they claim, into gold, diamonds, new currency, real estate, trusts, political parties, etc. To begin with, these laundering methods entail sub-optimal placement and layering techniques. Further, these transactions leave distinct money-flow footprints, which are easily detected during tax raids and statutory audits.

Others have been critical of the measure because cash constitutes only about 5% of black wealth. The complaint is that demonetisation infringes the "fundamental right” of people to withdraw monies from their bank accounts. Yet another red herring! The “right to hold property” is not an absolute, fundamental right under our Constitution. Persons can be deprived of property (movable or immovable) save by authority of law. Indeed, validation of zamindari abolition and agrarian reform laws, bank nationalisation and annulment of privy purses are all examples of past legislative and executive actions depriving people of property. Demonetisation, as we know, restricts only temporarily the access of people to their banked monies and assets.

Big Bang or Big Bust

In some quarters there is a belief that by December 30, 2016, most (if not all) of the old, demonetised Rs.500 and Rs.1000 notes in circulation (valued at about Rs.15.44 trillion) would enter the banking system. They argue that such an eventuality implies a botched attempt at rooting out illegal cash from the system─ estimates have put 25-40% of large-denomination notes to be black, laundered money. It defeats the very purpose of demonetisation.

In reality, though, such a scenario is highly desirable.

In the hypothetical context of all demonetised notes being redeemed, the Reserve Bank of India can effectively use modern software analytics tools and data mining techniques for: (a) detecting spikes in demand for new notes from bank branches; and, (b) identifying disproportionate deposits of cash in individual accounts. Based on the unearthed insights and intelligence, raids and investigations can be launched. The knowledge would help eliminate bad apples from within the banking industry. Indeed, black wealth often gets created only with the connivance of such black sheep. 

The geo-political scenario in the sub-continent makes India vulnerable to influxes of fake currency from hostile neighbors. Post surgical strike in the aftermath of the Uri attacks, there was a high risk of the Indian economy being crippled through the clandestine injection of massive quantities of counterfeit banknotes. The remonetisation move has necessitated perforce a significant thrust towards a cashless, e-monetised society. This ushers in a paradigm shift by making the country immune to subterfuge and unconventional, economic warfare tactics of inimical nations.   

Regardless of the value of old currency that gets redeemed, government is in for a windfall. Unreturned currency would reduce deficits and liabilities of government. The additional deposits mobilized and improved bank liquidity will enable RBI to adopt expansionary monetary policies, leading to the lower interest rates and cost of government borrowings. That surely would enable government to enhance fiscal allocations for social sector and infrastructure. GDP growth over the next couple of quarters may dip on account of productivity losses and subdued economic activity because of cash restrictions. The outlook though is bright in the mid- to long-term.

Concluding Remarks

In conclusion, I state that the true beneficiaries of the move are likely to be the underprivileged sections of society. Indeed the pain and agony of queuing up for hours is worth all the trouble. Too many people, particularly in rural India, have suffered silently for too long in anticipation of development and inclusive growth reaching them. The poorest of poor, who have been subjected to tougher challenges all their lives, surely are resilient enough to survive long waits in lines. The possibility of a new, corruption-free economic order, courtesy game-changing demonetisation, gives fresh hope and renewed vigor to aspirations for marginalised sections, be it better education, healthcare, infrastructure, opportunity or standard of living.

Therefore, regardless of how you slice and dice it, demonetisation holds a great promise of a better future for India and its citizenry. It is perhaps the most strategic policy decision since 1947. And, in my considered opinion, it is the panacea for many ills plaguing our nation.

The jury though is still out on how well this initiative has been implemented. But then, can one nitpick on the nitty-gritty of execution and risk missing the woods for the trees?

Bottom-line: Demonetisation, in tennis terms, is game, set and match, government!