Shabiha Nur Khatoon
Prime Minister Narendra Modi’s stated objective to flush out black money used to finance terrorism, drug trafficking and sundry other illegal activities is, on the face of it, laudable. But is demonetisation the solution? Experts point out that the crackdown on the black economy would require efficient tax laws and implementation of measures that facilitate the emergence of a ‘less-cash’ economy. In the absence of such radical macroeconomic policies, it is not just difficult, but impossible, to weed out the slush…
On the evening of November 8, around 8:15pm, Prime Minister Narendra Modi in an unscheduled telecast made an announcement that came as an unexpected jolt. He announced his decision to pull `1,000 and `500 banknotes out of circulation thereby rendering them invalid for most transactions.
What’s more, the withdrawal of legal tender of high-value notes, it was announced, would come into effect from November 8 midnight – nothing less than a sudden shock for a predominantly cash-based economy. The purpose of the drive, the Prime Minister said, was to “fight corruption, black money, fake notes and terrorism, in this movement for purifying our country”.
Demonetisation has since dominated discussion in the media with several news reports highlighting the distress and hardship ordinary citizens have had to face over the last few days. Long queues outside ATMs and at banks brought to the fore the bitter truth that, even in the digital age, a majority of Indians are over-reliant on cash for conducting daily transactions. It should also be borne in mind that millions of people in the country still don’t have bank accounts despite Modi going into overdrive with the Pradhan Mantri Jan Dhan Yojana scheme.
However, the NDA government’s bold move to weed out black money is not the first of its kind in Indian macroeconomic history. The decision to scrap high-value notes was first taken in January 1946 and again in 1978.
The highest denomination note ever printed by the Reserve Bank of India was the `10,000 note in 1938, and again in 1954. But the note was demonetised in January 1946 and again in January 1978, according to RBI data.
Higher denomination banknotes of `1,000, `5,000 and `10,000 were reintroduced in 1954 and all of them were demonetised in January 1978. The `1,000 note made a comeback in November 2000. `500 notes came into circulation in October 1987, which move was then justified as an attempt to contain the volume of banknotes in circulation due to inflation. This is, however, the first time that `2,000 notes have been introduced.
The value of high denomination notes in circulation in 1978 was a mere `130 crore. In contrast, `500 and `1,000 notes cumulatively accounted for `14.18 lakh crore, or roughly 84 per cent of the total value of all notes in circulation until November 8.
In 1978, a majority of countrymen didn’t possess big denomination notes which were only 15 per cent of the total currency. In 2016, the high denomination notes constitute a sizeable part – almost 80–85 per cent – of the total existing currency. Therefore, Modi’s move has resulted in massive churning of the economy considering the magnitude of the notes that were demonetised.
The scramble for cash over the last many days has hit a cross-section of society. The reason why demonetisation hadn’t affected the masses as severely in the past is that a majority of people didn’t have high denomination notes in their possession in, say, 1946 or 1978. Noted economist, professor of public policy at Harvard University and a vociferous advocate of a “less-cash economy” Kenneth Rogoff has observed, for example, that the demonetisation of the $100 bill in the US is plausible as the common man doesn’t have hoards of it and high denomination notes are used only for voluminous transactions not involving the aam admi. However, in Modi’s India, middle class and lower class people as well as farmers are having to bear the brunt.
Many distinguished scholars like emeritus professor of economics at Jawaharlal Nehru University in New Delhi, Prabhat Patnaik, are of the view that a sizeable chunk of black money is not “stocked” but “flows” in the economy, and could very easily be converted into white money. Demonetisation, Patnaik observes, could only add to the distress of farmers and petty traders.
Many economists have opined that rather than the sudden decision to recall high-value currency notes, the government could well have extended the deadline to December 30 for withdrawing the legal tender of `500 and `1,000 bills, and, in the meantime, could have introduced the new `2,000 and `500 notes. This move, experts argue, could have gone a long way in alleviating the hardship faced by a majority of honest taxpayers.
Sunday POST chats up experts and a cross-section of society on the short- and long-term consequences of the demonetisation drive.
Himanshu Sekhar Rout, head, department of analytical and applied economics, Utkal University, says: “Within India’s parliamentary system, determined leaders have a decisive mandate in shaping economic policy. The example that first comes to mind is Indira Gandhi’s bank nationalisation drive in 1969. The second biggest intervention in the working of the economy is certainly Narendra Modi’s demonetisation move aimed at curbing black money and terrorist activities. These are great and courageous moves, but before taking the decision the prime minister ought to have planned things in a better way.”
“India — a cash economy — with one of the highest cash to gross domestic product ratios in the world (of over 10 per cent), and a large informal sector which depends overwhelmingly on cash transactions, has been rendered financially immobile by constraining the money supply and making redundant the purchasing power of millions overnight. `500 and `1,000 notes constitute 86 per cent of the total currency in circulation. It is estimated that just about 5 to 6 per cent of black money is actually held in cash,” says Rout.
“Keeping in mind this overall scenario, the effect of demonetisation will not be momentous but certainly significant. The points which should have been factored in are:
- Banks could have been instructed to store ample low denomination notes
- ATMs could have been recalibrated to disburse `2,000 before the demonetisation move was formally announced
- Sufficient new `500 and `2,000 notes ought to have been kept ready
- Mobile ATM services could have been spread wide,” adds Rout.
The professor of applied economics is optimistic that demonetisation will help weed out black money from the system. “Banning high denomination currency is good for the country. It will wipe out corruption, black money and terrorism. The move has hit the common people the most but they don’t need to worry as they will not lose their hard-earned money since the government has made provisions for exchanging `500 and 1,000 notes with other legal bills,” he says.
Harun Rashid Khan, former deputy governor of RBI, assesses the impact of demonetisation from three angles – “transactional, transitional and transformational impacts”, as he calls them.
“Millions of Indians are facing problems and efforts are being made so that people choose electronic modes of payments like Paytm, cards and mobikwik. The most important thing is to watch closely how the transition period and transaction are being managed, and if things are not managed properly it could really create problems. We have to see how these three aspects play out over a period of time,” says Khan.
Dwelling on the impact of demonetisation in the long run, Khan says: “There will certainly be an impact; however, whether it will be substantial or marginal we still don’t know. The move by the government has hit the marginal sections and rural people. The rural economy is mostly cash-based and when there is cash shortage there will certainly be an impact. But the government is addressing their problems, like farmers have been allowed to withdraw up to `25,000 a week against sanctioned crop loan, and they are also allowed to use old high denomination notes for purchasing seeds.
ATMs are being recalibrated. The government and the RBI are trying their level best to reach the rural areas as digital infrastructure in India is still lacking in many respects,” he says.
Charter accountant A K Sabat is of the view that demonetisation’s effect on the macro scenario in the short-term will be bearish, but the move will bear fruit in the long run.
In view of shortage of cash, demand will temporarily be affected, maybe till March 31, 2017. But subsequently the economic equilibrium will be restored, he says.
“Rampant black money which was in the system after the 1978 demonetisation (that is for 38 years) should temporarily be out of the system. But it is very difficult to change the psyche of people and keep counterfeiters at bay. Unless tax laws are changed and efficient collection is ensured, black money will remain a curse for the Indian economic system,” says Sabat.
Experts opine that the move to ban high denomination bills is a positive one. It will affect the government but in the long run it will be beneficial, they say. This is surely going to be a significant positive surprise to the Indian economy.
If implemented in a proper manner, it will send a strong message about India’s vigorous anti-corruption drive and is very likely to improve the country’s reformist stance.
They also observe that the move will boost the government’s financial inclusion drive, pushing more households towards efficient banking and payment infrastructure. In the immediate run, they add, we are likely to witness larger bank deposits, price corrections and better tax collection possibilities in the economy — all great for Indian bonds.
The drive is also effective in flushing out fake money, as more and more people will, from now on, avail the banking system which will help keep a tab on transaction thereby facilitating revenue growth. There will be transparency in all transactions.
Florist Sudeep Kumar who owns a shop near Unit I market in Bhubaneswar says his business is his only means of livelihood. “The demonetisation move has adversely affected my business because buyers are disinclined to spend on flowers. Earlier, my daily turnover was around `1,500 to 2,000, but, in the past fortnight, it has plunged to around `1,000,” he says.
Fruits and vegetable vendors in the city have been severely hit by cash crunch. Business has come down by half and vendors are forced to sell their stocks at throwaway prices.
Grocery store owners are also feeling the pinch as customers don’t have low-value bills to make payments. A majority of kirana shop owners still don’t have bank accounts.
