Jaideep Unudurti
Modi government is extremely adept at optics, at policy measures
presented in a blaze of publicity that dazzles the public, rather than
with the required attention to detail that might ensure their success.
The latest announcement of the demonetisation of high value bank notes
is of the “shock and awe” variety of measures. While presented as
evidence of the government’s supposedly firm resolve to root out black
money, in reality it will barely touch the problem of generation of
black money, even as it is being implemented in a way that causes
immense economic harm to ordinary people and especially to poorer
sections of society.
The demonetisation of bank notes per se is not the problem. Indeed,
it has occurred periodically in India and many other countries, both to
reduce concerns about counterfeiting and to spread the use of cash-based
illegal transactions. To the extent that it reduces these, it should
certainly be welcomed. However, when this has been done in India in the
past or in other countries, it has typically been done gradually,
allowing adequate time for people to replace the old notes with new ones
to prevent too much disruption of economic activity. This overnight
shock, by contrast, is hugely destabilising, with likely medium-term
material damage to a very large part of the population. It affects very
little of the stock of ill-gotten wealth and does nothing about its
generation, but it has severe impact upon ordinary people, whose lives
have already been hugely disrupted.
Government spokespersons argue that secrecy and speed were of the
essence to achieve its goals. Otherwise, they state, those hoarding
black money would simply be able to convert their cash into “white”
through buying other assets in the intervening period. But this argument
is completely specious. Suppose the government had announced that (say)
from December 1, 2016, the old notes would no longer be valid. It could
then start tracking all large sales of likely assets (such as land,
houses, gold) and foreign exchange transactions, to follow up with those
who had made them. This would have involved no cost to the ordinary
law-abiding citizen but still provided the government with all the
information it needs to ensure legal and tax compliance from such
individuals.
Instead, the shock announcement seems to have emerged from the
current government’s penchant for drama and propensity for so-called
“big bang” reforms. Other explanations have been put forward about the
timing of this move: the need to distract the media – and indeed the
entire society – from the government’s increasing repression of the
media and of all forms of democratic dissent, which had recently become a
major issue of concern; and the upcoming elections in the two important
States of Punjab and Uttar Pradesh, in which rival parties would
definitely be wrong-footed by this announcement while the Bharatiya
Janata Party (BJP) might just have got some sort of heads-up before the
action. (Indeed there have already been accusations that several
accounts held by BJP members in different parts of the country were
suddenly filled with large deposits in the month before this dramatic
announcement, and that members of the ruling party were informed about
this demonetisation well in time to take precautionary measures.)
In any case, both design and implementation of this scheme have been
far from ideal. In terms of design, the secrecy and suddenness have
already been noted as creating completely unnecessary problems, which
have hugely affected ordinary people across the country. In addition,
the government clearly failed to recognise that, given the rise in
prices over the years, it is absurd to treat Rs. 500 as a
“high-denomination” note that poor and middle class people are not
likely to use. Given the prices prevailing for many essentials like food
items and medicines (with some dals costing nearly Rs. 200 per kg for
example), it is absurd to consider that Rs. 500 would be an amount that
only rich people or black marketeers would use. These Rs. 500 notes
accounted for more than two-thirds of the notes in circulation, and
removing those at one stroke inevitably has had huge repercussions on
liquidity, markets, production and consumption across the country.
In fact, when the Morarji Desai government had demonetised high value
bank notes in 1978, it cancelled only those notes with values of Rs.
1000 and above – and Rs. 1000 at that time would be the equivalent of
Rs. 25,000 today! As it happens, precisely because the notes involved
were of such high value at the time and accounted for only 0.6 per cent
of the money in circulation, the demonetisation of 1978 was not so badly
felt by ordinary people. However, even then the Reserve Bank of India
(RBI) Governor of that time, I.G. Patel, pointed out that “such an
exercise seldom produces striking results” since people who have black
money on a substantial scale rarely keep it in cash. “The idea that
black money or wealth is held in the form of notes tucked away in suit
cases or pillow cases is naïve.” And in any case, big players holding
large amounts of undisclosed cash can usually find agents to convert the
notes through a number of small transactions “for which explanations
cannot be reasonably sought.” Yet the government was insistent, and so
“the gesture had to be made, and produced much work and little gain 1 .”
The economists Brahmananda and Vakil noted that a measure like this
“has primarily a political and not economic objective. In such a case it
becomes a business in and among politicians 2 .”
If this is what has driven the current exercise as well, then perhaps
the government’s willingness to tolerate and justify the massive
administrative glitches and associated harm to common people are easier
to understand. In terms of implementation, what has been even more
surprising than the design is the apparent lack of preparation on the
part of the administration for such a major move. Once again, the need
for secrecy is being advanced for this, but that argument is untenable.
The chaos evident in the week after the announcement is partly because
not enough notes have been made available to banks and ATMs, and
arrangements to deal with what should surely have been an expected rush
to exchange notes were completely insufficient. Removing most (86 per
cent) of the currency in circulation at one stroke is a huge move that
necessarily constrains the payments system and can even bring it to a
halt in parts of the country where the new cash notes do not become
readily available. It is surely foolhardy to imagine that economic
activity in such a heavily cash-based economy as that of India would be
unaffected if these volumes of currency are not very rapidly replaced.
Then again, the choice to introduce first the Rs. 2000 note rather
than the Rs. 500 note is mystifying: obviously, this would hardly create
an effective liquidity substitute for the Rs. 500 note, yet government
representatives appear to be surprised when people complain that they
cannot find anyone to give them change for the higher value note. The
shortage of other lower value notes, that is inevitable when only newer
notes of even higher value are being introduced, should also have been
anticipated, yet that too was not factored in. In any case, surely if
the idea is to eliminate black money, then it is hardly desirable to
introduce even higher value notes that would presumably be even easier
to store for those holding large quantities of undeclared cash.
If the Prime Minister is correct in claiming that this was not a
sudden move but something that has been planned for nine months, then it
is incredible that so little effective preparation was made. It appears
that there was little official recognition of likely implementation
problems: the government began by claiming that things would be sorted
out in a matter of days, then weeks, and most recently 50 days, during
which time the Prime Minister has asked the people of the country to
bear with him. But it beggars belief that simple matters like ensuring
that the RBI has sufficient notes to replace the ones that have been
demonetised, or that ATMs are appropriately configured, were not taken
care of before going through with this, especially as there is no
pressing need for choosing this particular moment to do so.
Still, all this this would have been worth it, if indeed such a move
would eliminate all black money in the country. But in fact, it will do
little more than scrape the surface of the problem, even if it does so
in a blaze of hyperbole.
The nature of “black money”
What exactly is “black money”? The first mistake is to see it as a
stock of cash or pile of accumulated assets, because it is not about
stocks at all so much as flows or transactions that are concealed from
authorities or under-reported, so as to avoid taxes and various other
regulations. Bribery and other instances of corruption are one form of
such transactions, but there are many other forms, such as
under-invoicing and over-invoicing by companies of all sizes,
under-reporting of the values of sales of goods and services by
individual providers, overstating of costs, reporting false or
non-existent transactions and of course criminal activities of various
kinds. Many of these do not necessarily require cash transfers at all
but can be just as easily (and more speedily) done through electronic
means, and relate to different sorts of account-keeping. Also, money
does not acquire a particular colour and keep it; as it flows through
different transactions, it can move through white, black and grey hues.
For all these reasons, estimates of the exact amount of “black money”
in the system at any given time are necessarily problematic, since they
rely on assumptions about both the number and the value of unrecorded
and tax-evading transactions. A recent estimate by a private agency has
claimed that black money amounts to 20 per cent of total Gross Domestic
Product (GDP) or 25 per cent of recorded GDP, which would make this one
of the lowest in the world already 3. However, a report by the National
Institute for Public Finance and Policy (NIPFP) on the incidence of
black money in India (which was submitted in December 2013 but has still
not been made public or even submitted in Parliament) is reported to
have suggested that the black economy amounts to as much as 75 per cent
of the recorded GDP 4 .
Most of this is not – and indeed cannot be – held in the form of
local currency. It is more than obvious that those who are significant
recipients of such funds would speedily seek to transfer them into other
assets. In India today, these are mostly land and other real estate
property, gold and jewellery, benami accounts in banks, holdings of
dollars and other global reserve currencies, holdings of stocks and
shares through the anonymous vehicle of Participatory Notes and, most of
all, sending the money abroad through various means.
Let us try to estimate what proportion of the money in circulation is
black money that could be flushed out by this new measure. As noted
above, estimates of the incidence of black money vary between 25 and 75
per cent of GDP. Meanwhile, we know that currency in circulation
currently amounts to 12 per cent of GDP, and 86 per cent of this
currency is in the form of Rs. 500 and Rs. 1000 notes.
But we also know that a significant proportion of our GDP – around
half, according to current CSO estimates – is produced in the informal
sector, and around 85 per cent of the population relies on it. This is
unrecorded income, even though it is estimated in the GDP, but it is
dominantly not “black” because incomes here are generally too small to
fall into the direct tax net and are anyway subject to indirect taxes of
various kinds. Indeed, the incomes of farmers (which are not taxed),
the returns of small traders and micro entrepreneurs, the incomes of
daily wage workers, the incomes of small service providers: all these
and many more such incomes are clearly the result of what would be
considered as “white” transactions even though they are not registered
and reported to any fiscal authorities.
This informal economy in India is hugely, if not completely,
dependent upon cash. The preponderance of the informal sector is indeed
why more than 90 per cent of all transactions in India are still
estimated to be in cash. It is not unreasonable to assume that anywhere
between half to all of the estimated GDP of the informal sector would be
in the form of cash transactions. Since estimated cash balances amount
to 12 per cent of GDP, the cash equivalent of anything between 3 to 6
per cent of GDP is involved in such informal activity, which is
completely legal.
This in turn suggests that a move to demonetise larger denomination
notes of Rs. 500 and Rs. 1000 would be successful only to the extent
that it flushes out the part of black money that is held in cash, which
would then be equivalent to 2.3-5.2 per cent of GDP. In terms of the
available estimates of black money, this comes to only 3.4-6.8 per cent
of the NIPFP estimate of black money or 10-20 per cent of the smaller
recent estimate provided by a private agency. In all these cases, the
numbers suggest that only a tiny or at most a small proportion of black
money (or rather, of the assets acquired through illegal or unrecorded
transactions) would be captured through this move.
The impact of sudden demonetisation
Whatever little effect this measure may have to bring such black
money out into the open would still be an unmitigated benefit, if the
move did not simultaneously cause so much grief to innocent citizens.
The fact is that the both the insensitive design and the shoddy
implementation have already cause a huge amount of distress to different
people in various ways, and the pain is likely to linger for some time.
The rapid and sudden strike without warning meant that ordinary people
had no opportunity to prepare for it. The immediate impact – in the form
of drastic cash shortages leading to immense hardship especially among
less privileged groups; long and tedious waiting times in queues that
often prove to be fruitless because banks and ATM machines are unable to
provide the required cash – all these have been widely portrayed in the
media.
It is true that these are essentially temporary disruptions, which
should be eased over the coming weeks. Even if that does not provide
much comfort to those whose livelihoods have been adversely affected,
there is the argument that this temporary pain is worth it to ensure the
greater common gain of eliminating black money. As noted earlier, the
latter goal is unlikely to be reached with this measure. However, some
sectors like real estate are known for the fact that cash typically
accounts for a substantial share of the transactions. Those engaged in
this business (whether as buyers, sellers or intermediaries) who have
been caught at the point when they happen to be holding large cash
balances will be affected, and face substantial losses. To the extent
that it curbs the tendency to demand a certain proportion of the price
for a property transaction in “black”, and makes property more
affordable, this is definitely a good thing.
However, there have been and will be other effects that are very
damaging for the economy and especially for the groups that are already
in a weaker position. It will definitely put a brake on economic
activity. Indeed, the immediate dislocation, uncomfortable as it is, may
even be less damaging than the medium term impact.
The biggest negative effect is the loss of liquidity for the informal
economy, which has already been of massive proportions. This has led to
breakdowns in payments systems and has drastically affected trading. As
the chaos continues, the knock-on effects on economic activity have
grown. People hoard their slender cash holdings and do not shop; this
affects large and small retailers who rely on cash sales; this affects
their own demand for purchase of goods in the wholesale markets; and so
on. Even in megacities like Delhi, there are reports of shopkeepers
simply shutting their shops because of the lack of buyers as a result of
the cash squeeze, while traders in mandis have been caught with huge
amounts of unsellable stock of perishable items like fruits and
vegetables because of lack of cash purchasers. This has permeated down
the distribution chain to the small vendors and street hawkers. This has
also affected production systems, as moneylenders providing working
capital to small producers are unable to provide the new notes.
The decline in trade – even if temporary – has a knock-on effect on
production, and thereby generates further negative multiplier effects in
the local economy. There are already reports of daily wage labourers
unable to find work because employers cannot pay them with the new money
and are only able to offer old notes, which are now without value.
All this is worsened by the impact that the cash shortage has on
consumption, as people cut down on purchases of non-essentials and even
of food and other essentials, because of the lack of liquidity with
which to purchase these items. Consumption squeezes have been especially
dreadful for those facing medical emergencies. Many private hospitals
and clinics are not accepting old notes. Even when public hospitals do
accept them, they expect the patient’s family to purchase the required
medicines and materials required for operations, which in turn can only
be with the new notes. Stories of individual tragedies resulting from
this mess are abounding.
Of course, as always happens in capitalism, the market quickly
responds to these needs, in the form of intermediaries who offer to
collect the old notes and exchange them for a discount. The prevailing
rates in Delhi in the days after the banks purportedly opened were at 20
per cent discount: Rs. 400 for a Rs. 500 note and Rs. 800 for a Rs.
1000 note. Similar rates were also being offered by market vendors for
their goods. Those who are desperate to get hold of some cash quickly
for whatever reason, or who cannot afford to lose a day’s wages for
standing in the queue at the bank, are then forced to take these rates.
Since the people forced to take these rates also include the poor, this
amounts to an attack on their already low incomes.
In rural areas, matters may be even worse. The cash distribution
systems for the new currency notes that have failed so miserably in the
major metros and other towns are unlikely to be much more efficient in
villages. In any case, the number of rural bank branches has declined in
past years, and these branches are now few and far between. Banking
activities are supposed to be conducted through ATMs and though the
Banking Correspondents (BCs), most of whom have been largely dormant for
a while now, and thus far these systems have proved completely
inadequate to the task of ensuring the supply of new notes.
This has led to some truly difficult circumstances, which will be
hard to imagine for those in the administration or ruling party who
fondly believe that demonetisation will simply lead all Indians to shift
to cashless transactions. Migrant workers in Delhi report that in their
home village in Uttar Pradesh, which is still not electrified, kerosene
remains the essential fuel for lighting and cooking. But the current
cash crunch has affected villagers’ ability to buy kerosene as the local
private dealer (the only one in the village) refuses to accept the old
notes – so households must sit in darkness until they are somehow able
to exchange their old notes for the new ones. Since the nearest bank is
also some distance away and the villagers have received word that it has
also not received the new currency, things are not going to improve
anytime soon for them.
Farmers are in a particularly difficult condition. Across north and
central India, and in many parts of the west and east as well, farmers
have recently harvested the kharif crop and are now about to begin
sowing the rabi crop. Many of them had saved up the cash proceeds of
their kharif sales to buy inputs for the next sowing season. They need
money to buy seeds and fertilisers, and to hire tractors and other
equipment – and they need it now, because the agricultural season does
not wait upon humans. Even a day’s delay can be critical in some cases
depending upon weather conditions, but these farmers have already been
waiting nearly a week. In most rural areas, the compensating delivery of
coupons promised to farmers has simply not materialised, and not all of
them can access public supply systems for inputs, as these too have run
out of supplies. If delays caused by this policy-created cash shortage
affect sowing, it would surely be farce turned to tragedy for these
farmers and for agricultural output.
This particular policy move has also been shockingly gender-blind,
and therefore has already had highly gendered consequences. Policy
makers persist in seeing India in terms of households, not recognising
that men and women can have very different requirements and relationship
to banking. Around 80 per cent of women do not have access to the
banking system, and even when they do, it is often in the form of joint
accounts with their husbands. So saving up some money in cash hoards to
guard it from husbands who would use it for drink or other such
purposes, or to ensure some savings for children’s future needs, or to
provide for medicines in case of illness, or even to protect themselves
from abusive husbands, is a very common practice.
There are numerous stories of women who now do not know what to do
with these hard-won and carefully stored notes, and who have neither the
time nor the capacity and autonomy to go and stand in those endless
queues to exchange the money. When the amounts add up to what may seem
like a tidy sum in the context, say Rs. 50,000, the problem for the
woman becomes more acute. She not only stands to lose control over the
money, but even the knowledge of such a private hoard can infuriate the
adult men in the house, with potentially violent consequences. Surely
this is not the kind of black money that is being sought to be forced
out into the open? It is extraordinary that those who introduce such a
policy could have such little awareness of Indian society that they do
not stop to think of such consequences.
The cashless society?
It is not as if at least some of these aspects are not known to those
in the ruling party who are currently signing paeans to what they
describe as this “historic move”, supposedly a game changer” in the
reform process. Not so long ago, in fact in January 2014 when the United
Progressive Alliance (UPA) government had tried to, the then BJP
spokesperson Meenakshi Lekhi had described the move as “an attempt to
obfuscate the issue of black money stashed outside the country… This
measure is strongly anti-poor. The ‘aam aurats’ and the ‘aadmis’ – those
who are illiterate and have no access to banking facilities will be the
ones to be hit by such diversionary measures 5 .”
So what could have changed over the past three years to make BJP
leaders change their tune to such an extent? They would probably suggest
that this time is different because of the much greater coverage of
banking services through the Jan Dhan Yojana. Indeed, the official
website of the scheme notes that on July 1, 2016, 25.45 crore accounts
had been opened, with only around a quarter of them with zero balance
and an average of Rs. 1,780 per account. This has led to the claim that
almost all households in the country are now covered by banking. But
despite these claims, it is estimated that around one- third of the
adult population does not have any bank account, even of the no-frills
variety 6 . Others may have an account, which has been dormant ever
since they were made to take it on, but the distance from and sheer
difficulty of getting to the nearest bank has meant that institutional
banking plays no role in their lives. They rely on intermediaries – the
BCs created by the banks themselves, or local middlemen who spring up to
meet these gaps. So the logistical issues involved in exchanging the
old money for the new would be huge in any circumstances, not to mention
the strained and overstretched conditions of today.
The RBI – which surely should know better than any of us the true
state of the penetration of e-banking and digital transactions in the
economy – had its own Marie Antionette moment in a press release of
November 12, 2016:
“public are encouraged to switch over to alternative modes of
payment, such as pre-paid cards, RuPay/Credit/Debit cards, mobile
banking, internet banking. All those for whom banking accounts under Jan
Dhan Yojana are opened and cards are issued are urged to put them to
use. Such usage will alleviate the pressure on the physical currency and
also enhance the experience of living in the digital world 7."
Statements like this make one wonder whether the RBI is living only
in the digital world. Surely the worthies in that institution have some
idea of the conditions under which banking and money exchange occur for
most Indians? As well as some knowledge of the importance of electronic
transactions in the wider world? It is worth noting that even in the
U.S. currency is said to account for around 63 per cent of transactions
In fact, e-banking has been increasing in India, but the shares are
still very small: cash is still estimated to account for more than 90
per cent of all transactions, and the remainder is approximately equally
split between cheques and e-payments. The facile assumption that moving
to e-banking is just a matter of personal choice, which appears to
underlie some of these arguments, is completely mistaken.
Of course, it is desirable to move to less reliance on currency, but
that cannot be done in this abrupt and coercive manner, especially when
most bank accounts are still not e-enabled, when basic infrastructure
for this (such as secure internet connections or even electricity) is
not accessible everywhere, and where levels of education for a very
large section of the population do not allow for easy e-banking. This
must occur as a smooth and gradual process because of the greater ease
and facility of such transactions. Disrupting currency transactions is a
painful and ultimately much less effective way to push the population
towards greater e-banking. It also disregards the point that this is not
something people can just do at one stroke, and certainly not at this
moment, when the pressures on banks are anyway so intense that they are
in no condition to handle these new requests.
So what can be done to control black money?
It has been argued, with some justification, that this is a
diversionary tactic, designed to draw attention away from the fact that –
despite its fervent campaign promises – this government has so far done
very little to deal with the problem of black money. As it happens,
there is a lot it can do, relatively easily, if only it truly does have
the necessary political will – and none of these measures would cause
any hardship to the common people.
In terms of preventing the generation of black money, what is
required is a more effective, clean and accountable tax administration
that uses all the information at its disposal to go after those who are
evading the law in various ways. For companies, it is possible to
identify practices such as over- or under-invoicing, false transactions
and attempts to use loopholes in the laws. For individuals, it is now
easily possible to uncover undisclosed incomes by tracking payments and
following suspiciously large purchases, and put them under scrutiny.
Obviously, movement of funds abroad is a major avenue, which needs to be
monitored much more closely. Indeed, this is what most countries that
are known to have relatively “clean” economic systems do as regular
practice, without making a great song and dance about it.
In terms of dealing with the assets held from such undisclosed
incomes, this too can be easily done if the government has a mind to do
so. It is not just land deals and gold and jewellery purchases that can
be monitored, precisely as the government is trying to do now in the
middle of this cash crunch. The completely uncalled for possibility of
making buying securities through “Participatory Notes” in the stock
market, which do not require the buyer to reveal his/her identity, is an
obvious means of parking illicit funds. These should obviously be done
away with – yet both the previous UPA government and this supposedly
anti-corruption BJP government have proved to be curiously reluctant to
do so.
The most obvious thing to do – and the issue that Modi continuously
railed about in his electoral campaign speeches – is to go after those
who have stashed away their undisclosed funds in bank accounts and other
assets abroad. He had promised to “bring back” all this money, to the
point that many holders of Jan Dhan accounts today still fondly believe
that they will each receive around Rs. 15 lakh as their share of the
returned money! Yet the Modi government has steadfastly refused even to
divulge the names of such individuals, much less take any action against
them. Other wilful defaulters are similarly being dealt with kid
gloves. The facility with which the king of defaulters, Vijay Mallya,
was allowed to leave the country makes a mockery of the subsequent
official noises made against him, which are made with the full knowledge
that he will not be deported back to India by the U.K.
Overall, this ill-conceived and even more poorly executed move
appears to be an attempt by the government to display a lot of sound and
fury, but signifying very little. It is unfortunate that in the process
it has inflicted such damage on ordinary people and on the economy.
References:
1.^ Doctor, V., 2016. The cycles of demonetisation: A looks back at
two similar experiments in 1946 and 1978. [Sic.] The Economic Times,
November 12. Last accessed: November 14, 2016.
2.^ Ibid.
3.^ PTI, 2016. India’s black economy shrinking, pegged at 20% of GDP:
Report. The Indian Express, June 5. Last accessed: November 14, 2016.
4.^ Puja, M., 2014. Black economy now amounts to 75% of GDP. The Hindu, August 4. Last accessed: November 14, 2016.
5.^ The Wire, 2016. Watch: Bad in 2014, Great in 2016 – BJP’s
Flip-Flop on Currency Exchange. [Online] November 11. Last accessed:
November 14, 2016.
6.^ Datta, D., 2016. In one stroke, demonetisation has shaken the
trust our monetary system is based on. [Online] November 9. Last
accessed: November 14, 2016.
7.^ Reserve Bank of India, 2016. Withdrawal of
Legal Tender Character of ₹500 and ₹1,000: RBI Statement. November 12.
[Online] Last accessed: November 14, 2016.
The remedy Keynes suggested to resurrect ailing economies firmly emphasized the need for demand generation, primarily through public expenditure. In fact, he had explicitly questioned the effectiveness of monetary policy, such as interest rate reductions, to induce borrower-driven private spending to restore economic health. A lower cost of investment, he pointed out, was unlikely to stir up investment sentiments in a gloom surrounded economy. 
The remedy Keynes suggested to resurrect ailing economies firmly emphasized the need for demand generation, primarily through public expenditure. In fact, he had explicitly questioned the effectiveness of monetary policy, such as interest rate reductions, to induce borrower-driven private spending to restore economic health. A lower cost of investment, he pointed out, was unlikely to stir up investment sentiments in a gloom surrounded economy. 
