Sustain demonetisation positives with structural reforms

Dust is far from settling down on the Union government’s sudden move against black money and corruption. Demonetisation of high denomination notes made all fake currencies circulating in the system invalid, dealing a severe blow to terrorist network. Most importantly, it made the ill-gotten cash worthless, unless the corrupt hoarders found innovative ways to change their old notes.

The move was immediately hailed as a masterstroke by the poor and middle-class Indians – an attempt to fulfill the major election promise by Prime Minister Narendra Modi to recover black money. The Opposition parties were too stunned to react instantly. But, as the days passed and bank employees worked non-stop through the weekend; chinks started to emerge in the logistics in terms of long queues, cash crunch, non-functioning and dry ATMs. Hard-working, honest people were affected.

Harish, a poor carpenter, was distraught as he could not get Rs 5,000 for the treatment of his only son. Lala Ram, our driver, had to postpone his child’s operation in AIIMS as his bank could not prioritise the demand draft he needed. Preety, a salaried middle-class, was clueless as she had just sold her apartment and a part of the payment she received was in cash (as is the norm in real estate sector) and she was supposed to pay for her new apartment in the next couple of days. Ordinary working class people are struggling to meet their cash demand and wasting many productive hours in queues.

Opposition parties were quick to criticise the government and demand a rollback of the scheme. The timing of the move just before major state Assembly elections was also questioned. Most of the political parties were building up their war chest for election early next year, which suddenly became worthless.

It is obvious that the pain will continue for a couple more weeks as lakhs of ATMs will have to be recalibrated to dispense with the new notes of a different size. This led to an emotional appeal by the PM, “I also feel the pain but bear it till December 30 to straighten things... The long-term gain would be the India-of-their-dreams.”

According to the RBI, the Rs 500 and Rs 1,000 notes accounted for 86% of the total value of notes in circulation. Economic Affairs Secretary Shaktikanta Das said that the demonetisation is due to sharp increase in circulation of these notes in the last five years. This landmark move is being hailed as the “biggest currency conversion in the world both in terms of value and quantity.”

Economists, though, seem divided regarding demonetisation in India. Dr Kaushik Basu, former Chief Economic Advisor in the Finance Ministry, said, “GST was good economics; the demonetisation is not. Its economics is complex and the collateral damage is likely to far outstrip the benefits.” The unintended disruption can be huge in the cash-driven economy – particularly the informal rural sector where millions of consumers and small traders rely on cash for their daily transactions.

The magnitude of unaccounted cash in the metros could be ascertained by the fact that people bought gold, white goods, booked railway tickets till late at night on Nov 8. Jewellers made a humongous profit as they sold gold at a premium of 50%. Temples overflowed with donations. Individual transactions at Kendriya Bhandars are as high as Rs 50,000 as these centres continue to accept old notes.

A large number of people standing in bank queues are actually hired by the rich to exchange notes on a commission. Despite all these innovative efforts, stacks of torn, soiled currency notes worth crores of rupees are appearing in various garbage dumps all over India. These incidents have helped in continued massive support to the scheme among common men.

There was a slow build-up to the present drive. The creation of a Special Investigation Team was followed by renegotiated foreign treaties, mandatory use of PAN card for cash purchases above Rs 2 lakh, and Income Declaration Scheme. Even the Jan Dhan Yojana, that helped rural villagers in remote areas to open bank accounts, will be of immense help now.

Short-term vs long-term

The immediate short-term impact will be negative with a sharp slowdown in consumer spending due to limits on cash availability. However, according to Kishore Biyani, the founder and CEO of Future Group, the retail business is already bouncing back. Overall, the consumption will be hit and GDP might decline in the next couple of quarters. The real estate sector, where cash transactions are large, will be most impacted and will take some time to stabilise.

The medium to long-term impact will be positive. As the cash in circulation moves into the banks, deposits will spike over the next few months improving liquidity in the sector. This will cause monetary transmission to improve. Weak demand, low cash in circulation and continued fiscal consolidation will keep inflation at the RBI’s comfort level, paving the way for further rate cuts.

Going forward, the use of digital transactions over cash will increase the country’s tax base. As more of the parallel economy moves over to formal economy, productivity and growth will get a boost. Financial inclusion will slowly become a reality. Since every bank note is a liability for the RBI, any notes not exchanged will flow as the RBI dividend to government coffers.

However, this massive operation can only be a one-time clean up. If it is not followed by other structural reforms, the black money will be back in no time. There should be changes and simplification in tax laws, transparency in transactions in real estate, foreign trade, and political donations. Finally, the incentives to indulge in black money need to be minimised.

PM Modi has already hinted at further steps to curb black money in the coming months. It is difficult not to believe in his noble intent as he has taken a huge political risk of alienating his largest support base of traders for the greater good of the nation.

(The writer is a research scholar at IIFT and an adviser at Policy Monks)