Thursday, November 17, 2016

Demonetization of Rs 500 and Rs 1000: Could Modi have done it differently?

On November 8, just when a large number of Americans were queuing up to cast their votes in, what would turn out to be a historic presidential election, here in India, Prime Minister Narendra Modi made a surprise and unscheduled appearance on national television at 8 pm, in what would turn out to be a startling economic policy pronouncement that made as much as 86 per cent of India's currency invalid.

His aim was to wipe out the massive amounts of counterfeit banknotes in the denomination of Rs 500 and Rs 1000; and also to render invalid huge stacks of these currency that have been set apart to fuel unlawful practices like street protests, terror activities and corruption.  

Modi, who has survived cataclysmic social upheavals in Gujarat as its chief minister, knows well not only the power of symbolism but also that for anything to have a lasting impact it has to be swift and strong. The November 8 'surgical strike' on people who are wrecking India's economy and financial well-being, fitted well into the Modi style of governance.

The severity of Modi's decision can be gauged from the fact that it took at least one full day for the new economic order to sink in. Almost immediately, the stark reality of what is in every Indian's wallets struck each of them -- invalid Rs 1000 and Rs 500 notes and very few valid Rs 100 notes. Indians simply ran out of cash. And, to make it worse, banks and ATMs too ran out of cash. So, Modi's assurance that the invalid notes can be exchanged in banks for new ones amounted to not much.

Today is the ninth day; and instead of things getting better, seemingly it's getting worse. For example, today, the revenue secretary announced that the old notes can be swapped for new ones in banks only up to a maximum of Rs 2,000 per person. It was Rs 4,500. Since many ATMs aren't working, there is no point in depositing in accounts, since the money can't be withdrawn. 

While Prime Minister Modi deserves credit for taking this bold step, the lengthening queues outside banks and ATMs are fueling discontent among people and making both purchases and selling difficult. In short, it's hurting the economy, may be in the short term. But how it will play out in the coming days is not known.

Why Modi is correct

* Corruption is endemic in India. When the going gets tough, reach out for the banknotes, seems to a national mantra. Though it is commonly associated with government-related services, people bribe their way to convenience very often. While in some instances, cash can speed up matters, on other occasions it can mean serious compromise in quality. And, when government services are corrupted, nation's financial health weakens.

* Black money is in plenty. This is a large amount of unaccounted wealth. The beneficiaries are individuals, and groups of people who run organizations. The losers are the country (the government) and institutions, both private and public. Basically Indian financial culture is such that it promotes illegal wealth. For example, people don't mind forgoing the bill in return for a discount. They fake bills and financial agreements to escape tax. Many resort to cash transactions to avoid leaving a trail which would result in payment of tax. Poor people are only too willing to accept wads of currency from political parties who seek their votes. It's a huge ugly mess.

* Fake banknotes in the denominations of Rs 500 and Rs 1000 were so many that banks themselves were dispensing them and honest people too had them in their wallets.

* India has to reduce its dependence on hard cash. There has to be more of cheque or electronic transactions that will leave a trail. Unless people are pushed into it like this, the lethargic, complacent average Indian will not change.

Could this have been done differently?

* The Prime Minister had to make it a surprise announcement, since any inkling of this would have resulted in people turning black money into white, defeating the whole purpose of the exercise.

* It was common knowledge that - considering the amount of fake notes in circulation - demonetization was the only option. The most intuitive of the businessmen might have seen this coming, sooner than later.

* While the announcement of demonetization would have had to be a surprise, at the backend the government could have set the stage to minimise the hardship for people. 

* The RBI (Reserve Bank of India, the banking regulator) could have increased the supply of Rs 100 notes and instructed the banks not to put Rs 500 and Rs 1000 back into circulation. Instead new Rs 500 notes could have been put into circulation. It would have been a gradual process, and no one would have found anything amiss there. 

* May be a month into this quiet backend operation, the Prime Minister could have made the announcement of demonetization of the "old" bank notes. This way, while the end objective of curbing black money (it can't wiped out totally) would be achieved, the subtlety of the operation would have ensured that people had minimum inconvenience. 

What is at stake?

* This has both political and economic implications. Modi's advantage is that the opposition is fragmented, rudderless and leaderless. Elections in UP and Punjab could end up as a referendum on Modi's governance.

* Undoubtedly, business across the board has been hit. There isn't any cash around. Many people say this is just a temporary phenomenon. But how things would be dramatically better after a few months is not known.

* Nothing will totally wipe away black money from the economy. It can be reduced to a considerable extent. The government will have to follow this up with raids on tax evaders, bringing them book or even imprison them. Otherwise, this will just go down in history as a political stunt which amounted to nothing but inconvenience to the people.


  1. Good one. Either Modi is very smart or very foolish with this sudden move. As you said, if he is unable to show proof of Raids and data on subsequent black money and hoarders then he will be in trouble (election-votes) as people will never forget this huge personal inconvenience and sacrifice for the country, initiated by Modi.

    1. Thanks, Suresh for your comment. Hopefully, things will only get better in days to come.

  2. Excellent Analysis . Only disagreement is here

    "Instead new Rs 500 notes could have been put into circulation. It would have been a gradual process, and no one would have found anything amiss there. "

    - In India currencies of a particular value have same design, shape and colour. If 500 was put into circulation with new design and size ... it would have been a clear give away that demonetisation of old notes is going to happen !.

    1. Well, in all countries the standard procedure is to change the notes once in seven to ten years. New notes have come out in the past too. But no one ever said it is part of the drive against black money. Usually it is said that they have new security features.

      So, here too, more Rs 100 notes could have been brought out (with the stated aim to help people with smaller denomination for change) and also brought out new Rs 500 notes. And the demonetization could have followed soon after that without much delay.

      Still we would have had problems. But much lesser, I guess.