Some concerns about Modi's demonetisation move

Last Updated: Wed, Nov 09, 2016 15:23 hrs
Some concerns about Modi's demonetisation move

Some called it a surgical strike on corruption, Anil Kumble called it a googly and Sri Sri Ravishankar called it artha kranti. In a move that caught the entire nation by surprise, Prime Minister Narendra Modi announced the demonetisation of Rs.500 and Rs.1000 notes last night in an address to the nation. After listing out various welfare measures in keeping with the Sabka Saath Sabka Vikas slogan of the BJP, Modi went on to talk about the various efforts to curb corruption including the 2015 legislation which called for disclosure of money in foreign bank accounts , and the more recent law which aims to curb benami transactions. Making the case for the demonetisation, he said –



The magnitude of cash in circulation is directly linked to the level of corruption. Inflation becomes worse through the deployment of cash earned in corrupt ways. The poor have to bear the brunt of this. It has a direct effect on the purchasing power of the poor and the middle class. You may yourself have experienced when buying land or a house, that apart from the amount paid by cheque, a large amount is demanded in cash.

Admitting the inconvenience that it is likely to cause, he termed this a grand sacrifice towards a much needed cleaning up of the country.

In the sea of the overwhelming support from celebrities and spiritual leaders to politicians and the general public, who are lauding this as a brave and unprecedented move to curb black money and corruption, it is easy for some of the concerns to get drowned out. A sober and realistic analysis is much needed. Sify has carried this analysis by The India Spend Team on what the demonetisation means for black money. According to the article 22 billion of the costliest notes to print will be rendered useless, and people with black money can either go to the bank and deposit the money in their accounts for which they would need to identify themselves, or exchange the money.

According to basic calculations, with a daily limit of Rs 4,000 a day, a maximum of Rs 60,000 can be exchanged by a person, in 15 days from November 10 to November 24. From November 24 onwards, the exchange process will be eased for convenience, meaning the exchange limit will be increased. However, there is no limit on deposits.

But, the article also points out that there is an indirect benefit, which can bring more of the rural poor into the banking economy.

Individuals and households with no bank accounts – keeping all income in cash and at homes–will now have to create bank accounts to deposit money, making financial inclusion indirectly inevitable.

Yourstory.com carried reactions from bankers, private and public sector, who have welcomed the move and have assured consumers that they will be fully stocked with new currency. Industry heads, including the CII Chairperson, heads of Vendanta, JSW and the Mahindra group , among others have all called it a brave move. And it was hard to miss this full page Paytm advertisement in many of the newspapers this morning –

 

The Times of India reported
that many of the opposition parties chose to remain silent or guarded in their responses, waiting to see how it played out. This includes the Aam Admi Party and the Congress. The Trinamool Congress was more vocal terming the move as draconian. In an official statement, West Bengal Chief Minister, Mamata Banerjee said

This is a financial chaos and disaster let loose on the common people of India… The PM could not get back the promised black money from abroad from the rich so a drama to divert his failure…I want to know from PM how my poorest brothers sisters, who’ve recd their week’s hard earned wage in one 500 re note will buy ata, chal, tomorrow?

Expressing similar sentiments, the Communist Party of India – Marxist also called on the government to release the economic and social costs of the demonetisation and its replacement with new Rs.2000 currency notes.

The Uttar Pradesh Chief Minister Akhilesh Yadav, Samajwadi party appealed to the Central Government to assist transition to new currency in rural areas.

This article by Hema Ramakrishnan in The Economic Times raises some pertinent issues. While welcoming the move to encourage economic payments to promote greater traceability and minimising risks, she points out –

But India is a vastly unbanked country. Many of the poor do not have bank accounts. To expect rural India to switch to the plastics in a short span is unrealistic. What India really needs is systemic reforms to curb black money, given that the political system uses wads of cash to fund polls. The practice of political parties mopping up huge amount of poll funds through unaccounted contributions pushes businesses to generate black money.

The Wire has compiled the views of economists on what they see as the likely effects of this move. According to Abhijit Sen, former member of the Planning Commission, Reserve Bank of India statistics show that 80% of the currency presently in circulation comprises of the now invalid notes. And the demonetisation assumes that a large part of this money is being held as illegal stocks of black money. However, if it is not the case, it is likely to affect those who rely on cash transactions.

The size of India’s cash economy is not exactly known but, given the large proportion of workers in informal sectors, it is unlikely to be less than half the total economy. We can, therefore, expect an immediate contraction of this part of the economy in the next two days and with the effect stretching over a longer period of time, although diminishing over time. Indira Hirway, Professor at the Centre for Development Alternatives also pointed out that it is unclear how the new Rs.2000 note which will come into circulation will prevent further black money from being generated.

Ipsita Chakravarthy also feels that the move does not address the large amounts of black money that is being held in the form of real estate, jewellery or bullion. In this article in Scroll, she writes

This colossal shadow economy is believed to be the size of about 20% of the gross domestic product. Part of this illegal money is parked in offshore accounts and physical assets such as real estate, jewellery or bullion. The official figures are not known, but as of 2011, the legal real estate sector made up 11% of the GDP. Its illegal counterpart could be as large. About 30% of the real estate sector is said to be funded by black money.

And while the demonetisation plays out in the coming days and months, it will become clearer what long term and short term effects are. One thing is for certain, and it is that Modi’s announcement yesterday was a political master stroke. Chakravarthy concludes,

In the last few months, the government has had to battle charges of being anti-poor, anti-Dalit and anti-minorities, even as its old promises of economic growth and clean governance faded. But now, it has turned the conversation back to black money, with public discourse trying to keep up with the implications of a move that is generally acknowledged as bold and decisive. Well played.

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