Economy

Government’s Demonetisation Shock Has Hit the Poorest the Most

Wire-editorial

For the last few days the world is watching the bizarre spectacle of millions of Indians waiting in long, unending queues to recover their own money from banks, post offices and ATMs even as the government at the Centre remains firmly in denial about the untold hardship to the poor who cannot afford to stay away from their daily wage work even for a day. Some senior citizens have died of exhaustion standing in queues for hours on end. Families have suffered as private hospitals refuse to take currency notes of 1000 and 500 denomination, legal tender just till the other day.

To rub salt in their wounds Prime Minister Narendra Modi, on a visit to Japan, makes a statement that he had anticipated short term pain to the ordinary people and goes on to warn that even harsher measures could come to tackle black money in the near future. Meanwhile, the finance minister Arun Jaitley goes about his daily briefings spouting platitudes about how the people are willing to suffer some pain to promote the larger cause of fixing the black economy. He has however admitted that it will take a few weeks for the adequate supply of new currency notes to materialise and that the bank ATMs will take time to  be able to adjust to the size of the new notes. All this comes as no relief to the people of this country who are left wondering whether the government could not have prepared better to face what is undeniably the most extraordinary situation India’s economy has faced since independence.

It is now becoming clear that the sheer magnitude of the ongoing exercise of replacing 85% of all currency in circulation was not fully thought through in terms of its logistical complexity. Its basic economics  and ability to prevent future black money generation is also questioned by many. No wonder, developed as well as emerging economies have rarely resorted to demonetisation of this magnitude i.e replacing 85 % of all currency in circulation. To put things in perspective, India’s own demonetisation exercise in 1978 had resulted in less than 5% of the total currency being replaced. The well regarded economist Prof Kaushik Basu, till recently Chief Economist of World Bank, has said demonetisation per se is not good economics as the collateral damage could far exceed its benefits.

There are other economists and market practitioners who talk about the long term benefits of demonetisation such as the possibility of the government ending with a massive cash surplus equivalent to the black money which the owners may not come forward to replace at all. It gets extinguished in public and gets transferred to the government. This sum — estimated at Rs 2 to 3 lakh crore — could be used by the government for public spending in social and physical infrastructure. However, what is forgotten is such benefit , if at all, would only flow in the longer time horizon. In the immediate future the withdrawal of currency of this magnitude will cause a severe monetary shock which the real estate sector is already feeling. Generally it takes some time to recover from sudden price shocks to the land market as it negatively impacts the economy as a whole and dampens  consumer sentiment, especially in urban India. It is almost certain that the economy will slowdown further in the short to medium term and there could be more joblessness, especially in the construction sector. It would not be surprising if GDP growth contracts by a few percentage points in the initial few quarters.

Meanwhile Prime Minister Modi has further upped the ante by suggesting he could take more harsh measures in the future. The PM would have truly walked the talk if he had attacked the nexus between the big business and politics which truly nurtures the black money ecosystem.  It is an open secret that over 75% of political party funding is in cash whose source remains undisclosed.  BJP is the most cash funded party these days. Will PM Modi have the will to push for election funding reforms? If Modi wants his drive against black money to have credibility he must demonstrate he can go after the big fish and cause them immense pain. So far the pain has been largely borne by the ordinary people. Indeed, the PM has taken the biggest risk of his political career so far. The next few months will make it clear whether he has bitten more than he can chew.

  • K SHESHU BABU

    The ordeal is not yet over. With reports of tensions and heart attacks trickling out in the media, the aftermath may have long-term consequences as many families in rural areas may go astray and broken marriages or deaths due to lack of medical care may go up. Many cases may fall out of media’s radar.
    More importantly, counterfeit currency of two thousand rupees cannot be ruled out. That may even hit the economy hard and the efforts may become redundant. The measure is, as Urmilesh expressed in BBC Hindi interview, politically motivated and the PM wants to trample and stamp out the opposition in the country which is harmful in a democracy as diverse as India.

  • Anjan Basu

    The enormity of the risk that Modi has ventured to take shows up quite clearly in the hysterical, tearful histrionics: for once, he may have choked back genuine tears yesterday as he spoke of the gigantic petsonal sacrifices he chose to make ‘for the country’s good’. The enormity seems to be sinking in in other quarters as well, creating frustration and temper tantrums: consider Jaitley at his press’briefing’ on Saturday where he refused to answer many questions and gave outrageous, puerile replies to some others. ( Like when he said that the flow of deposits to ‘deposit-starved banks’ consequent to the demonetisation drive would finally enable to banks to lend more vigorously. Apparently nobody ever told the FM that (1) there is a serious excess of liquidity already existing in the banking sector today, and (2) for banks to be able to lend aggressively, they are required to up their capital, not deposits and other liabilities, because there is something called a ‘capital adequacy ratio’ that banks are mandated to maintain, an area where the banking sector is seriously compromised today because of galloping NPAs). The risk that the Indian state runs today is that as Modi and his govt realise that they may have erred fatally in ‘demonetising’ and crippling the economy in the short and medium terms, they may opt for some other desperate stratagems that will see everything spiral out of control.

  • S.N.Iyer

    This article has hit the nail on the head. Apart from getting reports from officers in his a/c office, why doesnt he go round the banks with his strong retinue of security staff where there are serpentine queues and people including senior citizens are standing for hours to get he money which is theirs by honest means. Account holders including senior citizens are bracketed with those who include touts and agents exchanging money for others for a commission.Why do the banks run out of money by midday.

  • pgb

    Demonetizing 500 note is not a good idea, because this denomination is a common man, poor man’s denomination in the current economy, unlike the olden days of 1978 etc. where even a middle class salaried person would not have even seen a 1000 rupee note, let alone possess it. Also, I do not understand why one should print 2000 rupee note, when most cash transactions of the poor, middle class etc. can be very well done by denominations of 500 and below and we aim to create a cashless economy. If we want to create a cashless economy, why introduce 2000 rupee note?

    • Nationalist

      The reason for the Rs 2000 note is logistics and not its practical utility to people. The time and resources to print one Rs 500 note and Rs 2000 note is the same. Its much easier, faster cheaper for the RBI to print and distribute one Rs 2000 note than four 500 rupee notes. Actually the RBI wanted to print Rs 5000 and 10000 notes due to the same reasons but the govt made them settle for Rs 2000. Thus they can say they gave your money back. Who cares if you cant use it in practice for buying vegetables. At least you can buy a car.

  • ashok759

    There may be wheels within wheels, hidden from the public gaze, but, on the face of it, seeing how so many people, the poorest the most, are being hurt by this measure, very difficult to figure out how this is an election winning masterstroke.

  • Rama Reddy, Hyderabad

    It is reported that Rs 18 lakh crore currency of all denominations is in circulation. 85% of 18 lakh crore is in denominations of Rs 500 and Rs 1000. It means Rs 15 lakh crore is in 500 and 1000 notes. These notes are no more legal tender, unless they get replaced by new notes. This article estimates that 2 to 3 lakh crores to be black money and it may not get into banks. I think we have to wait upto 31.12.2016 to be told by the union government how much has actually not been exchanged for new notes. It is a long way.

  • Nationalist

    Its quite clear even to Modi now that they have bitten off far more than they could chew. The printing presses in India just dont have the capacity to fulfill demand even in the next few months. Even importing notes will take time. The banks and other logistics cant cope with the sheer volume. The danger now is that the economy will go into meltdown and recession. Many people are still ignorant of this and are supporting this insane move but their enthusiasm is wavering and will disappear in the next few weeks.