On November 8, a shock to India’s financial system was administered by Prime Minister Narendra Modi as he demonetised Rs 500 and Rs 1000 notes. India is an overwhelmingly paper currency country: some 90% of the transactions are done with cash. India’s cash-to-GDP ratio is 12%. More than half of Indians still don’t have a bank account and some 300 million have no government identification. The two scrapped denominations – Rs 500 and Rs 1,000 – account for more than 86% of the value of cash in circulation.
The RBI had its own Marie Antionette moment a few days later in a press release on November 12, 2016. It said “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 .”
Economist Jayati Ghosh was aghast and wrote: “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?”.
For some families for whom getting a square meal was a luxury, the mocking advice of the Modi government was ‘if you don’t have food, eat plastic cards’.
Cutting beneath the arguments of national sacrifice, black money and moving to a digital world, one discerns fundamental flaws in the argument that demonetisation eradicates black money and counterfeit currency. It is as absurd as arguing that to prevent bank robberies one has to completely shut down all banks.
First, all black money is not held as hoarded cash. At best it constitutes 6% of India’s total black money. The bulk of it is spirited away in tax-free havens such as Switzerland and Panama, from where it is invested through mailbox corporations in equity, real estate and bullion all over the world. It is a matter of utmost irony that a number of the celebrities who endorsed the demonetisation scheme figure in the list of names of people who allegedly use illegal offshore accounts in places like Panama.
Moreover, elaborate tax frauds are committed by corporate giants in a squeaky clean, cashless financial environment. Then there is another game called capital round tripping played by big corporate businesses which bring back their black money through bogus companies which have no real business. These funds are invested in the economy as foreign direct investment. There have been no efforts by the government to clamp down on these activities. At the Mahesh Buch Memorial Lecture at Bhopal on October 5, 2016 former Reserve Bank of India governor Y.V. Reddy specifically noted that “there is a subsisting interest in influential policy circles to keep a window for round tripping open…”
The Indian stock market is also rigged through the route of participatory notes, where black money from India is parked in Mauritius in a shell company. This money then flows back as investment in the stock market, causing inflated share prices. It is no secret that demonetisation is the wrong policy instrument to handle such sophisticated chicaneries. It is like slicing a loaf of bread with a hammer.
Second, the engines of black money have been left intact, especially as election campaign contributions are often accepted in cash and unaccounted for. The BJP, which is now on a moral crusade of eradicating black money, has been guilty of accepting large sums of unaccounted money as campaign contributions. Moreover, bribes for government officials and the political class can continue unabated even after demonetisation. There are already reports that government officials are taking bribes in freshly-printed notes. It was reported that in the state of Gujarat, government officials demanded bribes in freshly printed Rs 2000 notes.
And finally, counterfeit notes circulating in the economy is estimated to be in the region of 400 crore, out of a total of 16 lakh crores. In percentage terms, this amounts a mere 0.03% of the entire currency. A sensible policy practised by most governments is to gradually phase out notes with certain serial numbers to lessen the dangers of counterfeiting, instead of shaking the entire currency market.
‘War on cash’
In his most recent remarks, Modi has now indicated that demonetisation is perhaps a necessary spark in the larger war against cash.
Let’s take a snapshot look at the Indian economy. Beneath the rosy headlines of robust GDP growth rates, the fact remains that growth is fuelled by the expansion of credit and not incomes from steady job growth, which is in a state of decline. Top corporates have borrowed heavily from public sector banks. These banks are groaning under the weight of corporate loans which may never be paid. The real estate sector of the economy is primed up with bank loans and credit expansion. The stimulus to the economy is through easy access to credit for consumer spending. Thus an illusion of prosperity is maintained to a certain extent on a mountain of credit.
We may be slowly reaching a crisis point in the Indian economy, where credit-induced asset bubbles are in danger of imploding unless there is fresh induction of credit into the system. The Indian economy is at risk of entering a deflationary spiral and this credit scheme has to be maintained through the expansion of demand for new credit. But credit expansion is now hitting the proverbial roadblock, as there are few lenders and few takers of credit since business confidence is low and the much-lauded ‘animal spirits’ are in short supply.
The constraint to monetary expansion is the engendered tribe of savers and the hoards of cash lying dormant in lockers or under the proverbial mattresses. One could even say that it is on these sections of the population that a war on cash must be declared to achieve a big push for credit expansion. There must be a moral crusade against physical cash which is hoarded and not available for borrowing and spending. To prise open the cash hoard, there must be the shock of demonetisation and restrictions on withdrawals which ensure that physical cash is corralled and sequestered in the banks for further credit expansion. The mirage of prosperity, therefore, is maintained by kicking the can down the road.
The first winner of the government’s demonetisation shock therapy is India’s corporate elite, who partly caused the debt crisis of the nation’s public sector banks in the first place. For them, loans are written off.
Second, the demonetisation of currency comes with a shock-and-awe element – the shock of losing physical money and the awe of being herded into a digital pen. Cash now carries a bad odour. Are you using cash because you are engaged in drug trafficking or are you a terrorist wanting to buy arms and explosives? Should you be flagged for suspicious activities?
Apart from the overwhelming propaganda that ‘cash is associated with criminality’, there is immense pressure on India’s rural citizens and denizens of the informal sector to tread the virtuous path to digital “you pay, we play” pens like Paytm. Also comfortingly and ironically referred to as ‘digital wallets’, these are the second big winners of the Modi government’s demonetisation step.
Companies like Paytm offer some solace and respite from the ordeal of cash transactions. But once secure in this digital pay pen, people have to deal with with a number of transaction costs and security burdens. Digital finance in India is not only privacy invasive, especially important in a country that does not have comprehensive privacy laws, but also operates on two basic principles from a government and corporate perspective: every financial transaction can be taxed every financial transaction can be charged a fee.
After all, as the handlers imbued with the wisdom of Jean Baptiste Colbert the French finance minister to King Louis XIV know, “The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing.”