On the evening of 8th Nov. 20016, the Prime Minister of India through his address to the nation stunned everyone when he brought out the cancellation of the legal tender of currency notes of Rs 500 and Rs 1000. The declaration definitely was more surprising for Indians than the outcome of US Presidential elections that followed. The move of demonetisation by the PM to deal with black money, corruption and terrorism evoked all kind of reactions. At the level of masses it has seen them crowd to collect amenities, oil etc. apart from acts of humor in form of images of the currencies used for non-transactional purposes. The opposition parties directed their criticism for its wrong timing coming at the beginning of the “Great Indian Marriage” season, inconvenience to the Aam Aadmi and shifting the focus from Panama Papers and the real repository of the black money-the Swiss accounts. The move over the past week has unfolded series of developments which are not just economic but social as well as political in nature. A serious understanding of the move requires answer to the following questions: What is demonetisation? What consequences will it have on economy as well as the wider political economy? Whether it can actually lead to the realisation of stated objectives of curbing black money, controlling corruption and addressing the issue of national security?
Demonetisation means a currency loses its intrinsic value-whereby the Central Bank refuses to back paper money with legal tender. India’s first major demonetisation came in 1978, when under Janata Party coalition led by Moraji Desai decided to scrap Rs 1,000, Rs 5,000 and Rs 10,000 to curb black money. Unlike now, notes of higher denominations formed a smaller part of the total currency in circulation then. So, the current decision to scrap the legal tender of almost eighty – ninety percent of money circulation is way too big in terms of its scale. As expected, the issue has been a subject of intense discussion over different platforms both for its wider impact as well as for the immediate toll of transitory hardships that it has generated. For the urban populace with its access to banking and internet infrastructure, the period of hardship is going to be brief one. However, the hardship is going to be slightly prolonged for those economic agents who are yet to connect with formal banking channels – the poor, unbanked, commoners and farmers who operate through informal monetary institutions. The bulk of cash available with these classes makes the distinction between the black and white money a difficult task. The hardships come in forms of what Greg Mankiw, a noted New-Keynesian Economist called “Shoe leather cost”-the costs associated with the conversion process like frequent visits to banks for conversion of old currencies into the newly printed legal tenders. Further there will be postponement of consumption. These costs appear to have been magnified due to the poor execution of the move.
Moving beyond the transitory inconveniences, the move is hailed for the benefits it is expected to bring in the long run, the primary of which is a better fiscal position of the government. Likewise it is expected to have and enduring effect on both black money and corruption. Definitely, pain will be felt by those agents of the economy whose accumulations over the years were based on corruption and unaccounted black money for years. However, black money stashed as high- value currency is much less than black money splurged in conspicuous consumption and invested in real estate, Benami lendings and Hawala transactions. In such a scenario, it is highly difficult to ascertain the efficacy of demonetisation in tackling black economy. What could be other benefits of demonetisation, over the long period? What will be benefits of such a giant step? On the macro-economy as a whole, the move will have some positive implications in future, the target to curb black economy, corruption and menace of fake currency will lead the economy into an environment of low inflation, positive savings, fiscal easiness and above all credibility of bright spot to the economy. The other implication will be growth in electronic transactions via move towards usage of credit cards, importantly being payment banks. The government has already licensed eleven payment banks in fiscal 2016-17. The implication on inflation is based on the assumption that money in circulation and velocity of money will fall. Mainstream Economists argues for a one to one relationship between money supply and velocity of money with inflation and output. Assuming no change in country’s current production in this short period, prices are bound to fall and value of money will increase. The highest proportion of fall is expected in real estate prices and luxury commodities. There are further positive implications of investment as the move will accelerate domestic savings which would be channelised into investment via banks and other financial intermediaries, largely financed by white money. It will be much easier for the government to commit to its fiscal obligations via an expected increase in revenue earnings from tax collections. An impact of the increase in government expenditure either to fulfill its obligations under the aegis of 7th Pay Commission or public spending will trigger a cycle of consumption spending which will eventually increase effective demand via multiplier mechanism. The challenge with the Central Bank is to ensure the availability of credit, and to its credibility, Reserve Bank of India is infusing rounds of liquidity in banking. RBI already announced conduction of overnight repo auction, amounting to Rs 200 billion. The challenge of replacing more than 80 per cent of old notes with freshly printed currencies won’t be a task of a week or two. Adding to this are technical problems in syncing new currency notes with existing ATMs. This means the era of temporary inconveniences will be here for a while.
Overall, the move will yield mixed results. An important lesson from the current move of demonetisation and reactions to it is that, the casting and declaration of an economic decision in a democracy media savvy era has to be free of language of political symbolism. The journey of issue from domain of economy to political economy to the domain of pure politics occurs in quick span. The euphemism of “surgical strike” on black money has casted the demonetisation move as a panacea for all ills associated with black economy. While in reality, the move cannot be more than one of the measures to deal with black economy. Likewise it also cannot be a single stroke for eliminating corruption and terrorism. A cautious and engagement along with circulation of information related with demonetisation is needed to enlighten general public thus allowing the formation of an educated expectation from the move.
(The writer is a Doctoral Candidate at Centre for Economic Studies and Planning, JNU and hails from Leh District of Jammu and Kashmir and can be reached at nzwab [email protected])