Will India’s Economy Be Able To Recover From Demonetisation?

Posted on November 25, 2016 in Business and Economy

By Avilasha Ghosh

On November 8, Narendra Modi shocked the whole country by announcing that from midnight of the same day, ₹500 and ₹1000 bank notes would become illegal tenders. The justification furnished by him for this bold move is that it’s an attack on terrorism and counterfeit currency. Although many have applauded Modi for this step, quite a few intellectuals and experts have criticised him for being too hasty and anti-people.

November 9 witnessed endless queues outside the banks for hours; anxious people stood in lines without food or water waiting for their turn to exchange (now) outdated notes.

Since ATMs were nonoperative for two days, the inconvenience was aggravated. Although Modi claims that the printing of the new ₹500 and ₹2000 currency notes had started six months ago, it’s rather dubious because banks are going through a crisis and haven’t been able to provide people with the much-needed cash. Also, the new ₹500 rupee notes have not been widely circulated.

Moreover, the withdrawal limit is ₹2000 per day for savings account holders and ₹2500 for current account holders, and this has added to the chaos by forcing people to visit banks more frequently.

More than 50 people have reportedly died waiting in lines, bank officials have died of heart attacks and the list is endless.

For the poor and the old who might have never felt the need to avail banking facilities for their small savings, this move has proved to be highly troublesome. For those engaged in daily labour, waiting in long queues for exchanging notes is feeding on their work time and significantly affecting their purchasing capacity and domestic activity.

The inconvenience is double for those without bank accounts; as they have to stand in the same queue to open an account and then get transactions done. Although many are hopeful that this move will benefit them in the long run despite the short-term inconveniences, it is being speculated that the economic imbalance will remain as the introduction of the ₹2000 note will make hoarding black money easier.

Experts have said that demonetisation has affected the overall cash transactions in the economy which is a massive 97%. In the words of development economist, Jean Dréze“Demonetisation in a booming economy is like shooting at the tyres of a racing car.”

The growth of the Indian economy will be drastically altered due to demonetisation; not only is there a crisis in investment capital but also a decline in consumers’ purchasing power and increased worker layoffs. Goldman Sachs has predicted that India’s GDP growth could get down to 6.8% due to demonetisation from 7.6% in the last financial year.

Prabhat Patnaik, Professor Emeritus at the Economics Department at JNU said that the government lacks the understanding of what and how capitalism works. In the context of capitalism, Black money which in commonsensical understanding stands for hoarded cash or unaccounted money that is usually responsible for accelerating the expansion of illegal activities. He feels that demonetisation is an ineffective method in countering black money as people with crores of black money will never go to a bank to exchange the whole amount in one day and fall under the radar of suspicion. Rather, they would send several factotums to the bank, each carrying a small amount, and would do so over a number of days prior to the December 30 deadline.

Moreover, black money does not refer to a stock but to a flow, hence, to unearth black money one needs to track down illegal activities and not attack money-holdings per se. Since many of the black activities are operated through banks located abroad, India has recently signed an agreement for automatic exchange of information with Switzerland to tackle black money stashed abroad. It is said that India will be able to access transactions by Indians with Swiss banks after September 2019. However, given the current liquidation crisis, it is too soon to say what form this agreement will take in the coming years.

In the opinion of the former governor of the Reserve Bank of India, Raghuram Rajan, to demonetise old notes and introduce new ones may not be the best way of getting black money out of circulation, especially if it is hoarded in the form of gold. Since it mostly means money which is not taxed, a focus on the incentives on taxes and better tax administration might do the needful.

Another argument underlying the demonetisation move is that it counters terrorism by preventing the circulation of fake currency notes across the border. The belief behind this argument is that the printing technology employed to print the new notes prevents the possibility of faking it.

What the government seemed to have overlooked is the fact that in the current financial crisis where people have less money in their hands, the need to print fake currency will be amplified. On November 22, the first fake note of 2000 denomination surfaced in Gujarat with a fake watermark and security thread.

A survey on the Narendra Modi app that aimed at finding out how Indians felt about demonetisation, more than 90% of the five lakh participants have supported the move in a country of 1.2 billion people which estimates to only 0.4% of India’s total population.

The challenge for Modi is to gauge how different sections of the Indian population are reacting to demonetisation rather than a small number of app users to make sure that the process is accountable and democratically executed. He should channel his resources into analysing if everyone is on an equal footing with him and are of the opinion that demonetisation is a step towards ensuring ‘Achche din’ in India.


Image source: Hindustan Times/Getty Images