India’s Demonetising of High Value Notes, A poorly thought-out, badly executed move

India’s Demonetising of High Value Notes

In his ‘war on corruption,’ Indian Prime Minister Narendra Modi took a strange decision on November 8 when he announced that the government would get rid of the 500- and 1,000-rupee notes, which together make up about 80 percent of currency in circulation, and replace them with new 500-, 1,000- and 2,000- rupee notes. The decision seems to be poorly thought-out and executed and, as expected, it generated mixed responses. The move caused immense hardship to people, especially those outside the banking system and without alternative means to access goods and services, in a largely cash economy. A more effective way to flush out black money without disrupting normal economic activities would have been to announce a specific date for demonetisation of old notes, followed up by an efficient tracking system.

Modi government is extremely adept at optics; at policy measures presented in a blaze of publicity, rather than with the required attention to detail that might ensure their success. The latest announcement of the demonetisation of high value banknotes is of the “shock and awe” variety of measures. While presented as evidence of the government’s supposedly firm resolve to root out black money, in reality, the move will barely touch the problem of its generation. And, even it is being implemented in a way that causes immense economic harm to ordinary people and especially to poorer sections of society.

The demonetisation of banknotes, per se, is not the problem. Indeed, in the past, it has occurred in many other countries to reduce concerns about counterfeiting and to spread the use of cash-based illegal transactions. However, this has been done gradually, allowing adequate time for people to replace old notes with the new ones to prevent too much disruption of economic activity. This overnight shock, by contrast, is hugely destabilising, with likely medium-term material damage to a very large part of the Indian population. It affects very little of the stock of ill-gotten wealth and does nothing about its generation, but it has severe impact upon ordinary people.

The shock announcement seems to have emerged from the current government’s penchant for drama and propensity for so-called “big bang” reforms.

Other explanations have been put forward about the timing of this move: the need to distract the media—and indeed the entire society—from the government’s increasing repression of the media and of all forms of democratic dissent, and the upcoming elections in the two important States—Punjab and Uttar Pradesh—in which rival parties would definitely be wrong-footed by this announcement.

In any case, both design and implementation of this scheme have been far from ideal. In terms of design, the secrecy and suddenness created absolutely unnecessary problems, which have hugely affected ordinary people across the country. In addition, the government clearly failed to recognise that given the rise in prices over the years, it is absurd to treat Rs. 500 as “high-denomination” note that poor and middle class people are not likely to use. These Rs. 500 notes accounted for more than two-thirds of the notes in circulation, and removing those at one stroke inevitably has had repercussions on liquidity, production, markets, and consumption across India.

It was due to this ill-planned move that a chaos engulfed the country in the week after the announcement. It was partly because not enough notes were made available to banks and ATMs. Moreover, there were no proper arrangements to deal with the people’s rush to exchange notes. Removing such a huge amount of currency in circulation at once is a huge move that constrains the payments system and can even bring it to a halt in parts of the country where the new cash notes do not become readily available. It is surely foolhardy to imagine that economic activity in such a heavily cash-based economy would be unaffected if these volumes of currency are not very rapidly replaced.

If it was intended to weed out black money, then Mr Modi seems oblivious to a simple fact that people who have black money on a substantial scale rarely keep it in cash. And in any case, big players holding large amounts of undisclosed cash can usually find agents to convert the notes through such small transactions for which explanations cannot be reasonably sought. Yet the government was insistent, and so the gesture, which produced much work and little gain, had to be made. Hence to many economists, the move “has primarily a political and not economic objective.”

Then again, the choice to introduce first the Rs. 2000 note rather than the Rs. 500 note is mystifying: obviously, this would hardly create an effective liquidity substitute for the Rs. 500 note, yet government appears to be surprised when people complain that they cannot find anyone to give them change for the higher value note. The shortage of other lower value notes, that is inevitable when only newer notes of even higher value are being introduced, should also have been anticipated, yet that too was not factored in. In any case, surely if the idea is to eliminate black money, then it is hardly desirable to introduce even higher value notes that would presumably be even easier to store for those holding large quantities of undeclared cash. If the Prime Minister is correct in claiming that this was not a sudden move but something that has been planned for nine months, then it is incredible that so little effective preparation was made. It appears strange that there was little official recognition of likely implementation problems and that simple matters like ensuring that the RBI has sufficient notes to replace the ones that have been demonetised, or that ATMs are appropriately configured, were not taken care of before going on with this.

Still, all this would have been worth it, if indeed such a move would eliminate all black money in the country. But in fact, it will do little more than scrape the surface of the problem, even if it does so in a blaze of hyperbole. Whatever little effect this measure may have to bring such black money out into the open would still be an unmitigated benefit, if the move did not simultaneously cause so much grief to innocent citizens. The fact is that the both the insensitive design and the shoddy implementation have already caused a huge amount of distress to different people in various ways, and the pain is likely to linger for some time. The rapid and sudden strike without warning meant that ordinary people had no opportunity to prepare for it. The immediate impact — in the form of drastic cash shortages leading to immense hardship especially among less privileged groups; long and tedious waiting times in queues that often prove to be fruitless because banks and ATM machines are unable to provide the required cash – all these have been widely portrayed in the media.

Overall, this ill-conceived and even more poorly executed move appears to be an attempt by the government to display a lot of sound and fury, but signifying very little. It is unfortunate that in the process it has inflicted such damage on ordinary people and on the economy.

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