"White is the new black", 'The Hindu', November 17, 2016

The economy strikes back

Five days into the demonetisation we are in the midst of a painful transition. In a televised speech on November 13 delivered in Goa the Prime Minister has sought fifty days’ reprieve, though he did not tell us what exactly we should expect. Perhaps we are enroute to a better state but in the interim we are left to ponder an unedifying  transition. Much of the evidence of what is taking place in the economy since the fateful night of November 8 is anecdotal, but no less valuable for that. News from different parts of the country indicate two developments. On November 8 itself there had been frenzied late night shopping till midnight especially in the upmarket malls. This indicates that some sections of the populace had money hoards from unaccounted activity and wanted to get rid of it while ti was still legal tender. From the next day on there has been a rush to the banks to exchange currency notes and to deposit money into savings accounts. The experience of those attempting the former has not been a happy one. Reports speak of long waits, scuffles, bank employees favouring relatives over fellow citizens and quite worryingly banks running out of cash. If not a run on banks it has raised questions about monetary management in India.

          The other development is the reported spurt in deposits on Jan Dhan accounts. Initiated with some fanfare by this government it was meant as a means to financial inclusion. As these accounts were mostly of persons with low incomes, and often showed a near zero balance, it suggests that these deposits may be black income being distributed among many agents. We have heard of benami titles to property, could we have just witnessed the emergence of benami deposits? Could the facility of allowing deposits of upto 2.5 lakhs without attracting income tax have unwittingly acted as a conduit to the laundering of black income? Accounts have also come of gold sales rising. How can this be possible as high denomination notes, which as we shall see constitute the overwhelming part of total currency in circulation, are no longer legal tender? We are told that this is made possible by pre-dating sales. Of course, where stock movement is verifiable this would be difficult. But it does speak of many loopholes that have been suggested are means to sabotaging the intent of the demonetisation. Others exist. We have actual statements made by party apparatchiks in Tamilnadu that they have distributed old notes to their workers before a bye-election to come. So, in UP where elections are due only in 2017, there is no reason why money cannot be distributed right away, a form of advance payment. One would expect that the 2000 rupees limit on the exchange of notes is just the right magnitude in the context.

          The demonetisation had targeted the stock of illegally accrued wealth held in the form of money. Where disgorging of it in the forms suggested above is not possible demonetisation would be successful in punishing the guilty. This view of the role of money as a store of wealth is appropriate. But the demonetisation can also affect the flow of income in the future even when it is to be perfectly legally earned. If this happens it also punishes the innocent. This it can do as money is also the medium of exchange without which the overwhelming majority of transactions cannot occur. It is not hard to imagine the impact on transactions of sucking out 85 percent of the country’s money stock, it being the share of high denomination notes in the total. The economy has responded predictably. The pre-midnight shopping spree of the day on which the demonetisation was announced was followed by a quietening not only in the bazaars but also in the upmarket shopping malls themselves. Where transactions involving employment of persons cannot go through there is a loss of output. And this is not going to be regained even after the currency shortage has been ended. The national political leadership and the technocrats of the Reserve Bank of India appear to have missed this possibility.

          The Prime Minister has expressed his confidence that his deshvasiyon, inevitably translated as ‘countrymen’ by All India Radio, will bear the inconvenience of the transition for the sake of purifying the country. But engineering a loss of employment is worse than promising a pie in the sky, and this could hardly have gone unnoticed by those affected. The RBI’s response is worthy of Marie Antoniette. It is quoted as encouraging Indians to turn to internet banking as it would “also enhance the experience of living in the digital world.” This is somewhat brazen as the bank has been granted the monopoly of note issue precisely so that it facilitate transactions. There are unlikely to be many takers for the government’s propaganda on public radio which has a kirana store owner say that he is not worried as his money is clean and he has till the end of the year to change it. This ignores the many who cannot earn an income as the system does not have enough money to enable transactions to take place. Thus views on the transition are likely to be influenced by where one is placed in relation to the income generation process. So, for instance in Kerala, where many live directly or indirectly on monthly remittances from the Arabian Gulf and where undeclared income is rife, a relatively aware local population is likely to see the demonetisation as justified and hurting the rich. They may well see it as a ‘surgical strike’. However, in small town northern India where households are dependent upon daily earnings from a local economy, the populace is unlikely to be moved by schadenfreude as much  as the pain they must inevitably suffer, about which we are presently reading in the press. They are likely to see the demonetisation as bloodletting.

          Could this have been foreseen? Yes, absolutely, were the move intelligently designed policy. The central bank could have started replacing the larger denomination notes by smaller denomination ones much earlier. This would have isolated those holding unaccounted income in the form of high denomination notes, the unspoken premise of the demonetisation. There is of course the case for secrecy, but the RBI has in any case shown itself to unmindful of the need to facilitate transactions in any case. This is the only conclusion that one can draw from the feature that so large a part of the money stock was held as high denomination currency. It reflects a complete disregard for the low value transactions that dominate the economy. It is not hard to see that a very large number of Indians must earn less than Rs. 500 a day. Given this it reveals a monumental lack of sensitivity to withdraw the 1000 rupee note and bring in a 2000 rupee one. Given the average daily income of an Indian and the average value of transactions a move to a money stock far more  balanced between the denominations is absolutely essential now.

          The Prime Minster has brought the issue of corruption centre stage. But it is important to recognise that there is more than one narrative on the issue. One is that a few rich entrepreneurs have evaded the rules laid down by the state and got ahead of the rest of the people. At one level this cannot be denied and this line of argument can be whipped up to some political advantage. But there is a counter-narrative, and it is that the entrepreneur in India is forced to generate ‘black money’ to gratify the political class and the civil service who are the gatekeepers to their activity. This is hardly a novel argument. It is what underlies Rajagopalachari’s description of India being governed by the ‘licence-permit Raj’. His only mistake was to see this as entirely due to Nehru’s economic policy. Actually this is India’s inheritance from colonialism, zealously guarded by its beneficiaries, again ranging between the political class and the civil service. So if Mr. Modi does go on to check all records going back to 1947, as he has said he is willing to do, he may also want to investigate the role of the government machinery in the process of generating unaccounted income. One should not be surprised if this role is quite substantial. Of course, one hopes he does not do this as it not only carries more than just a whiff of ‘retrospective taxation’ it can leave us mired in a transition longer than the one we are in now. We are told that our PM admires the late Lee Kuan Yew of Singapore. We know that in building his country Mr. Lee started with the civil service. He paid them well, but he also cracked the whip when they turned out to be corrupt.