We need a cash econ­omy for sta­bil­ity

De­mon­eti­sa­tion failed to achieve any of its stated ob­jec­tives. In­stead, it se­verely hit the poor

Hindustan Times (Bathinda) - - COMMENT - PULIN NAYAK Pulin Nayak is for­mer pro­fes­sor, Delhi School of Eco­nom­ics The views ex­pressed are per­sonal

I f there is one defin­ing eco­nomic pol­icy that the NDA gov­ern­ment has come to be uniquely as­so­ci­ated with, it is the de­mon­eti­sa­tion that was an­nounced on Novem­ber 8, 2016. Prime Min­is­ter Narenda Modi ad­dressed the na­tion in a tele­vised speech that evening to an­nounce that at mid­night, all cur­rency of ₹500 and 1000 de­nom­i­na­tion would cease to be le­gal ten­der.

His tone un­der­lined a de­gree of fi­nan­cial emer­gency. The ex­plicit pur­pose of the mea­sure was to rid the coun­try of “kala dhan” or black wealth. But there were some other ob­jec­tives as well. The move was a strat­egy to curb ter­ror­ist ac­tiv­ity and to put a check on coun­ter­feit cur­rency notes. But the main pur­pose of this mea­sure was de­clared to be to strengthen the hands of the com­mon man in the fight against cor­rup­tion.

The moot point is whether any of the ob­jec­tives stated above have been re­alised to any ap­pre­cia­ble de­gree. The an­swer is in the neg­a­tive. Hold­ers of these notes were given a cer­tain amount of time to de­posit the money in banks and ob­tain cash in other de­nom­i­na­tions, and a new ₹2000 note was soon cir­cu­lated.

There was a deep con­cep­tual er­ror be­hind the move which held that in­di­vid­u­als with “kala dhan” would not re­turn to banks to de­posit the 500 and 1000 ru­pee notes in their pos­ses­sion. The amount of cur­rency not de­posited back would con­sti­tute a net gain to the bank­ing sys­tem.

The re­al­ity was oth­er­wise. Bar­ring a tiny frac­tion of these cur­rency notes, vir­tu­ally all of it has re­turned to the bank­ing sys­tem. This is proof enough that the strat­egy of try­ing to iden­tify black wealth with high-value cur­rency notes was a fail­ure.

It would be er­ro­neous to think of “kala dhan” as a stack of cur­rency notes. It may be more use­ful to think of the flow con­cept which sug­gests that an ac­tiv­ity may be re­garded il­le­gal or ‘black’ if it evades taxes.

The real dif­fi­culty with the move was the sheer scale of the mis­ad­ven­ture. It hit 86% of the value of cur­rency in cir­cu­la­tion and, there­fore, in­stantly crip­pled the econ­omy. The en­tire range of farm­ing, con­struc­tion and in­for­mal sec­tor, for ex­am­ple, run on a cash ba­sis, and they af­fect the vast bulk of the pop­u­la­tion. This par­tic­u­larly hit the poor and the vul­ner­a­ble. Across In­dia there was a sharp fall in the prices of agri­cul­tural goods in all the ma­jor man­dis, which hit farm in­comes in an un­prece­dented man­ner.

The only other ex­pe­ri­ence of de­mon­eti­sa­tion in in­de­pen­dent In­dia was in 1978 when ₹1000, 5000 and 10,000 de­nom­i­na­tion cur­rency notes were flushed out. Mo­rarji De­sai was prime min­is­ter and HM Pa­tel was fi­nance min­is­ter, while IG Pa­tel was gov­er­nor of the Re­serve Bank of In­dia. The lat­ter was known to be against the move. In to­tal, the de­mon­e­tised notes con­sti­tuted barely 1.78% of the to­tal value of notes in cir­cu­la­tion. It was hardly no­ticed by the gen­eral pub­lic.

The con­trast with 2016 is ob­vi­ous. Both ₹500 and ₹1000 cur­rency notes, es­pe­cially the for­mer, were in com­mon use. The im­pact of de­mon­eti­sa­tion was too abrupt and ar­bi­trary. It crip­pled the vast range of eco­nomic ac­tiv­i­ties in the in­for­mal sec­tor, lead­ing to huge job losses.

The slow­down in the GDP growth rate is proof enough. The GDP growth rate in the past quar­ter has been down to a low of 5.7%, from the high of more than 7%, which had put In­dia among the fastest grow­ing ma­jor economies of the world.

When the de­mon­eti­sa­tion strat­egy was found to lead to a dead end, the gov­ern­ment changed the nar­ra­tive to the de­sir­abil­ity of a cash­less, dig­i­tal econ­omy. There is noth­ing in eco­nomic the­ory that sug­gests that one should es­chew cash. There is a sub­stan­tial body of eco­nomic the­o­ris­ing that pro­vides a clear ra­tio­nale for the use of pa­per cur­rency. A cash econ­omy is de­sir­able be­cause it fa­cil­i­tates ex­change and en­cour­ages eco­nomic ac­tiv­ity. Cash can be used as a store of value and it also en­ables agents to con­duct their eco­nomic ac­tiv­i­ties with greater sta­bil­ity.

While the de­clared pur­pose of de­mon­eti­sa­tion was to pe­nalise those among the rich who evade taxes, in re­al­ity it hit the poor in the in­for­mal sec­tor, many of whom lost their source of liveli­hood. The po­lit­i­cal nar­ra­tive how­ever was pre­sented with such con­sum­mate skill that the strat­egy be­came a ma­jor po­lit­i­cal weapon in the hands of the gov­ern­ment. The re­sult of the UP elec­tion goes to show how Modi was able to con­vince the com­mon voter that the mea­sure was ul­ti­mately for her good even while jobs were be­ing lost and GDP growth rate was shrink­ing.

One fi­nal point: There was hardly any trans­par­ent con­sul­ta­tion of this rather mo­men­tous de­ci­sion. From all ac­counts, the top most func­tionar­ies in the min­istry of fi­nance and the RBI were not kept in the loop. This raises se­ri­ous and dis­turb­ing ques­tions re­gard­ing the na­ture of de­ci­sion-mak­ing in our par­lia­men­tary demo­cratic sys­tem.

It would be er­ro­neous to think of ‘kala dhan’ as a stack of cur­rency notes

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