By demonetizing the Rs. 1000 and Rs. 500 notes, Prime Minister Narendra Modi may have miscalculated his strategy.
In a noble attempt to relieve India from the plague of corruption and threats of terrorism, Prime Minister Narendara Modi’s recent move to demonetize Rs. 500 and Rs. 1000 rupee notes, has brought millions to the streets protesting against the risky move.
As demonetization is put into the works in the world’s fastest growing economies, this crude clampdown on ‘black money’ in India comes with an air of fear and uncertainty leading to nationwide chaos as Indians scamper to get their existing currency changed for new banknotes.
What has triggered this need is the widespread phenomenon of corruption. A government survey, published in 2013, revealed that only 1 percent of the population pays taxes, while it is also stated that India’s illicit untaxed economy takes up one-fifth of the GDP.
The ideology that has given birth to this solution is backed by the notion that as more and more people get currency exchanged, the government will be able to track down incidents of tax evasion, eradicate black money
and uproot any domestic funding that might be taking place for terrorism, through counterfeit money.
Moreover, this process is a catalyst towards leading India to gradually mould its society to do cashless transactions, which will eventually create greater financial access, transparency and a promise of greater revenues for digitalized businesses.
Conversely, countries which have implemented quick demonetization have faced severe hyperinflation or economic collapse that has led to the question of how well a large economy like that of India can cope with the aftermath and position itself to absorb the shock that the change is likely to bring.
Despite the long term impact of this policy which is forecast to have a positive tilt for the overall economy, the short-term implications are grave. Currently, the Indian government is trying to brace itself for the possible slowing down of GDP growth to 5.8 percent from that of 7.3 percent estimated earlier.
On the other hand, what sounds like an achievable reality, in theory, becomes questionable when one measures it against the implications that it may have in an economy where cash is 12-14 percent of the total GDP. A nation where most of its population is based in the rural areas and less than one-third has access to financial institutions, the policy is likely to face many logistical issues.
With India, primarily being a cashled economy, this sudden change in policy has and will have a drastic impact on its overall economic stability. About 90 to 98% (in terms of volume of the transactions taking place in India, involve cash and with 86% of cash being withdrawn from the system and not considered legal tender has put much of the population in a conundrum.
The implementation of demonetization has consigned Indians to a state of confusion and desperation and has impacted the smooth execution of the new policy. The common man is suffering as he has to stand in lines outside ATMs, banks and post offices that are on many occasions out of cash.
The situation is much more severe for people who heavily depend on cash for their day to day needs. For some, it is a decision to choose between getting their existing cash changed against that of earning a daily wage, whereas in extreme circumstances it also means that some might not have enough cash on hand even for food.
In addition, businesses have been largely affected, especially those that deal in consumer goods as sales have dipped by one-third. Likewise, the agriculture sector has suffered as far as purchasing of raw materials like fertilizers and seeds and selling of crops and consumable items is concerned. The construction industry has been hit by rising labour costs, whereas the fishing industry is close to breakdown. Sectors such as real estate are facing a meltdown as they require huge cash investments which is now slowing down.
Besides the far reaching impact on the economy, the process of demonetization has also taken a toll on the cultural and social fabric of Indian society. Due to the ban marriages are being postponed and people are now in debt.
For many, especially the underserved population of Indian, this policy would also mean losing their savings as they fear that they will be harassed and questioned by the financial institutions to declare the legitimacy of their cash holdings. In a situation where a person brings 250,000 rupees to the bank has to explain the source of the cash. If he fails to do so, the amount could be slapped a 200 percent tax.
Despite the potential benefits and the purity of intention that the policy might hold, the costs that are associated with the implementation of the policy will be difficult for many Indians to bear. The demonetization proposal in India has faced a backlash at many levels, ranging from the public to officials and economists.
A considerable set of influencers believe that this may not be the most effective way to counter the malice of tax evasion as most black money in India is not dealt in cash but mainly in the form of gold, silver, property and overseas financial institutions. This would make demonetization a futile effort and a nuisance for the economy.
While the economic stability of the country is the primary driver behind this shift in policy, there is a political angle to it that works in favour of Narendara Modi.
His decision of implementing the radical strategy of demonetization highlights his position of a decisive head of state who is aggressively approaching solutions for macro issues threatening the country’s future. The move could also be seen as a way to strip possible contestants in the upcoming elections in Uttar Pradesh of assets and cash and destabilize their preparations.
On the flipside, a major base of voters for the ruling party comprise traders, businessmen and wholesalers who mainly deal in cash and now seem to have been flattened out.
Modi’s move may appear as bold and working towards greater economic stability but it could cause a lot of harm. The prime minister’s efforts to demolish the shadow economy could have a hard-hitting impact and lead to dire consequences for the Indian nation.