Bold Ex­per­i­ment

By de­mon­e­tiz­ing the Rs. 1000 and Rs. 500 notes, Prime Min­is­ter Naren­dra Modi may have mis­cal­cu­lated his strat­egy.

Southasia - - CONTENTS - By Zu­fah An­sari

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.

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