Demonetization: Impact on Political Economy

As Nobel Laureate Amartya Sen says, “Good policies sometimes cause pain, but whatever causes pain – no matter how intense – is not necessarily good policy.” With varied views among individuals regarding Demonetization – an amalgamation of promises and paradoxes, this article tries to bring out a ‘Politically Correct’ vision of public thoughts and aspirations before you.

To define the term, Demonetization is a policy enacted by the Government of India on 8 November 2016, ceasing the usage of all ₹500 and ₹1,000 banknotes of the Mahatma Gandhi series as legal tender in India after 9 November 2016. The government claimed that the demonetization was an effort to stop counterfeiting of the current banknotes allegedly used for funding terrorism as well as a crackdown on Black money in the country. The move was also described as an effort to reduce corruption, the use of drugs, and smuggling.

With the quantum increase in financial savings, the cost of debt capital in India should fall. This means, the interest rate a company is paying on all of its debt, such as loan and bonds is to decrease. Further, as the amount of savings increase, lending rates, that is, the amount that a bank charges on money that it lends, are likely to fall in the line. Through the demonetization exercise, the government has been pressing hard to become a cashless economy and is encouraging more and more people to adopt the digital payments system for their transactions. The government wants people with smartphones to use the United Payments Interface (UPI) app for a cashless transaction. Besides banks, online wallet companies including Paytm, MobiKwik and Free-Charge, too, are promoting their online products and wooing customers to get away from cash-based transactions.

However, questions arise regarding if Demonetization will really lead to an end in corruption. The major problem is the incapacity of the state to handle the banks. Not enough money is available at the banks and the shortage of cash has worsened the problems. This lead to a detrimental effect on all the sectors of the economy. Several deaths were linked to the inconveniences caused due to the rush to exchange cash. Yes, it is true that some steps were taken to see that people in hospitals do not face problems. However, given the huge population in the country, the conditions of the hospitals are not unknown to us. Despite the steps taken, people continue to face problems and there are cases of many health centers denying treatment without cash to the patients. A pertinent question that arises is, from when did corruption become more important than lives of individuals? Especially when the government comes to power with the votes of the individuals and in order to protect the interests of the individuals. It is definitely not about taking a pro-government or an anti-government stand. It is about seeing things as they are.

As Professor Prabhat Patnaik argues, the assumption that black money actually consists of cash-hoards makes little sense. A person possessing a huge sum of money say 20 crores, will certainly not come with the entire money to change it into the new legal tender but would rather send several factotums to the bank, and would do so over a number of days prior to the December 30 deadline. Thus, with such “black operators” exchanging black money from the old legal tender to the new, the ideas of unearthing illegal cash-hoards makes little sense. As he says, all money circulates with occasional pauses when it is held, whether it is employed in black activities or white activities. The essence of unearthing black money lies therefore in tracking down black activities , not in attacking money holdings per se. A sizeable portion of “black activities” however, is operated through banks located abroad. Thus, if foreign banks constitute the predominant source of funding “black activities”, then the act of demonetization will do little to eliminate such activities.

Demonetization therefore is unlikely to have a major dent on the black income generation but will be able to unearth black incomes held in cash which may be actually a fraction of total black incomes earned in the past. A significant part of black incomes generated in the past have already been invested in land, gold or other form of assets. Thus, the government gives the impression of fighting corruption while the black income generation continues as the propertied class remains largely immune to demonetization.

In 1978, the Morarji Desai government had demonetized 1000, 5000 and 10000 rupee notes .However, it caused no hardships as such since people had scarcely even seen such a note. It is true that this time, black money is kept at homes and to an extent, corrupted individuals are being caught. But then there is still a question of Rule of Law. Being a student of Political Science, I have been studying all my life that a law is applicable to all the individuals equally. However, case studies reflect that, while some are being let off, some others are being arrested. Also, the hardships created this time are for everyone to see.

In a cash-dependent economy like India, all of a sudden around 86% of the cash supply has been rendered useless. This has effectively imposed a tight constraint on real economic activity. This constraint will initially be felt most acutely in the cash-intensive sectors such as agriculture, construction, gems and jewellery, textile, trade, transportation and real estate as well as in the activities in the vast informal sector of the country. Beyond the initial impact, the shock from demonetization is likely to set off a domino effect that is a chain reaction with one event setting off a chain of similar events that will impinge on activities far removed from the cash-intensive sectors. This impact may result in a protracted economic slowdown going beyond the current financial year. We, however, argue that reviving the real economy and getting it back on a high growth track could be a much more difficult and time-consuming process.

Since November 8, the government has changed rules related to the currency ban over 20 times and the RBI has released more than 15 sets of frequently asked questions to clarify this change in rules. These actions create an environment of unpredictability and in such an environment, firms and households hold back their investment and consumption plans. This further puts a brake on real economic activity and it is likely that even after the currency notes are back in circulation, the brakes stay on or are only gradually lifted. During this time, the singular objective of the government should have been to adopt structural reforms to stimulate GDP and achieve a high and sustainable growth rate. Generating jobs to absorb the demographic dividend while it lasts should have been another policy priority. Instead of prioritizing these objectives, the government announced a measure that has in fact dealt a severe negative blow to the overall economy.

The associated policy uncertainty is contributing to macroeconomic instability. Arguably, this is the last thing that was needed now given the pervasive weakness in the credit and investment climate. Policymaking over the next couple of quarters is likely to get hijacked by this single event in order to ameliorate a potential economic damage. All this is very costly both in terms of the time spent and the resources used up in first delivering the shock and then in restoring normalcy.

Thus, to conclude, we are not sure if Demonetization is a political gimmick or a transformational change that has been brought to the economy. The question is for you to answer.

The author, Riddhi Sanyal, is a student of Political Science and International Relations at Jadavpur University, Kolkata.

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