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Why demonetisation failed

On november 8, the country observed the first anniversary of the shock demonetisation (invalidation) of Rs.500 and Rs.1,000 currency notes of the Mahatma Gandhi series announced by prime minister Narendra Modi last year in an unscheduled nationally televised broadcast. Overnight, this announcement in effect invalidated 86 percent of all the cash (Rs.14.2 lakh crore) in circulation within the Indian economy. The public with currency notes in these denominations were permitted to exchange them for new Rs.500 and Rs.2,000 notes and to deposit large aggregate sums in banks with detailed explanations of their source. Citizens were allowed to exchange old demonetised notes for the new, subject to a ceiling of Rs.2,000-Rs.4,500 per day (it varied) over the counter of bank branches.

The explanation advanced by the BJP-led Central government was that the demonetisation initiative would invalidate the cash hoards of tax evaders. Yet, the real intent of India’s third ineffectual (after 1946 and 1978) demonetisation initiative was to render the large hoards of cash reportedly held by rival political parties, particularly the Congress — which has ruled India for over half a century — useless and to cripple the party and its financiers. Naturally the treasurer of the BJP and their major supporters were tipped off and converted their cash holding into notes of lesser denominations well in time.

However this stratagem failed — 99 percent of the invalidated notes are back with the Reserve Bank of India — because prime minister Narendra Modi and his trusted advisers (less than a dozen of his inner circle were privy to the demo intent until the announcement date) were unaware of several ground realities of the Indian economy. For one, only 6-8 percent of ‘black money’ accumulated by direct and indirect tax evaders (and political parties) is held in the form of cash. Most of it is quickly converted into assets — real estate, gold and/or foreign currency deposits abroad by ubiquitous super-efficient hawala dealers — and can be converted back into cash after elections are announced. 

Secondly, Modi and his demo advisers are clearly unaware of the sheer magnitude of unemployment and under-employment and the impact of the collapsed law, order and justice systems in post-independence India. The foolish neglect of agriculture and unchecked population growth has forced hundreds of millions off the land into urban India in search of declining jobs. This huge army of unemployed youth are always ready to stand for hours in long queues to exchange old notes for new for a modest commission. 

To be sure, demonetisation will yield some long-term benefits. There is greater awareness and incremental usage of the digital banking system which will broaden the tax base. But the costs of demonetisation — at least 1 percent (Rs.140,000 crore) drop in GDP, huge unreported distress in rural India and within the labour-intensive small-scale industry — far outweighed the benefit of this ill-advised initiative. 

54 Views  | Posted on: 5 Dec,2017 Add Comment  Show Comments (0)