Sunday, December 4, 2016

On Modi's Demonetization



Introduction 
On the eve of 8th November, 2016 the prime minister of India Mr. Narendra Modi came out on the national television and started announcing a rather unexpected policy decision of his. He said:

To break the grip of corruption and black money, we have decided that the 500 rupee and 1,000 rupee currency notes presently in use will no longer be legal tender from midnight tonight, that is 8th November 2016. This means that these notes will not be acceptable for transactions from midnight onwards. The 500 and 1,000 rupee notes hoarded by anti-national and anti-social elements will become just worthless pieces of paper.
This is how the demonetization, or as the former finance minister P Chidambaram termed the demonization of cash, policy of Narendra Modi government started. This announcement surprised the whole country. It shocked people.

Objectives of this policy 
So, why did Prime Minister Mr. Narendra Modi took this drastic step? What prompted him to plunge India into mayhem? Immediately after the announcement by the prime minister, the department of economic affairs published a communiqué in which they stated the goals of this policy. They are: 
  1. With a view to curbing financing of terrorism through the proceeds of Fake Indian Currency Notes (FICN) and use of such funds for subversive activities such as espionage, smuggling of arms, drugs and other contrabands into India; and
  2. For eliminating Black Money which casts a long shadow of parallel economy on our real economy.

Will it achieve its objective? 
The real question now is will this policy achieve its stated objectives?

The immediate evidences that have started coming in after 25 days of implementation of this policy point a finger at a failure of this policy to achieve the first goal. Already in Kashmir the state police have found two new 2000 rupee notes with the Kashmiri separatist militants that they killed in an encounter (‘Jammu and Kashmir’, 2016). Not only this, within few days of demonetization move fake notes of new 2000 rupees have surfaced at multiple places in India (‘Fake 2,000 rupee note found in Chikkamagaluru - Times of India’, n.d., ‘First fake Rs 2,000 note surfaces in Gujarat - Times of India’, n.d., ‘Rs 4 Lakh In Fake 2,000 Rupee Notes Seized In Odisha, 1 Arrested’, n.d.). Keeping aside the surfacing of the fake new 2000 rupee notes, in a hurry to print new 500 rupee notes RBI itself has printed and distributed defective notes in the economy (‘Defects in new Rs 500 notes, RBI blames it on rush’, 2016)! These all means all the efforts to curb the fake currency notes in the Indian economy have started failing even before the demonetization policy completes its first round! RBI itself is adding in this problem by printing different versions of its new notes in a rush!

If demonetization is not successful in curbing the problem of fake currency notes then how is it doing when it comes to curbing the so-called menace of black money[1] and corruption? Again, as in the case of fake currency objective, the evidence is already coming in that this objective is also not been achieved by this policy e.g., already two port officers at Kandla port in Gujarat are caught taking bribes of 3 lakh rupees in newly printed 2000 rupee notes (‘In Gujarat, Bribe Of Nearly 3 Lakhs Paid Entirely In New Rs 2,000 Notes’, n.d.), and the IT department in Bangalore seized 4.7 crore rupees in new 2000 rupee notes from two government bureaucrats (‘Biggest haul in new currency’, n.d.). The actual issue here is that, the proportion of cash in the black money is of negligible amount of 6% (‘Why govt’s demonetisation move may fail to win the war against black money’, 2016). To recover this 6% government has waged a war on every honest citizen of this country.

Also, now after 25 days of demonetization government’s claim of around 10% of total money supply of around 14 lakh crore not coming back into the banking system is falling apart. They thought if this money doesn’t come back in the system, because it is black money, then RBI can lessen its liabilities by that amount and transfer that money as a windfall in the account of the central government!  But according to latest estimates already over 11 lakh crore of that money has come back in the banking system (‘Over Rs 11 lakh crore back into banking system’, n.d.)! This means there is no windfall for the government or RBI and their liabilities still stand. In fact, the money that is going to remain unaccounted for is just few thousand crores of rupees only (‘How PM Modi’s note recall narrative has fallen apart’, 2016), which is nothing compared to the total cost of this whole exercise.

Sensing that there is no black money to be unearthed by this scheme surprisingly the government itself has become an official money launderer now by changing the IT Act in parliament. Initially the government announced that anyone depositing anything more than 2.5 lakh rupees will face a penalty of 200%. But now they have declared that that penalty will be only 50% and the rest of the black money people can keep it as white money! So the demonetization scheme, which started with a big fanfare as scheme to eliminate black money from the economy, has now become a scheme of government to convert black money legally in white money after giving government its commission of 50%!

Seeing that the black money and corruption story is falling apart against the capacity of Indians to launder money at a gigantic scale, again government has changed its tune and saying that the real objective of demonetization is to make India a “cashless” economy (‘India’s prime minister is planning to make the country completely cashless’, 2016)! In this regard Prime Minister Narendra Modi in his recent Parivartan Rally in UP said, hinting to a satirical joke circulating on social media, that even beggar are now using a swipe machine in India (‘PM Narendra Modi Urges People To Go Digital, Says Even Beggar Using Swipe Machine’, n.d.)!

Also, in a recent rally in Moradabad, Prime Minister Narendra Modi has again changed the objective of his demonetization move and he is now promising the poor people of this country that he will do something so that the money that rich people deposited in their Jan Dhan account will remain with poor (‘Will find way to give black money in Jan Dhan accounts to poor, says PM Modi - Times of India’, n.d.)! Many are terming this statement as a Marxian dream of outright confiscating rich to enrich poor!   

The claims of the government that demonetization has completely stopped the violence on borders of Kashmir and the borders of India are completely secured are also turning out be an illusion. Within few days of this move, 3 Army soldiers were killed by separatist fighters in Assam (‘Army convoy ambushed in Assam, 3 soldiers killed - Times of India’, n.d.), and in a recent attack on an Army camp in Nagrota, Kashmir militants killed 7 Indian soldiers (The Associated Press, 2016)! So neither the surgical strike along the LoC (line of control) nor the financial surgical strikes in India have achieved their stated goals.  
Effects on Society and Economy

When I am writing this article it has been 25 days of this policy announcement and the chaos that started on the day of announcement is still everywhere. Instead of subsiding the mayhem is just increasing in the country.
First, the biggest effect of the demonetization policy is the lives lost of those people who died standing in bank’s long lines. If we believe the figures being quoted by member of parliaments in the debate and various other independent news outlets then already more than 80 people have lost their lives in this mayhem (‘Demonetisation death toll’, n.d.). These lives lost were precious, and no amount of quantitative figure can measure or justify its loss.

On the economic front CMIE (Center for Monitoring the Indian Economy) estimates the total transaction cost of demonetization exercise to be Rs. 1.28 trillion (‘CMIE’, n.d.)! And as the former Prime Minister Dr. Manmohan Singh said in the parliament recently, this exercise will likely cost the Indian economy equivalent to 3% of its annual GDP! 

Apart from the above estimates there are myriad of other opportunity costs that can’t calculated in numbers e.g., the man hours lost due to this exercise or the amount of mental and physical harassment that people are suffering. The wealth generating class of the Indian society is busy standing in long queues outside banks for 25 days now (look pictures below) instead of generating wealth. This is a huge loss.

 

The bigger issue is, going in future, as due to this measure the capital base of the Indian economy has now eroded, this policy will make all of us poor. The amount of uncertainty the government has created in the country – e.g., since the beginning of this policy the government has changed its policies at least 50 different times and have already broken so many promises by flip-flopping every now and then – is going to be a huge detriment to the future investment activities in India. Under such tremendous uncertain conditions no investor, whether local or foreign, is going to invest anything big in India. Investors invest only in those markets where their returns on investment are safe. By suddenly making the official paper currency worthless pieces of paper the government has broken the trust of people. No one is going to trust the government in India now. No one is going to trust the RBI and banks too. The fiat paper currency monetary standard works only on the trust factor that government backs that currency with their legal authority, but by breaking that trust factor the government has given a death blow to the fiat currency monetary system. After demonetization limits are over at the end of December, people will withdraw their money from banks en-masse creating a big banking crisis in India. The real bank runs will begin once the limit period is over. In future people will not trust fiat paper currency and instead keep their wealth in hard assets like Gold or Silver or land, real estate etc., more and more.

And looking from the economic point of view the whole demonetization policy is going to be a disaster for the country in the long run as against the claims of the government. The government is attacking the wealth generating class of this country. They are confiscating their honestly earned wealth and promising to give it to poor people. This will not end well because wealth generating people will not tolerate this and they will either stop being productive or likely start leaving India if this policy continues for long. When the property rights of business owner are not secure, businesses will not flourish in India. 

Conclusion
In the end, Indians have only two choices in front of them, 1) either make rich people of this country poor by confiscating their wealth and thereby making everyone poorer than before or 2) make poor people rich by securing their property rights and letting them work in the free market thereby making everyone richer than before. There are no other choices. The demonetization policy is choosing the first option. If this policy continues for long than Indians must prepare themselves for mass poverty. 



References
Army convoy ambushed in Assam, 3 soldiers killed - Times of India. (n.d.). Retrieved 2 December 2016, from http://timesofindia.indiatimes.com/city/guwahati/Army-convoy-ambushed-in-Assam-3-soldiers-killed/articleshow/55519836.cms