Of money good or black, digital or paper
The decision by the BJP government on 8 November to demonetise the 500 and 1,000 rupee currency notes has been presented as “strength in the fight against corruption, black money, money laundering, terrorism and financing of terrorists as well as counterfeit notes”.
The release added: “Prime Minister Shri Narendra Modi made these important announcements during a televised address to the nation on the evening of Tuesday 8th November 2016. He said that these decisions will fully protect the interests of honest and hard-working citizens of India and that those five hundred and one thousand rupee notes hoarded by anti-national and anti-social elements will become worthless pieces of paper.”
Rs 14 lakh crore – 86% of the value of Indian currency currently in circulation – became useless from midnight of November 8, 2016. The Rs 500 notes amount to Rs 7.85 lakh crore and Rs 1,000 notes amount to Rs 6.33 lakh crore, according to Reserve Bank of India data. The immediate result was panic, in hundreds of towns and cities, as citizens ran for ATMs. Confusion prevailed as on the next day, 9 November, all banks were to shut to the public and ATMs too.
There was chaos outside hospitals, railway stations and petrol pumps which were allowed to accept Rs 500 and Rs 1,000 notes till Friday (but interpreted the directions as they pleased). Smaller denomination notes such as Rs 100 and Rs 50 were in short supply due to the heavy demand. Small traders, rickshaw pullers, taxi and auto-rickshaw drivers, daily wage labour, and unorganised sector workers said they have been hit hard.
This public inconvenience was necessary, said the government, to have the time to restock bank branches and ATMs with new currency notes and to prepare the bank branches for the exchange services they would have to begin on 10 November.
The government explained that:
1. A law was passed in 2015 on disclosure of foreign bank accounts. In August 2016 strict rules were put in place to curtail benami transactions. During the same period a scheme to declare black money was introduced. These efforts have over the past two and a half years, brought more than Rs. 1.25 lakh crore of black money into the open.
2. These efforts have led to India emerging as “a bright spot in the global economy”, a preferred destination for investment and an easier place to do business in. “Leading financial agencies have shared their optimism about India’s growth as well.”
3. Indian enterprise and innovation has received a fillip due to the ‘Make in India’, ‘Start up India’ and ‘Stand up India’ programmes for enterprise, innovation and research in India.
There is no doubt that India’s economy has been plagued by the creation of wealth in some quarters that is obscenely disproportionate to the stated sources of individual and family income (see the press release from the Department of Economic Affairs, pdf). This has for long signalled corruption, and the means by which the corrupt (both giver and taker) become so is cash (but not only). The demonetisation has affected the political class and bureaucracy which accounted for the bulk of the corrupt money. The other difficulty the government and enforcement agencies have grappled with especially over the last decade is counterfeit currency notes, which have been used to maintain anti-national, secessionist and terrorist networks.
With about 86% (by rupee value) of currency in circulation being in the notes that have been demonetised. There are 16.5 billion Rs 500 notes and 6.7 billion Rs 1,000 notes in circulation now, and replacing them with lower denomination notes, and also the new series of Rs 500 and Rs 2,000 notes, will take several weeks.
I have several concerns about the demonetisation of the 500 and 1,000 currency notes, and the accompanying directions that the banking and financial services sector in India is now pushing the public.
Question 1 – Estimates are that currency in public circulation in 2006 was around Rs 4 lakh crore. In 2016 it was about Rs 16 lakh crore. If this estimate is of what RBI printed, why did it for ten years print physical currency at a rate higher than top annual GDP growth estimates?
This article explains the extraordinary rise of cash economy through high denomination notes, powered by generation of black money in real estate, stocking of gold, bribery and corruption. But it does not help answer my question above. “While the high denomination notes made illegal businesses, including hawala transactions to transfer money out of India easy to execute, it has facilitated huge tax evasion even in the otherwise lawful businesses. High denomination notes have made it easy for the bribe taker to handle huge bribes with ease.”
Question 2 – As the 500 and 1000 notes are ‘high value’ and so used for hoarding ‘black’ cash, why is the higher of the two (1000) being replaced by a note twice its value, that is, Rs 2000?
Since yesterday, there have been explanations offered about the effect of demonetisation on consumption and on slowing down an economy whose GDP growth is rated as the best amongst the large economies. “Consumer spending will likely fall in the immediate weeks as households adjust to the new system. India’s economy grew 7.1 percent during April to June, the slowest in 15 months, but the government and experts have been pointing out that a pick-up was likely in the next few months riding on good rains, a pay bonanza for government employees and festive-season buying.”
According to the national income data for the first quarter (April-June) of 2016-17, private final consumption expenditure (PFCE) – which measures household spending – at current prices is estimated at Rs 21.19 lakh crore, or about 55% of the gross domestic product (GDP). These are the numbers that a new class of ‘growth’ advocates in India are betting on. There is a connection to inflation – in the price of services, cost of manufactured articles and the prices of food – which however has not been answered as yet. Raising the denomination of the highest value currency note from Rs 1,000 to Rs 2,000 is in my view such a signal.
A number of petitions challenging the notification by the Department of Economic Affairs, Ministry of Finance, Government of India (which is the order for demonetisation) have been lodged at various High Courts and with the Supreme Court. Some protest the order as “illegal and arbitrary” and others for the order not granting reasonable time for ordinary citizens (presumably with legitimate cash in hand) to comply without jeopardising livelihood (by having to spend time in bank branches, for which leave is to be taken or a day’s income has to be foregone). While the Supreme Court may hear a petition next week, the response of the Madras High Court – that it cannot interfere in the policies of the government related to monetary system – should help prise open to greater public scrutiny one of the most opaque areas of policy making: the public monetary and fiscal system.
Question 3 – Is the net monetary gain by Government of India – more physical money from the ‘black economy’ brought onto the national accounts books – a way to ensure that India will next financial year also record the ‘fastest GDP growth’ (without the manufacturing, service and agriculture sectors doing so)?
For this question I can see only a few partial answers. These have to do with the enlargement of the digital rupee and digital payments, and this is the most serious concern. A government-appointed panel was set up in August to suggest ways such as tax rebates and ‘cash back’ to incentivise card and digital transactions. The government is also examining the feasibility to create a history for all card and digital payments, how to use the Aadhar database for authenticating card/digital transactions, providing low-cost micro-credit based on credit history.
Another partial answer comes from the Ministry of Finance, which said that “weak global demand” is among the “strongest challenges” in the near term for Indian economy. “Weak global demand is one among the strongest challenges in the near term. Exports and imports together constitute 42 per cent of the GDP (gross domestic product), even at the reduced levels in 2015-16.” The ministry said that reviving the savings and investment cycle in economy is challenging. The savings rate that stood at 34.6% in 2011-12, declined to 33% in 2014-15. Investment rate declined from 39% of GDP in 2011-12 to 34.2% in 2014-15. So these are the conventional macro-economic arguments, but the demonetisation will as I see it push any revival in savings and investment in quite a different direction from what the rural and agricultural base of the population require.
That direction is the ‘cashless’ one, with cash being blamed for fuelling the black economy. This is a danger-filled direction, one which we have already had a troubled history to look back at recently – the micro-credit bubble of the 2000-10 decade – to serve as a guide of what not to do. The banking and financial services industry has been expanding over the last two years, in tandem with the mobile telecom industry, with mobile payments and ‘wallets’.
“You cannot have 12% of India’s GDP in shape of currency,” Finance Minister Arun Jaitley has said. “Ideally developed countries have only about 4% and therefore you have to squeeze the amount of currency available and you need to get people into the habit of using digital, cheques, plastic currency and so on.” This – apart from the short-term gain by herding cash hoards into banks to be taxed – is what the direction is: the rupee as a bit, the rupee’s already tenuous basis in a physical standard now becoming more virtual, and this in a monetary and fiscal environment about which the public has scant understanding and in which the public has no participation.
Such a direction only widens the already troublesome gap between an acceptable physical basis for a value that the rupee represents (we have no gold standard, or any other acceptable equivalent) and the assigning of a notional value to a digital rupee whose issue, transfer and control will be entirely electronic. When viewed against the increasing “liberalisation” (or increasing “reforms”) of the banking, insurance, non-banking finance, financial services, small credit industries that has taken place in the last two years, and especially the opening up of these new services to foreign direct investment (FDI), the picture of the cashless economy so strenuously advocated by Finance Minister Arun Jaitley.
Consider this gleeful reaction from what is called the fintech sector (we had IT, BT and there’s FT): “We might grow 10x when it comes to digital payments. Today, three to five percent of the transactions happen digitally, but we will see a 10x growth to almost 15–20% when it comes to digital transactions in the country. This is huge and this rise in digital transactions will lead to a digital exhaust where better credit risk scoring will happen, catapulting into exponential growth.”
This is the very troubling new landscape that the demonetisation decision – taken with the good reason of weeding out a black economy – has brought the rupee into.