How India Copes with Demonetization
What happens when your cash is worthless all of a sudden
November 28, 2016
The assessments could hardly be more divergent. One side says India’s currency reform is a stroke of genius. It is a surgical strike by Narendra Modi which dries out the morass of the black economy overnight.
Noble intentions perhaps
For the opponents of this reform measure, the sudden invalidation of huge amounts of paper money is a source of pain and misery. It is also a threat to economic growth, in short: a political scandal.
Political controversy is part and parcel of India’s democracy. However, the ongoing commotion triggered by Prime Minister Narendra Modi’s radical currency reform is abnormal – even by Indian standards.
The sudden invalidation of 500 and 1000 Rupee notes (equivalent of $7.3 and $14.6) – bills that account for over 85% of liquidity – is a drastic interference into the lives of every single household.
An “F” for implementation
Irrespective of which side of the debate they are on, most Indians agree with The Times of India (national newspaper) that the implementation of the policy is “a logistical nightmare.”
Two weeks into the campaign, new banknotes worth only a tenth of the withdrawn notes have been pumped back into the economy. That severely shrinks the economy.
Poor are hardest hit
Perhaps surprisingly for observers from outside India, the poor are the hardest hit. They represent the big majority of Indians. They also are a constituency that Mr. Modi and his team usually pay close attention to.
Like most things in India, converting old money into new notes is a bureaucratic process. Applicants need a bank account and a government ID. The catch is very many Indians possess neither.
Poor people belong to the informal sector. They are day laborers and farmworkers and they live hand-to-mouth. In case their meager incomes allow, they hide the savings under the mattress and don’t bring it to the bank. For them, demonetization is a catastrophe.
Bureaucracy vs. livelihoods
Now, they are forced to spend hours, if not days in long queues at banks in the hope to exchange their invalidated money for legal tender. These banks are often far away from their rural homes.
The patience and forbearance of these people are remarkable. One could call them “collateral damage” of an ill-conceived policy. They are simply too poor to make a difference to the political operators.
The main target of the devaluation of the rupee bills are the tax evaders and the many others who prosper in India’s rampant shadow economy – the rich and the super-rich who over the years have channeled billions past the tax authorities.
It’s a gigantic grey zone. For obvious reasons, no one knows the exact dimensions. Estimates put the black economy at between 20 and 66% of India’s national economy.
Not surprisingly, the main criticism of Modi’s measure is that it targets the wrong people. Surely, the real “black sheep” – i.e., the tax evaders — don’t hoard their illicit wealth in bundles of bank notes in the basements of their luxurious mansions.
These people promptly invest whatever liquid funds they get a hold of in property, foreign currency and gold.
The ebbing of the flow of illicit cash has hit India’s building and property sectors. The construction sector is one major area in which black money manifests itself especially strongly.
Before Modi’s shock announcement, the construction industry was a driving force of the economic boom. It also provided many jobs to day laborers and the many poor.
Rooting out all evil?
Demonetization has dried up the flow of construction projects. This, in turn, now threatens the overall performance of Asia’s third-largest economy.
One projection predicts GDP growth may be dragged down to 3.5 % in the current financial year, less than half the previous year’s 7.5 %.
Obviously, this is not what Prime Minister Narendra Modi who thinks of himself as the champion of development has envisioned.
The few opinion polls published indicate a vast majority of Indians is willing to take up the inconveniences for battling the black economy.
A reform that backfires completely?
The opposition rejects this and argues the suffering of the masses will do little to root out corruption and tax evasion.
Meanwhile, Narendra Modi is determined to continue on his path. Amid rising criticism from all sides, he told party leaders the partial note ban was “just the beginning and not the end” of a long battle.
A new nation? Or a leader lost?
“In the new year, there will be a new nation,” Mr. Modi said and added: “The whole nation is with me.” For a growing number of opponents, words like these show the prime minister has lost touch with reality and with the political mood on the ground.
Only weeks away from Assembly elections in important states such as Punjab and Uttar Pradesh, the timing of the controversy is very fortunate or unfortunate, depending on one’s party preferences in Indian politics.
2019 and the future of India
The upcoming electoral battles will predetermine India’s political landscape in the run up to the national polls 2019.
Just like a good Bollywood movie, this drama too will find a clear ending: The people will speak. Then, at the latest, we will know whether Modi is asking too much of the Indian people with his slap-bang reform – or whether they choose to go along his uncharted and chaotic path.
The sudden invalidation of 500 and 1000 Rupee notes is a drastic interference into the lives of every single household.
Converting old money into new notes needs applicants to have a bank account and a government ID. Many Indians possess neither.
The main target of the devaluation of the rupee bills are all those who prosper in India’s rampant shadow economy.
According to Modi, this partial note ban was "just the beginning and not the end" of a long battle.