EconoMatters

How India Copes with Demonetization

What happens when your cash is worthless all of a sudden

Credit: Michael www.flickr.com

Takeaways


  • 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.

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Two weeks into the campaign, new banknotes worth only a tenth of the withdrawn notes have been pumped back into the economy.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.

Wrong target?

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.

A semi-success

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.

(Visited 4,738 time, 11 visit today)

Tags: , , , ,

About Ronald Meinardus

Ronald Meinardus is the Regional Director, South Asia, of the Friedrich Naumann Foundation for Freedom (FNF) in New Delhi. [India]

Responses to “How India Copes with Demonetization”

Archived Comments.

  1. On November 30, 2016 at 6:49 am Rajesh Dokwal responded with... #

    Ronald overlooking another huge benefit. The terror finding is suddenly stopped and there is no more stone throwing in Kashmir. Moreover, all political parties had stashed away hordes of cash for the upcoming state elections. Also to say that the economy will be dragged down to 3.5% is highly exaggerated. It will definitely have a short term dip of about 1% and then things will improve.
    A lot of money will be available for infrastructure and welfare funding.

  2. On December 5, 2016 at 1:02 am Bob of Bonsall responded with... #

    Coming to an economy near you!
    Demonetisation of large denomination currency is a means of forcing people who have “savings under the bed” to place their money in banks where it will become the target for a “savings tax”.

  3. On December 13, 2016 at 3:32 am Aaron responded with... #

    I do know that putting your trust in government is a recipe for financial disaster. The currency collapse in India is not “sporadic”, it is widespread and anyone that is holding gold is laughing. I’m sure Modi has some.

  4. On December 13, 2016 at 3:39 am Aaron responded with... #

    As it stands, money is now dead in India – and a police state is rapidly encroaching. Both at home and abroad the only topic of conversation for Indians is the currency ban. If they are not busy planning how to escape the depredations of the tax authorities (whose minions are rapacious and will insist that people be obsequious and pay them large bribes), people exchange slogans, sound-bites and mere hopes – which seems to be the best India’s irrational society can do. Should this be all people are communicating about? Human beings were destined for higher things in life, not merely for the task of protecting themselves against the State.