Cash Crunch: Slowdown, more pain ahead, warns Kaushik Basu

According to him, the currency shortage in the country is unlikely to ease any time in the near future.

Written by George Mathew , Priyanka Sahoo | Mumbai | Published: December 10, 2016 1:07 am
demonetisation, cash crunch, kaushika basu, currency ban, no cash, new currency, atm rush, bank rush, black money, indian express news, india news, economy, business The World Bank chief economist Kaushik Basu.

India’s former Chief Economic Advisor and former chief economist of the World Bank, Kaushik Basu has warned the government that the economy would take a turn for the worse next year besides greater suffering for people in the days ahead and of a new form of corruption building up in the wake of the withdrawal of Rs 500 and Rs 1,000 notes.

Basu has been quite critical of the government’s move after it was first announced on November 8, having tweeted that the economics of demonetisation was complex and that the collateral damage was likely to far outstrip its benefits, joining a growing number of those who have slammed the government’s decision, including former Prime Minister Manmohan Singh.

According to him, the currency shortage in the country is unlikely to ease any time in the near future. He said that close to Rs 12 lakh crore has already come into the banking system of the total high value notes in circulation of around Rs 15 lakh crore. However, the RBI has supplied only Rs 4 lakh crore notes. Around Rs 6 lakh crore will be supplied by the end of December 30, leaving a big shortage, he said at the third N R Kamath Colloquium at the Indian Institute of Technology, Bombay. on Friday.

Basu, who was the Chief Economic Advisor of the UPA government during 2009-12 and is currently the C Marks Professor of Inetrnational Studies and Professor of Economics at Cornell University, hit out at the demonetisation drive, saying “it’s a wrong step with design flaws … that needs to be corrected. It’s hurting people which are not the intended target.”

Basu said that there will be deeper second and third round effects of the demonetisation move including an imminent slump in growth of economy. “The RBI said GDP growth will come down from 7.6 percent to 7.1 per cent this year. I think it will be 7 per cent or 6.9 per cent. The next year will be worse as productivity will suffer and agriculture sector will be hit,” he said.

Basu cited the example of the only other precedence of demonetisation in the country in 1978. While it was a ‘small demonetisation’ as only the Rs 1000 notes were demonetised, the following year was when independent India had the worst growth. “In 1979-80, India grew by -5.2 percent… Maybe there was some role to be played by the demonetisation,” said Basu adding that interfering with the law of the market was not good for the economy.

Basu said the support for demonetisation is unlikely to last for a long time once the people undergo sustained hardship over currency shortage and the economy and agriculture faces slowdown. Productivity will suffer and demand for certain things will rise and others will fall, he said. Cautioning the government over the ‘money mules’ who will convert black money into white money for others, Basu said, “a new form of corruption is already building up in the country. People can easily create black money using Rs 2,000 notes. Besides, demonetisation has already spawned a new black market to service people wishing to offload old notes. Large amounts of cash are broken into smaller blocks and deposited by teams of illegal couriers.”

Quoting World Bank and McKinsey reports, Basu said black money is around 20-25 per cent of the country’s GDP and tackling corruption and black money would require changing institutions and mind-sets and formulating suitable policies considering the complexities of the economy and society. Close to 98 per cent of the transactions in the country are by cash, he said, adding, “it could make the old Rs 500 notes legal tender again. The government can use ‘helicopter’ money to inject more funds into the system. It will take some time for the country to get into the digital mode”

Basu said Rs 500 and Rs 1,000 notes form 86.4 per cent of the value of currency in circulation. “To suddenly jam on the brakes on these has to have huge effects on the economy. The first effect observed is people queuing up to exchange money,” Basu said and added that these effects will appear smaller compared to the future effects that the move is bound to have. “Because of this huge jamming [of currency] that has taken place due the demonetisation, the government has to step in everywhere. They are trying to bring new rules, regulations, trying to get into the market. This is interfering with the invisible hand which is the law of the market,” Basu said.

In another example, Basu said that Brazil’s measures to fight corruption following major scandals had side-effects, too and the country was grappling with a current growth rate of -3.2 per cent.

Basu challenged the reasons cited by the government for the demonetisation move. “That the demonetisation will counter India’s problem of fake Indian currency notes was a non-argument,” he said. He said the move will not catch the menace at its root — the source where the counterfeit currency is printed — as the fake currency was already in circulation among people who had nothing to do with the source.
Moreover, the problem will not be wiped out as soon new counterfeit notes of the denomination of Rs 2,000 and Rs 500 will be printed. “For this what you need to do is keep improving the quality of currency notes gradually,” he said.

He thrashed the government’s claim that taking black money out of the system would dampen inflation.

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  1. Devinder Kohli
    Dec 11, 2016 at 2:25 pm
    very good write up from a seasoned acconomist. but our finnancial wizard on helm, will go honky dori..
    1. D
      Dec 11, 2016 at 9:11 am
      IF PEOPLE LIKE TO TRANSACT IN CASH, THEN THE GOVT. SHOULD OBEY, RATHER THAN DICTATE. An arrogant govt. will naturally be rejected.
      1. H
        haridas p
        Dec 10, 2016 at 5:29 am
        It is fast becoming clear,embarringly to say,that this w gargantuan exercise,which appeared sensible initially, is turning out to be search for rat in the labyrinth,too much said and done for too little an outcome and the upsetting and totally unexpected disruption entailed in the financial and business transactions from payment of wages to the purchase of essential medicines and drugs and collection of revenue to the productive employment of one's genuine deposits tells severely of about the lack of planning to meet such everyday crises faced by common people who form majority of the potion.The extant of money laundered or illegal or unaccounted is diminishing each ping day with deposits amounting in the banker's vault.Now visits the banks and ATM have multiplied manifold and everyday review by RBI is fast turning a mockery of and a sad reflection of efforts to tailor make policies to suits whims of '' ac chosen few''. Things are getting streamlined , cashless country...plastic having clear ideas of people's choices and preferences...they are imposed in a Procrustean way and parliamentary discussions are avoided to every possible extant.Opposition is boycotting proceedings and they indirectly salvages government from answering about their utter short shortsightedness..make available shorter denomination noted i sufficient quanies...savings bank accounts are being opened in record breaking numbers that now banks are turning away or discouraging opening ry accounts citing lack of sufficient manpower and infrastructure....most are zero balance accounts,you must ''appreciate''...sirs..
        1. M
          Dec 10, 2016 at 1:25 pm
          Akilesh yadav has cot a new friend Mr.Basu,both believe black is a must for India's growth.
          1. R
            Ramesh Nittoor
            Dec 10, 2016 at 2:58 am
            tackling corruption and black money would require changing insutions and mind-sets and formulating suitable policies considering the complexities of the economy and society. ------- At personal level Prof Basu is comitted to probity and aboveboardness, this context creates a strong reason why his sattvik voice be heard seriously and acted upon. Unless followup measures he has outlined above are in put in place, the economic outlook is certain to turn grim. Given the reality long term threats Sino-Pak axis poses, success of this transformation effort, and meeting the expectation of the aspiring poce, is the only way for Indian democracy to counter it.
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