Demonetisation 2.0

It has become manifestly clear that it is a political move without an economic rationale.

Written by Ashutosh Varshney | Updated: February 2, 2017 10:22 am
demonetisation, demonetisation move, modi government, modi demonetisation, narendra modi, BJP govt, indian economy, indian express editorial page, latest news, indian express It can be bluntly stated that Prime Minister Narendra Modi’s withdrawal of 86 per cent of the nation’s currency had no economic rationale.

My last column (IE, January 3, 2017) was on demonetisation. After spending three more weeks in India, the politics and economics of demonetisation have become clearer. It can be bluntly stated that Prime Minister Narendra Modi’s withdrawal of 86 per cent of the nation’s currency had no economic rationale. The motivations were entirely political.

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Economic theory and comparative historical experience point to three reasons that might provide legitimate justification for demonetisation. The first is hyper-inflation. In the second half of the 20th century, some Latin American and African countries experienced exorbitantly high inflation rates. If the inflation rate is, let us say, 15,000 per cent, the value of the currency changes virtually every day, if not every hour; people don’t wish to hold on to domestic notes; and the monetary function of the currency begins to collapse. Demonetisation, under such circumstances, is a way out of the economic crisis. Second, if a substantial part of the currency is counterfeit, it makes sense to demonetise. It restores integrity to the monetary system. Third, rarely used in routine transactions of citizenry, high-value notes primarily help the operations of smugglers and criminals. As an attack on organised crime, such high-denomination notes can be decommissioned without hurting law-abiding citizens.

None of these conditions obtained in India on November 8. India’s inflation rate is low; the estimated size of counterfeit currency is small; and the crime-fighting purpose of large-value notes was undermined by the issuance of new Rs 2,000 notes. Moreover, if only an estimated 6-8 per cent of the black economy was in cash, it is unclear how an overnight decommissioning of high-value notes meaningfully attacked the problem of corruption.

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Finally, and this has not been adequately noted, economic policy in all democracies is debated in terms of costs and benefits, not in terms of loyalty and disloyalty to the nation. Historically, only Communist (or authoritarian) polities have tended to link economic policy with loyalty to the nation or polity, as Stalin did in the Soviet Union during the First Plan (1928-32) or Mao in China during the Great Leap Forward (1958-61). In democracies, a cost-benefit calculus is used for economic reasoning; the loyalty-disloyalty binary is deployed in times of war. Modi chose the latter narrative. Economic policy is not war.

All analytical roads thus lead to political motivations as the primary, or only, rationale for why Modi undertook demonetisation. Modi is an intense political being. Gujarat’s economic progress gave people the impression that he knew economics well. But it is worth reconsidering that conventional wisdom. In May 2014, in his last election campaign speech in Varanasi, I heard him say that for balanced development (santulit vikas), he would turn the Indian economy into “1/3 agriculture, 1/3 industry, and 1/3 services”. He repeated the same argument in another speech I heard after his 2014 election victory.

Agriculture now constitutes only 12-13 per cent of India’s GDP. There is no branch of economics which argues that economic development calls for increasing the share of agriculture in the economy, let alone nearly tripling it. If anything, economic progress requires reducing the share of agriculture in a growing economy, and creating jobs for the rural folk in non-agricultural sectors. No society has ever helped its villages by keeping people tied to agriculture. Getting one-third of the GDP from agriculture is a sign of poverty, not prosperity.

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These incidents betray the paradox that even if Modi wishes to lift India economically (which he undoubtedly does), he does not always think economically. Economic policy for him is, more often than not, a political tool. Most political leaders are, of course, non-economists. But for economic policy, the advice of economists is always sought, though politicians normally reserve the right to pick among the alternatives offered. Never, perhaps, since Independence has India’s political leadership reduced economists to such awful irrelevance. Their job now is to provide ex-post justifications for demonetisation, or deal with its consequences in the best possible way.

What, then, are the political motivations underlying demonetisation? Unfortunately, Modi rarely allows interviews, nor does he give press conferences. In democracies, these are the routine forums for asking leaders questions about policies. Nor was demonetisation issued as an ordinance. Had that been done, there would have been a debate in parliament, or the ordinance would have lapsed in six months. We only have declarations by the prime minister, no direct questioning yet.

Only Mrs Gandhi’s bank nationalisation is a policy parallel, as has been widely noted. All of Nehru’s economic policies were debated in parliament or in party forums. Significantly, even Nehru’s plan to collectivise agriculture, which would have radically shaken the Indian countryside, was discussed — and defeated — in a Congress party forum in the mid-1950s. Nehru accepted policy defeat at the hands of Charan Singh.

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The probe into political motivations can thus only be presented as a set of hypotheses, listed below. No single hypothesis may suffice. It may be that a combination of these motivations were at play.

First, Modi needs to win the Uttar Pradesh elections. The data collected by the Association of Democratic Reforms makes it clear that compared to the BJP, the election funding of the BJP’s two main rivals, the SP and BSP, depends much more on unaccounted money. Sixty-five per cent of the BJP’s income comes from unknown sources, whereas that figure is 83 per cent for the SP and 100 per cent for the BSP. Demonetisation was aimed at hurting adversaries disproportionately.

Second, though he remains popular, Modi needs a new grand narrative to re-energise his political prospects. Swachch Bharat (clean up India) is not working; achche din (good days) haven’t yet arrived; digital India and smart cities can’t win elections. Attacking black money, a promise made in the 2014 campaign, could in principle provide a new narrative to fire up upcoming campaigns.

Third, Modi wishes to reduce the BJP’s dependence on the RSS, which remains obsessed with old ideas of Hindu revival. The turning point was the cow protection campaign, which Modi vehemently criticised, but the RSS did not disown. Religion and culture fuel the organisational energy of the RSS, not economic policy.

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Who knows which of these hypotheses constitutes the true motivations? But it is manifestly clear that demonetisation, a giant economic policy move, was politically driven.

The writer is director, Centre for Contemporary South Asia, Sol Goldman Professor of International Studies and the Social Sciences, Watson Institute for International and Public Affairs, Brown University

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First Published on: February 1, 2017 12:05 am
  1. H
    Hemant Kumar
    Feb 1, 2017 at 10:07 am
    Read Mr. Modi's interview to India Today for factual information rather than this discredited newspaper.
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    1. C
      Chetan
      Feb 1, 2017 at 10:10 am
      Ashutosh Varshney, thanks god that you are not in India. Good riddance to bad rubbish.lt;br/gt;The so called economist great brains, you guys fail to understand the social and morale value system of this country which is thorogly corrupt, so such shots or jabs are needed to a) give psychological shocks and 2) importantly the rich data on tax evaders that govt could collect lt;br/gt;Don't try to show off your Intellectual bankrutcy thinking you know everything about economics......
      Reply
      1. H
        Haradhan Mandal
        Feb 1, 2017 at 6:56 am
        About 66% of BJP as compared to 83% for SP and 100% of BSP money/donation that are in CASH.lt;br/gt;If this(%age) is to show that BJP is relatively CLEAN - and SP and specially BSP are thoroughly CORRUPT, that is misusing statistics to prove your favorite point. It should have given the ABSOLUTE figures of donations (in CASH form).
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          Haradhan Mandal
          Feb 1, 2017 at 6:12 am
          Author needlessly made some insinuating reference to Stalin and Mao (and Indira and Bank Nationalization) - probably to protect himself from being labelled as "one more Leftist, JNU and Anti-national". Living (and teaching) in America , it is impossible not to know about F D Roosevelt, "great depression and its calamity" and the New DEAL program to LIFT millions of Americans out of poverty.
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            Haradhan Mandal
            Feb 1, 2017 at 7:52 am
            No that is not my point. I asked for absolute figure. In absolute terms - BJP gets 10-15 times (my guess) more (in cash) than the combined figure of SP,BSP (in cash). BJP also enjoys support (and blessing) of many sister/front and background(non political ?!) organizations - who spend money/time/effort for BJP - and that does not show/come under as donations. Even Congress do not enjoy that.
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            1. H
              Haradhan Mandal
              Feb 1, 2017 at 4:31 am
              OFF COURSE - It's aim was political - the G battle of UP election. (It took such a long time for such an article to come! ) . Modi strategist patted on their back for coming up with such a clever and smart strategy. It had no rationale - it only needed PRETENSIONS and pretentious patriotism. And it had plenty. lt;br/gt;If the AIM was genuine and sincere - it would have attacked the ROOT of the CORRUPTION that KEEPS generating BLACK money. "To fight against BLACK MONEY", it PROCLAIMS to use the same weapon (the GOVT machinery ) that oils, preserves protects the same CORRUPT system , the GOVT officers - BUSINESSMAN -politician -broker-middlemen nexus in place, . What more pretentious it can be. NO to talk of what action it has taken for (now INFAMOUS) LOKAPAL BILL, Independent CBI and CVC HUGE 6-7 lakh Crore NPA..
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              1. M
                Maz
                Feb 1, 2017 at 2:00 am
                Wow what an answer and what a narrative ..U r filled with hatred against a specific community. Good very good ..So require some motive to live for and that's hatred ...keep it up
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                  PCKULKARNI
                  Feb 1, 2017 at 6:41 am
                  Because Indian people are tolernt. Bhakts like you will get the answer in Punjab and UP elections
                  Reply
                  1. P
                    PCKULKARNI
                    Feb 1, 2017 at 6:43 am
                    Do you read any newspapers?
                    Reply
                    1. P
                      PCKULKARNI
                      Feb 1, 2017 at 5:07 am
                      Excellent article. Realistic analysis of all aspects of demonetisation.Govt survey itself shows FY 17 GDP to be 6.5 and FY 18 GDP between 6.75 and 7.5. Even the higher figure is less thsn FY16 GDP. Thus pain from demonetisation is real but gain imaginary
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                      1. R
                        Rajat
                        Feb 1, 2017 at 5:47 am
                        "All of Nehru’s economic policies were debated in parliament or in party forums"lt;br/gt;lt;br/gt;Joke. Planning Commission came up with Executive resolution. Debate in party forums is not balanced, and inclusive, as it is limited only to party/ideological circles. lt;br/gt;lt;br/gt;Another article which has to criticize for the sake of criticism. Read quarterly return figures of listed companies, 58% companies show improvement in earnings.
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                          Rajat
                          Feb 1, 2017 at 6:09 am
                          Anyway, my comment was in the context that there was rhetoric that GDP will fall by 2% points, companies will go bust, nothing like that happened.
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                          1. R
                            Rajat
                            Feb 1, 2017 at 6:11 am
                            Kejri, mamata tried to incite people but failed badly.
                            Reply
                            1. R
                              Rajat
                              Feb 1, 2017 at 6:11 am
                              No doubt it was hard for people, but no one resisted.
                              Reply
                              1. R
                                Rajat
                                Feb 1, 2017 at 6:10 am
                                People have largely supported the move.
                                Reply
                                1. R
                                  Rajat
                                  Feb 1, 2017 at 6:09 am
                                  Several years? Show data, not your own om musings.
                                  Reply
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                                    Ritesh
                                    Feb 2, 2017 at 3:54 am
                                    Your analysis seems week and lacked depth, infact your entire article seems politically motivated, who is mr Varshaney? Does anyone know?
                                    Reply
                                    1. S
                                      SubbuI
                                      Feb 1, 2017 at 6:41 pm
                                      STILL THEC SLY POLITICAL TURNCOAT NITISH KUMAR YET TO GIVE HIS FINAL VERDICT ON DEMONETISATION OF NALAYAK NMODI. HE PROMISED AS JD(U) PRESEDENT THAT ON 21st JANUARY HE ON BEHALF OF HIS PARTY WILL GIVE THHEIR VERDICT.BUT IT IS NOW IST FEBRUARY. Why NITISH KUMAR IS SILENT. OR HE HAS CHANGED HIS MIND. You can't trust this political wizards. lt;br/gt;WHY INDIAN EXPRESS IS NOT ASKING NITISH KUMAR? SOME THING IS FISHY
                                      Reply
                                      1. S
                                        SubbuI
                                        Feb 1, 2017 at 6:55 am
                                        DEMONETISATION 2016-TOTAL FAILURE. NALAYAK NMODI HASTY DECEISION ON INDIAN ECONOMICS IS BER AND UNFORGIVABLE.WHEN HE IS OUT OF POWER IN 2019. HE MUST BE JAILED FOR FULL LIFE FOR THE DEATH OF 108 POOR AND OLD INDIAND DIED IN BANK/ATM QUE STANDING UPTO 48 HOURS FOR THEIR HARD EARNED MONEY. JUSTICE MUST BE DONE FIR THESE POOR SOULSlt;br/gt;P.S:- It is 1st Feb today. Hallo. what about NITISH KUMAR'S Final vertiict on NALAYAK NMODI'S DEMONETISATION which he was suppose to reveal on 21st January
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                                        1. K
                                          K SHESHU
                                          Feb 1, 2017 at 2:11 pm
                                          The failure of demonetisation is obvious ..now they are trying to defend a lost cause
                                          Reply
                                          1. Z
                                            Zaki
                                            Feb 1, 2017 at 11:44 am
                                            Uncle Tom, please read Arun's rationale about the tax base, in the IE, but hey don't let the facts get in he way
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