The country is in the throes of dealing with the removal of 85 per cent of its currency in circulation. Some laud it because they think it is a necessary pain that has to be endured while others feel it was uncalled for, since it would not serve the purpose it was meant for.
The government gave two reasons for this step, namely, eliminating counterfeit currency used by terrorists and smugglers and the dehoarding of cash held by the generators of large sums of black income.
The chaos all around suggests that the step was announced without preparing for it so as to achieve a degree of surprise and to prevent those with hoards of cash from unloading them. The average citizen who is not involved in black income generation is facing hardship. The government and the banks are not able to deal with such a complex exercise. New currency notes are not available in enough quantity to replace the ones demobilised. The Rs 500 and Rs 1,000 notes constituted 85 per cent of the currency, so 15 per cent of the currency has to serve the task of the whole. Replacing 85 per cent of the currency may take months if not years. The capacity to print notes is limited, especially if the smaller denomination notes need to be printed in large numbers immediately. Reconfiguring ATMs may take long.
While greater use of credit and debit cards will help the better-off to buy from bigger shops and malls where they have card readers, the poor and the lower middle classes without cards would find it difficult to transact. The same problem would also impact smaller businesses who do not have the card readers. The average farmer, daily wage worker, rickshaw driver, may have difficulty transacting their business and also buying their daily necessities. But these could be temporary.
All this may pale into insignificance if the government’s objective is achieved to a major degree. The PM spelt out that black economy is the source of continuing poverty, policy failure and flight of capital. If the black economy is checked, the rate of growth of the economy would rise substantially and help reduce poverty. Terrorism is a source of constant tension for the public. If this is checked, the wasteful expenditure on the huge and growing police forces would decline and more would be available for development. No wonder many in the public are supporting the moves. The point is whether these objectives can be achieved via the demonetisation announced.
Counterfeit currency is used to finance terrorist activities. But each such note can be used only once to finance the activity. It is constantly generated by those financing the terrorist activities. So, extinguishing counterfeit currency one time is not going to stop this activity. Its fresh printing has to be tackled. State actors who were printing such currency could continue to do so. If the old notes could be counterfeited, so can the new ones even if new features are introduced. Terrorism is a continuing activity and not a one-shot matter. It could also be financed with dollars or gold or narcotic drug trafficking, as is often the case.
To check the large and growing black economy in the country, there is need for conceptual clarity about what one is dealing with. Just like from our white incomes we make savings and a part of that is held as cash for daily requirements and for an emergency, out of the black incomes, too, people make savings and hold it in different forms, one of which is cash. Here also, as in the case of the white economy, cash is used in businesses, by shop-keepers, banquet hall owners, jewelers and the like.
Only a small part of the total black savings are held in the form of cash. Why keep it as dead investment and not get any return on it? So, while some may keep tens of crores, especially, those not in business, like corrupt politicians or policemen, most would circulate it in real estate, gold, businesses. From the available data on notes issued and the fact that three per cent of the population generates big black incomes, the average holding of cash may not be more than Rs 1 lakh per person in this group. The government is permitting people to deposit Rs 2.5 lakh without questions being asked. So, most of the black money can be deposited and recycled.
So, the amount of currency that does not come back into the banking system may not be more than a few per cent of the black incomes generated annually. Above all, that is the saving and not the income generated annually. So, the real estate business will go on and there will be under-valuation of properties as before; but, temporarily there may be a lull in sales. Spurious drug production, capitation fees, under and over invoicing in business, would not stop with demonetisation.
But with liquidity sucked out of the system, even if temporarily, money supply generation via banking and credit availability will be a problem. Bankers are also busy dealing with the work associated with demonetisation. The unbanked poor and the informal sector will be hard hit with transactions becoming difficult. With a lot of uncertainty, discretionary expenditures on white goods could decline as would over-all investment in the economy, leading to a further slowdown. Black markets in currency, gold, are likely to emerge and lead to some benefits for the poor but this would be small compared to the harassment.
In brief, all are being put through a roller coaster ride for very uncertain gains, to punish the 3 per cent who generate a lot of the black income and who could be brought to book in other ways which would specifically target them.