Fifty years from now, historians could well remember November 8, 2016, or 8/11, more for India’s ‘notebandi’ than Donald Trump’s victory in the American presidential election held on the same day. It is equally possible that India’s forced surrender of high-value notes will by then be no more than a footnote in India’s monetary history, only of interest for Ph. D theses. It is too early to tell, and much depends on the future actions of the Modi government in the remainder of its present term and beyond if re-elected.
An image shared by an American academic comes to mind on this first anniversary of demonetization : Swans glide smoothly on the water, even as they paddle furiously below the surface. Similarly, fast growth in an economy demands continuing churning. Furthermore, the impact of such improvements on measured growth is not immediate and the short-run impact may well be negative, as economic actors cope with uncertainty. For these reasons neither the short-term growth impact nor the proportion of cancelled notes exchanged at the RBI are appropriate measures of the success of demonetisation. It needs to be judged by its impact on productivity growth, through mechanisms that I discuss below.
In all but the most absolute autocracies, the choice and timing of structural reform is inevitably driven by political imperatives. Prime Minister Indira Gandhi’s nationalisation of the banks in 1969, or US president Franklin Delano Roosevelt’s bank holiday as he took office in the US in 1933 are other examples where speed and surprise were seen by the leader to be essential to reinforce the political symbolism of the action.
In the present case the Union government formally acted on the advice of the Reserve Bank of India. However, the tenor of the Prime Minister’s address to the nation left little doubt that he endorsed the RBI’s drastic, indeed draconian action, and the associated political accountability for disruption, failure and success. To me, this whole-hearted embrace by the Prime Minister (where deniability and distance were clearly available to him), is one of the most intriguing aspects of the episode. The Prime Minister’s many critics (including some in his own party) have been quick to dismiss the whole affair as callous, thoughtless, expensive demagoguery with little gained for the massive, even if temporary disruption to economic activity.
I certainly accept that there was a lack of proportion between the objectives cited by the RBI Board — tackling black money, invalidating counterfeit currency and undermining terror-financing — and the measures adopted. But in my view the Prime Minister was chasing bigger game, both economically and politically. Inevitably, the two are intimately linked. Mr Modi’s underlying purpose is to signal a fundamental discontinuity in the prevailing economic ethos.
Since time immemorial currency and coinage have been the most visible symbols of the ruling authority. And unlike many countries in Latin America and Central Europe (where the dollar and the euro are often preferred), no other currency competes with the rupee as a medium of exchange in India. A currency exchange of the magnitude unleashed a year ago was an event that no Indian resident could remain unaware of or ignore.
The Australian diplomat and scholar Ross Garnaut has noted the difficulties, in Australia, China and India, of economic reform being conducted by the same political party that presided over the earlier closed economy. (Japan under the LDP and Mexico under the PRI are other examples of the same phenomenon, though not explicitly cited by Garnaut.) As Mr Modi (and Mr Jaitley) never tire of repeating they are not similarly constrained by the burden of the past.
Mao Zedong sought similar discontinuities with the Great Leap Forward and the Cultural Revolution, so we know that there are potentially huge risks involved. But it is important to note that Mr Modi is not being entirely whimsical. Chief Economist at the IMF, former Reserve Bank Governor Dr Raghuram Rajan had published a co-authored paper questioning whether the Indian economy could reach escape velocity through steady, incremental reform. Even as deep a thinker on development and reform as Albert Hirschman saw development strategy as the creation and management of unbalanced growth.
Through his actions and his speeches Mr Modi has given the country a pretty good idea of the defects that he thinks need to be cured for India to have a chance to achieve its economic and human potential. These include honesty in public and political life, a culture of tax compliance, and a much larger role for modern, formal employment in both manufacturing and services. What is much less clear is how this politically bold but economically costly initial move will propel us in the desired direction.
In his foreword to a recent book on India’s demonetisation, former RBI Governor Y.V. Reddy has noted the remarkable forbearance of the Indian population in dealing with the massive disruptions and inconvenience of the period of currency shortage. Mr Modi has rightly sensed that in a young and restless population there is appetite and desire for change. If the rigours of the last year are seen to have been in vain he has ensured that it is he who will pay the political price.