4 disastrous effects of demonetisation that Modi ignored


In spite of several inefficiencies, fortunately, India never witnessed a bank-run or monetary crisis parallel to the scale in Europe or America. However, the chaos and long queues that engulfed banks across India now perfectly mirror the plight the Greeks faced last year, albeit for different reasons.

Demonetisation is a rudimentary monetary instrument of the pre-digital era used only in case of extreme financial exigencies to control income, consumption and usage of currency. Authorities avoid taking such drastic monetary steps because demonetisation puts the whole economy and society under a great deal of inconvenience.

As we dig deeper, demonetisation not only appears to be an enormous logistical challenge for the Reserve Bank of India, government and the banking system, but also inflicts huge collateral damage on the economy, struggling to gain momentum.

Financial events always come along with unintended consequences; and we cannot afford to ignore them.

1. Crushed consumption

Demonetisation has damaged India’s consumption growth story, for the time being. India turned into a shining economy amid global slowdown only thanks to burgeoning consumption in the country, but the recent currency ban has now sucked Rs 14 lakh crore from the system and thus self-engineered a recession of unexpected consequences.

Currency printing and distribution is a slow and technical process. RBI has limited capacity to print currency and depends heavily on imports for technology and material related to security features of notes. In fact, no central banker in the world can exchange currency to the tune of Rs 14 lakh crore overnight, which has been printed and circulated over the last many years. Consequently, India’s consumption is likely to stay reduced to the level of subsistence buying for a longer than anticipated time.

Demonetisation generally dampens consumption spirit and pushes people towards safer bets like gold. Incidentally, as much as 25 tonne of gold was reportedly bought in the last four days. The real productive consumption may take months to come back to normalcy.

2. Questionable curbs

The demonetisation strategy apparently goes against the ethics of currency management in economies running smoothly. Currency is legal tender, which promises full realisation of its value to the carrier. Currency cannot be put under conditional transactions i.e. being allowed for medicine but not for food.

As the RBI, not government, is primarily responsible for money supply and management of currency in circulation, the politically enforced decision to demonetise currency has come across as an impingement upon the RBI’s sovereignty.

No central banker in the world approves of demonetisation in normal circumstances as currencies have become the most sensitive instrument in an integrated global economy. Currency curbs suggest financial calamity and badly hit credibility of host currencies.

India is well exposed to global financial markets and demonetisation has definitely not augured well for the credibility of the rupee against global currencies.

3. Bold shot but in dark

Demonetisation is not the boldest move against black money, but a bold shot in the dark having collateral damage on law abiders. The revenue administration was expected to burn the midnight oil in analysing annual information returns with the help of technology for cracking the whip on tax cheaters, while lawmakers were expected to plug loopholes of co-operating, accounting, political funding and tax laws to effectively tackle the problem. However, the government chose to suffocate the house to eject murky mice.

4. Black sheep

The effectiveness of demonetisation against the black economy is always debatable as the measure does not hit the root causes of generation of black money and is largely limited to inflicting penalties on those who hold their black wealth in the form of cash at the moment of demonetisation.

As there exist avenues for converting high-value notes into lower denominations at discount or hiding cash into business books through intermediaries, it disturbs only temporarily the black economy and gives a chance to stakeholders to be on guard in the future.

Way back in 1989, National Institute of Public Finance and Policy (NIPFP) concluded, in a working paper titled ‘Aggregate Demand with Parallel Markets’ that “demonetisation curbs the white economy and will also curb the black economy in a credit constrained regime”.

We are witnessing unequivocal harsh curbs on the white economy while its impact on the black economy still remains a subject of claims and estimates.

The economy has now come to a standstill just because demonetisation is too harsh an instrument to be used as a disruptor, particularly in cash-driven economies.

The damage is already done and recovery may be long and painful.

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