Could India’s demonetization cause more harm than good?
India is either in the throes of a man-made cash crisis or on the verge of a new economic dawn. Depending on whom you speak to in the days following Prime Minister Narendra Modi’s decision on November 8 to demonetize the Rs 500 and Rs 1,000 notes ($7.5 and $15, respectively), the world’s largest democracy has either taken a crash course towards a cashless economy in the direction of the rest of the developed world—or could simply crash-land in its attempts to imitate it.
To give some perspective of the enormous dependence on cash—and consequently the impending crisis at hand – the two demonetized notes, Rs 500 and Rs 1,000 together, account for 86 per cent of all currency in circulation; over 85 per cent of workers are paid in cash, a reflection of the unorganized nature of the economy, despite 25 years of economic reform; and over 90 per cent of all transactions are conducted in cash.
As the winter session of parliament opened a week after the demonetization decision, the debate unfolded on predictably political lines. Piyush Goyal, minister for power, coal and renewable energy, insisted that “no honest tax-payer would lose a single rupee (and) only those who have amassed wealth through corruption and black money will be affected.” Sitaram Yechury, general secretary of the opposition Communist Party of India (Marxist) pointed out that the prime minister was draining the pond to kill the crocodiles.
Certainly, in the two and a half years he has been in power, Narendra Modi has not been subject to the kind of unified opposition, as he has in these last few days. It will certainly not dislodge him from the premiership because Modi’s ruling Bharatiya Janata Party (BJP) has a majority in the Lok Sabha, or lower house of Parliament, where a vote of no confidence must be passed.
But if he and the party are not able to properly communicate the seriousness of the message backed up by a fully cranked-up banking system, Modi is in serious danger of being shown up as a willful, medieval ruler who issues diktats that subscribe to personal inclination instead of public good.
Across the country, several reactions are playing out in ample measure – an early indication of the fact that the move could either be Modi’s most significant economic reform yet or shave hard-fought gains from the economy, as much as 1 per cent of the $2.3 trillion GDP, over the next year.
If the chaos continues beyond the December 31 deadline that he has imposed upon his own government, the BJP may be in danger of being forced to deal with public unrest. This would bring into question not only Modi’s leadership of the nation, but also India’s self-proclaimed pre-eminence across the developing world.
However, if Modi manages to transmute the short-term pain into a purposeful vision of the future, he will have neutralized an opposition unwilling to look at the bigger picture. Truth is, Modi’s moment of truth is upon him—and the rest of India knows it as well.
Those keen on looking at the glass half full are focusing on the impact of demonetization on the black money market, as well as the counterfeiting of high currency notes commonly used to finance terrorism as well as drug-trafficking. None other than Modi has complimented himself on taking such a brave step. He has insisted that the terror networks in the neighborhood, especially in Pakistan and Afghanistan, have made full use of the 1,898 km-long open border between India and Nepal to infiltrate fake currency into India and thus seek to undermine its economy.
Stories of hawala or money-launderers with bases in Dubai and Mumbai having to burn their notes or tear them up—or more ingeniously, float them down India’s several rivers so they can’t be traced back to them—are being underlined by the BJP as well as pro-government media, who say Modi must be “given a chance” to implement his version of shock therapy.
But those who believe that all therapy must have a human face, have tended to look at stories of Indians who already live on the margins of economic activity and who have been deeply affected by the demonetization move. These include small-time farmers, landless laborers and extra-small and medium enterprises, who (predominantly) only use cash for their business and personal transactions.
For example, even as Members of Parliament in Delhi gathered last week to—angrily—debate Modi’s pathbreaking war against black money, farmers in large parts of the country began to worry about where and whether they would find cash to buy seeds and fertilizer to plant the rabi or winter crop, mostly wheat. This sowing immediately follows the harvesting of the Kharif or summer crop, predominantly paddy, and will take place over the next few weeks. But with cash in such short supply, farmers are finding it difficult to employ laborers who are willing to work on credit.
In largely agrarian north India, which includes states such as Uttar Pradesh and Punjab, going to the polls in a few months, this is usually a frenetic time. Threshers and combine harvesters are in full flow in agriculturally advanced states such as Punjab and Haryana, while Bihar and Uttar Pradesh still count on human hands to thresh the paddy and sow the wheat. Farm experts point out that if the paddy stays on the stalks for longer than a week—which it is feared will happen because of the expected shortage of labor—then it may either rot or significantly depreciate in quality.
As India’s towns and cities are witness to long and angry queues of people fighting to deposit their hard-earned cash in banks, India’s villages are on the brink of a possible crisis that could destabilize the farmer’s carefully-constructed cycle of life—if immediate measures are not taken to stave off the growing risk.
Moreover, bank branches are few and far between in rural India—in fact, India has the fewest ATMs when compared to other emerging economies. According to a 2015 Ernst & Young report, India only had 693 such machines per million population, while China and Russia each had 4,000 terminals and Brazil had a whopping 32,995 terminals.
Moreover, only five banks—the State Bank of India, ICICI, HDFC, Axis and Corporation Bank—account for about 81 per cent of all terminals in the country, pointing to an acute shortage of infrastructure that is needed to serve all Indians, if Modi’s impassioned drive towards plastic currency is to have any meaning.
Modi’s ministers have responded to critics and sceptics by pointing out that the sudden decision to demonetize was necessary as the black money economy was growing by leaps and bounds, especially with terror financiers making use of the 1,898 km-long open border between India and Nepal to push fake currency into the market. The black market is said to account for 20 per cent of India’s GDP.
Officials at Niti Aayog, the government think-tank who spoke on the condition of anonymity, said that Modi had been pushing them for recommendations on how to move towards a cashless economy. “India’s goal is to reach the level of Australia or Japan, which has only 35 per cent or so cash in the economy,” a member of the Digital Payments Committee told Newsweek Middle East.
Certainly, hawala traders are running scared. But with only 6 per cent of “black money” or illegal income in cash—preferred destinations are—jewelry, real estate and chosen foreign currencies such as U.S. dollar or Euros—reports point out that hawala traders are charging as much as 20 per cent commission to exchange old notes for new.
A hawala trader who lives just outside Delhi explained how he continued to maintain the perfect circle, on the condition of anonymity. “Earlier, one of the commonest ways of using illegal income was to put it into jewelry or real estate. But with the banning of high-currency notes, we have had to find trustworthy strangers who are willing to put your money into their accounts. There is a limit of Rs 2.5 lakhs that you can deposit without attracting the notice of the tax authorities. Once you do that, the money can be withdrawn over time so that it doesn’t attract attention,” the hawala trader told Newsweek Middle East.
Perhaps the biggest impact of the demonetization has been on the impending elections in Uttar Pradesh, Punjab and Goa. According to former Chief Election Commissioner S. Y. Qureishi, “Only Rs 28 lakhs is allowed per candidate to contest a state election, but it is India’s worst-kept secret that expenditure is often as much as hundred times this amount,” he told Newsweek Middle East.
Of course, excess money is in cash. The demonetization move has certainly affected the funds of several political parties, whether the mainstream Congress Party or regional parties like the Samajwadi Party and the Bahujan Samaj Party, both of whom are contenders for power in the all-important Uttar Pradesh election. In one fell blow, large parts of their finances have been incinerated.
Surjit Bhalla, political observer and India analyst for the U.S.-based Observatory Group, which specializes in advice on pension and hedge funds, told Newsweek Middle East that Prime Minister Modi’s move to ban high currency notes had the capability of becoming the “biggest bang” for economic reform. But this was on the condition, Bhalla said, that the prime minister quickly follows up with reforms in election financing, property taxation and income taxation.
Pointing to the inherently risky nature of the move, he pointed out that it was necessary to compliment Modi because he had gone against the BJP’s core constituency, which is small traders in cities and towns, who would be hurting the most because of their inability to deal in cash matters. “I hope that Modi will bite the bullet and implement the other reforms as well. Otherwise this big move has the potential of turning from a big bang to a big thud,” Bhalla told Newsweek Middle East.
Certainly, the political opposition is smarting. The Aam Admi Party, which rules Delhi and had huge ambitions in Punjab, as well as West Bengal’s Trinamool Congress, has asked for a rollback. Ghulam Nabi Azad from India’s main opposition party, Congress, told reporters inside and outside Parliament that more people have died because of stress related to the banning of high currency notes than in recent terror strikes. His remarks have since been expunged.
“When BJP doesn’t have an answer to something, they will brand you as a Pakistani or an anti-national, or they will accuse you of comparing the situation to Pakistan. In this way, they are using new methods and trying to shut the voice of the opposition parties,” Azad told reporters.
But Finance Minister Arun Jaitley remains undeterred. “The whole thing is a very well planned and executed exercise. First three days, obviously, there was a rush, but it has significantly come down,” he said, rejecting calls for rolling back the move.
Speaking at an event organized by the TV channel ET Now last week, Jaitley congratulated his government, insisting that the replacement of such large amounts of currency without social unrest was a big achievement.
“When currency replacement takes place, initial inconvenience takes place, but there is not a single major incident in the country. It’s moving smoothly as every day passes by. The queues are getting smaller,” he said.
So as the BJP forges ahead, disregarding political opposition inside Parliament and civil society criticism outside, it is also clear that Modi will lead the BJP into the coming state elections on two main planks. The first is the war against terror that was notably manifested when Indian troops crossed the Line of Control into Pakistan-administered Kashmir in September-end.
By owning up to the strikes, Modi did what no prime minister has done recently, which is to claim the inflicting of a bloody nose against Pakistan. This has certainly improved his standing among the people who seem tired of tall rhetoric and little action displayed by all the major political parties, especially the Congress, on the matter of terrorism.
Modi’s other plank is, clearly, the war against black money, which he has attacked through his demonetization move.
Regardless of whether the citizenry has been put to enormous inconvenience this last fortnight and the country could significantly lose up the economic gains it has chalked up since the BJP came to power in 2014, Modi has defended the move with a missionary zeal.
In fact, BJP President Amit Shah has conflated the two moves, invoking the jargon of war and describing the demonetization as “surgical strikes” against black money.
Meanwhile, several billboards in Uttar Pradesh have been put up, congratulating soldiers for defending the motherland. In a country where the army has always been proudly apolitical, the BJP’s claims have apparently embarrassed the top army brass.
Moreover, a fine line that separates state institutions like the armed forces from politics, may have been crossed with competitive politics being played around important issues like patriotism and nationalism. The BJP has been at the forefront of the charge, seeking to disallow a criticism of the armed forces.
As he celebrates the half-way mark into his first term of being in power, it is clear that Modi has upturned the national landscape. Whether he will be revered or reviled for it, is still a question with no answers. The good old cliché, “Time will tell,” has not been so relevant in such a long time.