One year ago today, Indian Prime Minister Narendra Modi suddenly announced that 500-rupee and 1000-rupee currency notes were no longer legal tender. Over 1.2 billion people had until December 31 to swap/deposit their old notes at the banks. “demonetisation” led to pandemonium. Over 100 citizens died on queue, waiting for their own money.
It is a measure of demonetisation’s success that Modi’s predecessor, the taciturn, scholarly and globally-regarded Dr Manmohan Singh, on the anniversary’s eve went to Gujarat and gave Modi a dressing down for his ill-advised and “disastrous” move. It must have rankled Modi because one, Gujarat is his home state and it is in the midst of a state legislature election that has surprisingly put Modi in a panic; and two, because Dr Singh rarely puts up a political attack, it is all the more effective when he does.
Till date, no one knows the economic reason for undertaking this massive disruption. Demonetisation’s aims kept changing: to tackle the parallel economy by hitting directly at “black money”; to hasten digitisation of the economy; to foil counterfeiting; to hit at financing of separatism, Islamist terrorism and left-wing extremism; and to fight corruption.
Demonetisation is not a novel concept. Harvard University (and ex-IMF) economist Ken Rogoff suggested it in his 2016 book ‘The Curse of Cash’. His prescription was gradual: the US would first cease printing the 100-dollar bill, then the 50-dollar bill, and finally the 20-dollar bill. The notes in circulation would still be legal tender, so the process would take several years.
Modi, who has publicly derided Harvard economists (though his aim was at ideological opponent and Nobel laureate Amartya Sen), did not follow Rogoff’s advice. It is in character, for Modi likes big gestures, like the September 2016 “surgical strike” on terrorist camps across the Line of Control in Kashmir. Whether or not these gestures make significant gains is questionable; they did certainly enhance Modi’s image as a strong leader. Yet too much theatrics can also backfire.
Today, the currency-value in circulation is 85 per cent of what it was a year ago; about 99 per cent of the money returned, so either people laundered their money (in collusion with banks) or black wealth is mostly held in real estate, gold, and tax havens (the Cayman Islands is immune to demonetisation). After a brief rise, digital transactions have gone down once currency availability stabilised; Indians seem averse to paying transaction charges. Separatism is unaffected, as evidenced by the cold response that former intelligence chief Dineshwar Sharma, the recently-appointed special representative to Jammu and Kashmir, has received during his visit to the state starting Monday. Recovery of fake notes has come down, which implies nothing. Corruption continues.
Worst of all is the GDP decline. As Dr Singh predicted in Parliament, it dropped two percentage points, with the trend to continue for at least the next three-to-four quarters. Dr Singh called the move “organised plunder”. Modi’s supporters say the GDP drop is because black money is being absorbed into the economy; no professional economist has boarded this unscientific wagon. Ironically, the government printed 2000-rupee notes to tide over the cash crisis; no doubt illicit transactions found a new avatar.
So why did Modi do it?
The assembly election in Uttar Pradesh, India’s largest state of over 200 million, in March gave Modi’s Bharatiya Janata Party a two-thirds majority, unique after three decades of coalition governments. The poor endorsed demonetisation because they believed it hit the rich and corrupt.
“Indians still have socialist beliefs,” says a UP businessman, who requested anonymity. “They instinctively look at money as bad, so demonetisation was an attack they welcomed.”
“People endorsed demonetisation because of the wave of nationalism,” says Firdous, a Bangalore-based academic. “Nationalism produces what we call in India a brain-fever. Demonetisation makes no economic sense, yet it was endorsed by people caught up in the nationalistic wave.”
Demonetisation began to backfire once the government switched over to a Goods and Services Tax (GST) on July 1. The GST, which Dr Singh envisioned as a unified and simplified single-tax system was complicated and its implementation clumsy. The government now blames software producers for the resulting chaos (software producers demanded more time from the start, to beta-test the tax forms).
The anger has been visible in Gujarat, among other places. Though the BJP is not expected to lose next month’s election, Congress party vice-president Rahul Gandhi is attracting large crowds at his rallies. Modi has resorted to name-calling against the much younger opposition politician.
“While people supported demonetisation, GST nailed their suspicion that this government does not know economic management,” Firdous says.
“Basically both moves together have hit the semi-urban traders the hardest,” says the UP businessman. “That’s what has hit the BJP’s core base, and made them nervous about the election.”
The finance ministry has given a positive spin to demonetisation, but the final word came from Dr Singh, who advised Modi to “graciously acknowledge” the blunder of demonetisation, and “to stop politicking and seek support from all quarters to help rebuild the economy”. But that’s not Modi’s style.