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On November 8th, 2016, 4 hours short of midnight, Prime Minister Narendra Modi announced the demonetization of Rs.500 and Rs.1000 notes, making these notes invalid in a major “surgical strike” on black money, fake currency and corruption.  The timing was perfect: a month after the income tax disclosure scheme, a week after Diwali and post the day’s banking hours- it gave black money hoarders, in the literal sense, a run for their money. As hoarders struggled to get their black money off their hands before the clock struck twelve, the average Indian flocked to his nearest ATM to exchange the notes in his wallet and withdraw money to meet his day-to-day expenses. While this landmark mark step may be indelible progress given our history of feeble attempts at jostling the nexus of corruption, it  isn’t the first time that the government has revoked notes of high denominations. Our economy witnessed the “death” of banknotes- the 1000, 5000 and 10000 rupee notes- for the first time in 1946, a year and a half away from freedom and then a third of a century later in 1978. The Janata Party coalition government under the lead of the Gandhian moralist Morarji Desai cancelled these notes for the second time (after they were brought back to life in 1954) in response to publicly-made recommendations of the Wancho Committee to demonetize as a measure to “unearth and counter the spread of black money”. Apart from the home state of the Prime Ministers and the last name of the governors, the “currency wapsi” policies of 1978 and 2016 have little in common. In 1978, the notes that were stripped of their legality made up no more than 1% of the total cash in the economy while those that were banned on November 8th are worth 86% of the total cash in the system.Unlike the Rs.500 and Rs.1000 notes of today, notes of high face values were barely in circulation back then and the overt nature of the Wancho Committee’s “publicly made” recommendations (which sparked black money hoarders to act fast and rid themselves of high denominations before the government was able to clamp down on them) combined with the sheer lack of technology put the scheme in jeopardy and defeated the very object of demonetization. Not only did it fail to curb black money, it also led to a spectacular rise in gold smuggling as people simply shifted to hoarding their undeclared cash in bullion and besides, if the demonetisation of 1978 did manage to weed out corruption, would we still be “going through the trauma” of another one just 38 years later?

While the new and improved version of the 1978 demonetisation-underpinned by digitalization and bolstered by deft execution-does have an edge over its predecessor, it is impossible to overlook its immediate flaws in spite of the promising long-term gains.  This policy can knock down cash heavy sectors such as the real estate and jewellery sectors which have proportionately high cash transactions and are preferred investment areas for those holding black money. These sectors will face severe liquidity issues and will not be able to meet their short-term obligations. In the real estate sector, for instance, the high cash component is the main source of working capital for builders and due to fall in demand from customers who pay in cash, builders are forced to reduce real estate prices going forward. This, coupled with improved liquidity of banks following demonetisation could mean affordable housing for masses in the long run. The worst-off in the short run are these very masses: the use of debit cards is not a regular stunt for many living in the city and remains a distant dream for those residing in semi-urban and urban areas. Most stores do not provide payment-through-card services and the ones that do are not within the reach of the lower classes. The demand for cash is hence always high while the supply has contracted leading to a cash crunch, slowing down consumer spending.  Scores of frustrated people are queuing up outside banks and the crowd continues to swell by the hour. Banks are struggling to swap demonetised notes. The anger is only intensifying and chaos continues to reign. In a nation of 1.2 billion people and just 1.5 lakh banks (which gives around 8000 people per bank, ignoring the disparities in financial infrastructure), pandemonium is inevitable and the inconveniences that the people face right now are worthwhile for long-term benefits. Meanwhile, on the other side of the doors, banks face their worst nightmare as they are over-burdened with the herculean task of managing cash replacements and deposits while simultaneously ensuring that they don’t buckle under pressure. The only real beneficiaries seem to be mobile wallets which have seen a surge not only in transaction value but also in the number of new users and app downloads over the past few days, because of the cash shortage.

Serpentine queues and ecstatic fintech companies aside, one thing remains rigid and that is the human attitude. “To see others suffer does one good, to make others suffer-even more”: much to the sadistic pleasure of the common man, burre din have finally dawned in the underground for those who have stored their ill-gotten wealth in the now useless Rs.500 and Rs.1000 denomination notes. Over the next few months, those with legitimate money will safely deposit their money in banks while those who possess unaccounted cash will be in for a rough ride. Firstly, they may try to launder their illegally-gained proceeds at the stake of prosecution from the authorities and bring it into the economy. The tax loss that arises from black money is a sunk cost and the government will have to bear its brunt whether or not it enters into circulation. They can also choose to come clean by openly declaring their under the table cash and get slapped with a tax plus penalty of 90% which will flow into the government’s pockets and relieve its strained exchequer. The most unfeasible strategy for these hoarders will be to not budge and let their notes expire worthless: neither depositing these notes in the bank nor converting them into clean money. The “I promise to pay the bearer a sum of XYZ rupees” on note indicates that every currency of every denomination is the liability of the RBI. When a note becomes worthless, the RBI is no longer obliged to pay it back and a part of its liability is extinguished. Thus, the government seems to be at a considerably advantageous position with respect to illegal-wealth holders after this annulment.

Will the government will retain its streak of luck? Will the economy recuperate from this unanticipated shock? These are questions only time can answer. As the system slowly absorbs and assimilates this reform, there is hope for a multitude of gains in the long term. The lost faith in paper money could theoretically mean a boom for the cashless economy, which for now is a distant prospect. The jewellery industry will thrive as people place more trust on jewellery than on cash. This turn towards gold could reverse the government’s previous effects to increase investments in financial markets rather than park their savings in the form of a dead asset which contributes little to the economy. Bank’s deposit base will receive a fillip of around 0.5-1.4 per cent of GDP and financial savings are also expected to rise close to this proportion. Though the Jan Dhan Yojana has recorded stellar growth in the number of accounts over the last two years, the share of these accounts in the total deposit base has remained below 1% and 43% of these accounts remain dormant. The demonetisation drive could give a push to cash deposits and inculcate banking habits among the unbanked. Though the dip in consumer outlay will hit our GDP growth for the next two quarters, the long-term benefits of a higher GDP growth will outweigh the transitional effect. Transactions outside the formal economy will enter the economy itself.

The responsibility of the government begins with the implementation of policy and only ends when the objectives of the policy are duly fulfilled. Though the idea of demonetising has-in a single swipe-cured the economy of the cancerous, malignant forces that plague the system, there are always the chances of a recurrence. The stocks of black money that float around in the country have been taken care of, the government now needs to chart a roadmap to address the issue of flow. All in all, this swacchata abhiyan to clean the economy has given the nation a new lease of life and has re-instilled our faith in the potential and capacity of the government.

By Varsha Reddy.

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