This is another country where a bumbling regime thought it could take care of a complex problem with a single stroke, simply by voiding large-denomination banknotes, only to find that the collateral damage caused by the move far outweighs any benefits. The consequences are not quite as dramatic as they have been in Venezuela’s case, but they are quite disruptive and serious, nonetheless. It all began when Prime Minister Narendra Modi last November 8 told the country that – with virtually immediate effect – the two largest existing banknotes, the Rs 500 and Rs 1,000 bills, would stop being legal tender and that holders would have 50 days to convert the old notes into new ones. The purpose, assertedly, was to punish “antisocial and antinational elements,” meaning corrupt officials, tax evaders, counterfeiters and the like, as the measure would make their hidden stash of illicit money “just worthless pieces of paper.”
The problem is that Prime Minister Narendra Modi’s step effectively voided roughly 86% of the country’s paper currency – hardly a negligible thing for an economy in which cash has been representing 98% of all transactions by volume – and that the Reserve Bank of India (RBI) was woefully ill-prepared, having been unable to print replacement banknotes anywhere near fast enough. The regime calls the measure part of a “grand cultural revolution” in a still mostly cash-based society, aiming for a dramatically stepped-up use of modern, cashless payment methods, such as debit cards and what is known as “digital wallets.” Granted, such a transition would make it much easier for officials to track (and tax!!!) transactions. But India does not have the infrastructure it would need to cope with a radical, overnight change of this sort. Its 1.3-billion people hold only about 700 million debit and credit cards, and these have been used mostly to withdraw cash.
Predictably, given all this, the economy has been hit hard. The RBI has been issuing limited amounts of 2,000-rupee notes, and these have proven to be rather illiquid, since the lack of Rs 1,000- and Rs 500 notes makes them extremely difficult to break for change. Many of India’s hundreds of smaller rural cooperative banks are still starved for cash, as are the country’s 93,000 agricultural unions. With this, produce prices have been plummeting. In some rural areas, Indians have been resorting to barter. Small manufacturers, unable to come up with the cash to pay their workers, have instead given them supermarket gift certificates. But many of these enterprises ultimately wound up having to close their doors at least temporarily. Much of the country’s real estate business, which used to be conducted on a cash basis, ground to a halt. Sales of big-ticket items such as cars also dried up. In other words, the short-term results of this unprecedented economic experiment have been harsh. It will probably take months to fully restore the nation’s cash circulation and there is reason for expecting that in the end one or two percentage points have been knocked off annual GDP growth this year.
The last day on which people could still convert money was December 31. An initial assessment suggests that over 14 trillion rupees in old banknotes have been returned out of the Rs 15.5 trillion that were demonetized, which is a lot more than the Rs 10 trillion the Modi administration had expected. To put it differently, the government had thought that thanks to stringent checks for untaxed income trillions of rupees would not come back and that those liabilities could then be written off, at the same time as mountains of illicit cash would turn into rubbish. It did not turn out that way. Either officials vastly overestimated the amounts of illicit cash in the system, or, more to the point, new ways to launder “black” money have been discovered.
This is not to say that the powers that be are at the end of their rope. They have made a number of moves to cushion some of the impact of their measures on poorer workers, given that the ruling Bharatiya Janata Party will have to face several regional elections this year. These include offering higher interest rates to senior citizens, adopting rural housing schemes and providing cheap loans to farmers. The anti-corruption drive will be continued. Its next target will likely be property bought with illicit money and not registered in the name of the true owner. Work will also continue on a plan to replace India’s hodgepodge of local and state taxes with a single Goods and Services Tax (GST), ending the currently widespread problem of goods being held up at state boundaries and turning India into a true single market for the first time. Thought is being given to abolish income tax and replace it with a banking transaction tax that could go a long way in curbing pervasive tax evasion. For now, though, the economy will have to overcome the nasty effects of an ill-considered and badly implemented currency demonetization.