The carrot is no longer dangling. PM Modi has taken us all by surprise by wielding the stick. It seems like he had been waiting to make this sharp move since he took office. The repeated admonishing of the government for not walking the talk on black money was certainly pulling the government down, but it now looks like business will not be usual. The PM’s risk appetite is at its peak.
The announcement to demonetise is fraught with risks, but looking back over the last year, it is clear that this has been carefully thought through by the government. With programmes such as Jan Dhan to universalise bank accounts, use of Aadhaar in transactions, and the push towards a cashless economy with the JAM ecosystem — it is clear that the government sought to build capacity in the economy to absorb such a demonetisation. Coupled with the amnesty scheme to allow space for individuals to change tack, the hammer has finally fallen.
Indeed, whatever be the many arguments in support of this move, the primary objective is clearly to curb black money. In July 2010, the World Bank estimated the size of the shadow economy for India at 20.7% of its GDP in 1999. In 2007, that went up to 23.7% of our GDP. The politics aside, the announcement makes considerable economic sense since the above large estimates make for discouraging outcomes. After all, a parallel shadow economy denies the government of legitimate revenues which can otherwise be directed towards development activities. But more importantly, the excess unaccounted money generates inflation which adversely affects the lesser well off, creating distortions in markets like real estate. It is no wonder that the use of policy instruments by the RBI to check inflation takes time since monetary transmission is slow, indicating pressures that are difficult to capture due to the shadow economy.
So how does this move curb black money? Is this a one-time measure that will eliminate unaccounted wealth, or another step to reduce black money? What stops the new currency notes being introduced to be used for activities that it hopes to prevent – nexus of corruption, black money and terrorism?
One of the first effects that one will witness is the quicker identification of disproportionate assets in the process of exchange of old to new denominations. With the government ensuring these transactions are done with valid proof of identity and extant Know Your Customer (KYC) norms, those with unaccounted currency stashed will be comprised if they want to salvage their old denominations.
The squeeze is considerable; according to the Livemint we are looking at a little over 80% of the cash in India (by value) that has become a worthless piece of paper. Indeed even an honest citizen would attest to its inconvenience, imagine the position of a dishonest individual. More so, the economics of a large number of industries in India that thrive on black money will face the music. Of course, this is not to suggest that money launderers cannot find a way around this.
Second, this perhaps is the most definite way to get rid of counterfeit currency from the economy. One is given to understand that large amounts of fake currency with large denominations are used to fund terrorist activities. Pakistan has been a prime suspect for cross-border inflow of fake Indian currency. The new large denominations will boast higher security features, taking time to replicate and incorporate, from the point of view of a terrorist organisation. In a smaller measure, two years ago the RBI had announced that it was decommissioning all currency notes from circulation issued prior to 2005.
Third, this announcement gives push towards a cashless economy. By making large denominations scarce (demonetisation and regulating new issuance of Rs 2000 notes), or placing withdrawal/exchange limits, will together increase the cost of holding cash. This could be in the form of both, a) an inconvenience (difficult to get change post transaction, or alternative greater payments ecosystem), or b) security (risky to carry large notes, or alternatively more secure payment options). Naturally this would result in enhanced monitoring of financial transactions potentially involving black money.
Complimented with the government’s schemes like the Jan Dhan-Aadhaar-Mobile (JAM) ecosystem, and the Universal Payments Interface (UPI), the demonetisation announcement could move a large set of the population to the cashless economy after the initial hick ups of migration. Those of us already comfortable using electronic cards, or mobile wallets, would be the first to move. Fintech companies will move towards augmenting the range of services and the customer experience they offer. Looking ahead, the nudge towards a more cashless society is inevitable.
However, even a calculated move has loose ends that will show only with time. Apart from the initial inescapable panic across, the working section of society – small businesses owners, domestic helps, drivers, cooks, and informal sector workers, etc – those that rely on cash payments will be deeply impacted. Fortunately the co-ordinated announcements from PM Modi, Finance Ministry and the RBI, coupled with a number of exceptions, give the reassurance that the transition is being executed carefully.
On an individual level, we too can play a responsible part in this transition. In this really exciting/anxious time in our monetary history, let’s take a moment to educate or possibly help out our domestic help, cook or driver; so that they too are prepared for the changes that have gone in to effect. Especially when they are the most vulnerable to sharp changes in their cash flows, or worse, ponzi schemes. A smooth transition perhaps seems premature with the current squeeze, but given time the benefits would outweigh the costs.
(The author is a policy analyst. Follow on Twitter @rohitrrs)
