Narendra Modi’s Demonetisation Successful in Wrecking India’s Rural Economy

by A.V.V.S.K. Rao

The World is Governed by Three Things—Wisdom, Authority and Appearance.

Wisdom for thoughtful people, Authority for Rough People, and Appearances for the great mass of Superficial people who can look only at the outside.—Raynal, Abbe (1711-1796), French philosopher

The Aggregate Happiness of Society, which is best promoted by the practice of a virtuous policy, is or ought to be the End of all Government. 
—George Washington (1732-1799, First President of USA)

Introduction 

The BJP Government, headed by Prime Minister Narendra Modi, is known for initiating many radical changes. One such change is to make India an unplanned economy turning it into a ‘programmed’ corporate economy. The result is disbanding the prestigious ‘Planning Commission’ which was the brain-child of our first Prime Minister, Jawaharlal Nehru, after extensive consultations with leading experts from different parts of the world. The second is keeping the ‘Lok Pal’ in cold storage. The Supreme Court collegium is totally bypassed with utter disregard to the judiciary. The latest one is demeaning the prestigious and highest monetary authority, the central bank of the country—the Reserve Bank of India. On November 8, 2016 midnight BJP PM Narendra Modi sprang a surprise by announcing the banning of High denomination (Hd) currency notes of Rs 1000 and Rs 500 value.

Many senior Cabinet Ministers, along with other Ministers, were herded into a room and made to listen to the PM Narendra Modi’s announcement of the ‘demonetisation’ decision on television.

The Indian Government’s demonetisation move is startling and even incredible. It is without any doubt a novel experiment of its kind ever. Such a large-scale demonetisation of major currency notes—around 86 per cent of the value of the currency in circulation—has occurred in the past only in extreme hyper-inflationary situations (as in Germany in the 1920s) or in periods of war and civil conflict in which the currency was already debased (as in China after the communist revolution). For the demonetisation measure to be adopted in normal situations, in a period of moderate and low inflation, and generally rapid growth of economic activity was both unexpected and unprecedented.

Rationale

The main planks of the (haphazard) demone-tisation programme, as cited by Narendra Modi, were black money, fake notes in circulation, and curbing terrorism aided by fake currency. The idea was that unaccounted wealth would come out with mandatory depositing of the withdrawn notes. Replacing new currency old Hd notes with new currency would curb the circulation of counterfeit or fake notes enormously and restrain accumulation of black income and as a result slow down terrorism aided by fake notes. The government’s tall claim was it had absolute clarity on the parallel economy and black money.

It has been claimed time and again that Narendra Modi’s decision was intended to create a new economy by changing the expenditure pattern of Indians. It has also been added that frequent use of cash in transactions was mostly favoured by the underground economy.

A window of time was provided till December 30, 2016 to allow those holding the Hd notes to deposit them in their bank accounts. The thinking behind the move was that a large chunk of the Rs 15.44 lakh crores of the two high value bank notes would not be tendered back to the banking system by the ‘holders’ fearing punitive action. It was estimated that (windfall) gains made from the scrapped notes that could not be deposited in banks would be anything between Rs 3 lakh crores and Rs 5 lakh crores, which would be used for social welfare and other projects.

It is claimed that advanced economies, aided by technologies, have gradually moved towards total banking and online transactions by curtailing excess use of cash in day-to-day transactions in the economy.

The government presses at Nasik (in Maharastra) and Dewas (in Madhya Pradesh), were responsible for printing the new 500 rupees notes. However, these presses were unprepared for the task of meeting the huge challenge of replacing 17.16 billion 500 rupee denominations that were wiped out of circulation on the midnight of November 8, 2016. As reports of glaring error in the new Hd notes came in, the government was forced to shift production to the RBI-managed currency printing presses at Mysore (Karnataka) and Salboni (West Bengal).

The accute shortage of currency, especially those of small denominations, was what was being reflected in people queuing up at banks and ATMs across the country. Attention to some of the basic details, such as designing the new currency notes in identical dimensions and thickness as the ones they were replacing, would have prevented India’s 2 lakh plus ATMs from going out of action for at least six weeks.

When 86 per cent of India’s currency, constituting 12.2 per cent of the GDP, is withdrawn from circulation and sought to be replaced by new Hd currency, there would obviously be a significant impact on the economy. It was never expected or estimated that a sudden fall in economic activity on account of the currency squeeze, particularly in rural India, during remonetisation would have long term consequences on the entire economy.

Though the main objectives of demonetisation were elimination of fake currency and the resultant black money, and curbing finances to terrorism, a major shift towards a cashless economy emerged as a necessity. Note ban on a large scale caused a cash crunch in the system and forced the government move towards on-line transfers and digital payment. However, in India, few use non-cash payment methods, only 10-15 per cent of the population is estimated to have ever used any kind of non-cash payment instruments. Given the rate of cyber crime and fake methods of transactions, the digital transactions improved marginally.

Legality

The first demonetisation in independent India was done in the year 1946 and another major one in 1978. At that time currency notes of higher denominative constituted only three per cent of the total currency in circulation. Notes demonetised in 1946 were of the value of Rs 143.97 crores as against the total notes issued of the value of Rs 123,593 crores. Again in 1978, Hd notes of Rs 1000, Rs 5000 and Rs 10,000, which were reintroduced in 1954 after the demonetisation in 1948, were demonetised. The demonetisation of high value currency in 1978 was less than Rs 150 crores. As a result, it caused minimal inconvenience.

In 1978, when Prime Minister Morarji Desai’s government declared high-denomination currency notes as not being legal tender, it did so through an ordinance. The ordinance, and the Act that replaced it—the High Demonetisation Bank notes (Demonetisation) Act, 1978—was described as ‘Demonetisation’. In contrast, the November 8, 2016 announcement embodying Narendra Modi’s dramatic decision and subsequent notifications were devoid of legislative support. The absence of legislative backing meant that the government could not declare illegal the transfer and receipt of these Hd currency notes to all entities or persons other than banks as had been prohibited by the 1978 Act legally. Such a prohibition would have required legislative backing in the form of Ordinance or Acts passed by Parliament.

The government did not consider the infringement of the right to property of those without bank accounts who had discarded currency notes that they had legally acquired but could not exchange within the stipulated deadline. Those who were heavily dependent on cash for their livelihood but not part of the formal banking system, therefore, were likely to suffer the most from the restrictions on the exchange of discarded currency.

To restore normalcy, the GOI came up with different and contradictory measures during the week following the declaration of note ban. As many as 10 modifications were made to the demonetisation scheme’s procedures in a matter of seven days. The amendments to the Income Tax Act, pushed hurridly through Parliament within a month (December 2016), amounted to a concession to tax evaders. This came within two months of expiry of the Amnesty Scheme in September 2016.

Only free people can hold their purpose and their Honour steady to a common End, and prefer the Interest of Mankind to any Narrow Interest of their own. 

—Woodrow Wilson (1856-1924, 28th President of the USA)

Rhetoric and Reality

Demonetisation, as a means of tackling the black money in India, was a total failure. It was carried out on the wrong premise that black money means cash. It was assumed that if cash was squeezed out, the black money can be eliminated. However, ‘cash’ is only one of the components of black money, probably about less than two per cent. As per the RBI sources, it was clear that little more than 98 per cent of the demonetised currency had come back to the banking sector. Again, of the Rs 16,000 crore cash that was still outside the banking sector, most of it was accounted for by August 2017. In other words, the demonetisation measure could bring out not even two per cent of the unaccounted money.

Black money is the result of the black income generated in the working of the economic system. Black income is the result of various means which cannot be contained by a single monetary measure. Any monetary measure aimed at controlling black money would regenerate black incomes in a different manifestation as the wheels of the economy cannot be halted and quickened only by a single monetary measure.

The radical monetary measure was the first test of BJP PM Narendra Modi’s mettle and the PM was found wanting. Slogans—Vikas, Viswas and so on—Modi’s favourite ploy, did not help in retrieving black money, extinguishing fake currency or halting terrorism. People want answers. The public have every right to demand accountability for the havoc created. Alas, democratic thinking is alien to the BJP’s, Pradhan Mantri.

There is no doubt that everybody is trying to hoard some cash, especially Rs 100 notes, simply because the 2000 rupee notes worth as a medium of exchange (a primary function of money in any economy) is virtually nonexistent. It was clear within a few weeks of note ban that the poorer sections, whether rural or urban, were able to hoard a far smaller proportion of their income than the rich. Tens of millions queued for hours, at bank branches and cash machines, to get rid of the useless notes and collect some new money for spending. This resulted in the springing of a new business in laundering cash for a fee for those without time or inability to queue up or with more notes than they can account for.

So far as the richer sections are concerned, they found a simple and convenient way to escape demonetisation in the exchange market in new money. Within a few days of the demonetisation measure, there were reports of a thriving ‘exchange market’ across the country. The exchange of banned Hd currency for legitimate notes for a ‘commission’ ranging from 20 per cent to 35 per cent started growing and prospering all over the country, in even smaller towns and big villages. However, the illegal growth of the ‘exchange’ market, though a convenience for the vast number of the rich, certainly imposed an additional burden on the poor in the face of the monetary crisis. The exchange of invalid currency was, in turn, siphoning out a significant portion of valid cash from the the system. Cash-based corruption and tax evasion almost returned as people started accumulating new currency notes.

Besides, it turned out that the new notes were smaller and all the ATMs in the country had to be reconfigured, which took more than 45 days. Some 22 billion notes were affected but the printing capacity was said to be only 3 billion a month. So even if fewer notes were needed because more money was in banks, printing new notes took enormous time. The banks were ill-prepared to handle about 8000.5 billion cash in new deposits in a month after demonetisation.

Over four-fifths of India’s workers were in the ‘unorganised’ and ‘informal’ sectors, paid in cash. Untold numbers were laid off within weeks of the demonetisation drive as their employers could not pay them wages in cash.

Out of 450 million persons in the total work-force, around 92 per cent were in the unorganised and also informal sectors. The Indian unorganised sector still operates with liquid cash as it needs working capital for purchase of raw material, making payments (on a daily and weekly basis) to casual labour and contract workers; for movement of output to truck owners and other miscellaneous expenditure. The same is the case with agricultural operations carried by billions of medium, small and marginal farmers.

With small factories idle, small shops struggling and a shortage of cash to farmers for their produce, the rural economy started stuttering within three months of the note ban. There were reports that sales of farm staples had fallen by more than half and those of consumer durables by 70 per cent by February 2017. The simple reason was: cash is used for 96 per cent by volume of all consumer transactions in India.

Within a few weeks, demonetisation heaped on the entire economy, particularly the unorganised and informal rural sector, a high burden by denying the much-needed lubricant of working capital (cash). The informal sector accounts for 20 per cent of the GDP and 80 per cent of employment. At the other end, vegetable vendors and people running teashops, eateries in Indian villages, towns and small cities, and for farmers for whom cash is critical especially in (December, Rabi crop) sowing season, were left to their ill fate. With the Reserve Bank of India banning cooperatives from accepting old Hd cash for exchange, the small and marginal farmers were forced to sacrifice the surplus from the Kharif season 2016. Consequently, a huge number of farmers abandoned and gave up the next crop.

Besides, small industrial units in small towns Moradabad (brassware), Tirupur and Erode (hosiary), Ludhiana (bicycles, winter wear and sport goods), Firozabad (glassware)—to mention a few—along with beedi-making units and handlooms in many leading States which employ a large number of semi-skilled weavers—the second largest activity next only to the agri-working class in the countryside—were thrown into the financial tornado. Never before had the entire array of economic activity been brought to a sudden collapse and extinction within a few months.

By January 2017, there were about 5.55 lakh unbanked Centres—defined as Centres without a brick and morter branch—in India. Of these about 5.54 lakh unbanked Centres were in rural areas. The population that resided in the unbanked Centres in rural areas amounted 62.9 crores. In other words, about 81 per cent of the rural population did not have access to a bank branch within their centres.

The impact of the ill-conceived and poorly implemented demonetisation on rural india was disastrous. A sudden withdrawal of Rs 6.5 lakh crore worth cash—valued at 48 per cent of all currency in by November-end, 2016—had a crippling contractionary impact on the rural sector. The immediate impact was on rural credit, agricultural production, thereby rural incomes and rural demand. According to the RBI sources (RBI Annual Report 2016-16, August 2016), currency in circulation amounted to Rs 16,415 billion; of this Rs 500 notes accounted for 47.8 per cent in value and Rs 1000 notes constituted 38.6 per cent, and together they comprised more than 86 per cent of the value of notes in circulation.

According to the RBI’s Report released on August 31, 2017, 98.96 per cent of the withdrawn notes had been returned by June end 2017. According to government sources, Rs 3000 billion would not return to the banking sector as they had been in the form of black money and were accounted for. However, with the return of nearly 99 per cent of the demonetised notes, that claim of the government did not hold.

In its biannual economic update (October 2017), the World Bank said disruptions by demonetisation and Goods Services Tax (GST) had affected India’s growth momentum. Both the World Bank and International Monetary Fund predicted the slowdown of the growth rate below seven per cent. In its report released in May 2017, the World Bank said ‘while the macro-economic impact of demonetisation has been relatively limited, the distribution of costs is uneven as the informal economy is likely to have been hit especially hard. The liquidity crisis that followed demonetisation impacted the investment climate.’ By June 2017, the economy’s four growth engines, including exports, and private investment, slowed down.

What the Indian Government had done was to commit a massive theft of the citizen’s property without even the plea of proper process—a shocking move for a democratically elected BJP Government. Rural India is home to two-thirds of the country’s population of some 870 million people where much of activities social (marriages, festivals, etc.), economic (farming and village industrial activities) need a lot of cash for their existence. The government’s fake claim was that the radical move would curb circulation of counterfeit notes, contain black money and help raise tax revenues that would be ultimately spent on large sections of people in the form of expenditure on health and education and in extreme cases deposited in Jan Dhan accounts of lower sections. This high-sounding and illusory argument reflected monetary (economic) ignorance.

On the historic day of November 8, 2016, Modi’s late night speech (in English) lasted 25 minutes. The PM uttered the phrase ‘black money’ 18 times in his eloquent speech. He mentioned ‘fake money’ or ‘counterfeit’ five times in his speech. For the first time in independent India, the nation was cursed with a secterian leader by religion, region and language. He has followed his Gujarat Model diligently by debasing the political discourse nationally as he had in Gujarat.

Narendra Modi’s surgical strike on ‘black money’ through radical demonetisation turned in the end to be a ‘surgical strike on the common man’ in India, by promoting a gigantic transfer of income and from the poor to the rich on a scale unprecedented since independence. The country never faced an economic crisis of the kind as has been undergoing and there is no historic precedent to learn from anywhere in the world.

Prof Rao is an Honorary Professor in Economics at the Jawaharlal Nehru Institute of Advanced Studies (JNIAS), Hyderabad. He was formerly Senior Professor and Head, Department of Economics, Osmania University, Hyderabad.