Economists speak up on demonetisation

Featured are summary views, solicited by The Tribune, on the government’s demonetisation move from nine economists of impeccable credentials, differing ages, a spectrum of ideological persuasions, and a variety of locations.

Economists speak up on demonetisation

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Featured are summary views, solicited by The Tribune, on the government’s demonetisation move from nine economists of impeccable credentials, differing ages, a spectrum of ideological persuasions, and a variety of locations. We encounter amidst this diversity of backgrounds a profound sameness of opinion, as reflected in unanimous denunciation of the government’s action in sentiments and assessments such as: “essentially political move,...insensitive,…,gratuitous,..,appalling”; “firing cannonballs to kill mosquitoes”; “arrogance and insensitivity”; “an exercise in Manichean economics”; “authoritarian quackery”; “heavy cost to the economy”; “frightening abandonment of reason”; “throwing the baby out while retaining the bathwater”; and “a cavalier or even cynical political calculation”Here’s a cross-section of  scholarly opinion.

Essentially political move

Venkatesh Athreya (retired Professor of Economics, Bharatidasan University, Tiruchi)

The demonetisation measure of the Government of India may, at best, disable a portion of black wealth held in the form of currency notes that have ceased to be legal tender. The stock of black wealth held in currency form has been generally estimated at around 5 to 6 per cent of the total. A portion of this stash has already been laundered. Current estimates of black money trapped through demonetisation do not exceed three lakh crore. The claim that the demonetisation was aimed at immobilising counterfeit currency is lacking in credibility, with such currency estimated to value no more than Rs 400 crore, a very small proportion of the value of the high-denomination notes that were in circulation. The current measure does not address the continued generation of black money through tax evasion. Demonetisation as a weapon against terrorism is a claim bordering on the ridiculous.  Corruption is not a one-time activity to be put an end to through this measure. 

The move seems essentially political. The Prime Minister’s statement that the opposition parties are unhappy because they were not “prepared” can be construed to imply that the ruling party at the Centre was prepared. The mounting criticism of the government on its failure to bring back black wealth stashed abroad as promised in the Lok Sabha polls, agrarian distress, industrial stagnation, rising unemployment, intolerance of alternate points of view, and the perception that this government is anti-Dalit and anti-Muslim, could all have been seen as negative in the context of the impending elections in some major states. 

Demonetisation may have been seen as a “big-bang” measure that would enhance the regime’s credibility in fighting black money and divert attention from its perceived failures.  The informal economy accounts for 80 per cent or more of the workforce and nearly a half of total output. It has been grievously stricken by the government’s woefully inadequate preparation and complete failure to anticipate the impact of the move it has unleashed.  This has been the inevitable consequence of the massive reduction in liquidity visited on an economy that conducts nearly 90 per cent of its transactions in cash. It has not only meant a great deal of avoidable distress, including deaths, for the mass of the people but also a devastation of the economy in the short and medium terms, with no guarantees for a revival subsequently. The advice to ordinary people to go digital in a context of poor bank and internet penetration is not only insensitive and gratuitous, but positively appalling.

Huge collateral damage

Maitreesh Ghatak (Professor, The London School of Economics and Political Science, London)

The demonetisation policy, at best, is a one-time tax on black money that is stored in the form of cash.  But only around 5-6 per cent of undisclosed income is held in cash. Therefore, even if all of it gets targeted by this measure, it will not be an effective way to go at the existing stock of black money. Moreover, black money generation is a continuing process that involves evading taxes and regulations, and engaging in corrupt and criminal activities. These cannot be tackled with a one-time measure. They will continue unabated with the new currency notes. Ironically, this reform may even increase the stock of black money held in cash in the future by facilitating hoarding in currency notes of a higher denomination (the Rs 2000 notes). 

Even if the effectiveness of the policy in curbing black money will be minimal, the cost will be very high.  Other than the direct cost of printing new notes, given that the affected currency notes constituted 86 per cent of the total volume of cash in the country, this policy effectively led to a much higher drop in liquidity than even the drop in the money supply (about 30 per cent ) that the US Fed is criticised for doing during the Great Depression. The informal sector is largely cash-dependent and alone accounts for 40 per cent of the GDP and employs 80 per cent of the workforce. It, along with the rest of the economy, is suffering perhaps the biggest policy-induced recessionary shock in post-Independence India.  Add to it the physical hardship imposed on ordinary citizens in terms of standing in line, and strain on the capacity of the banking sector, which have resulted in deaths. This may go down in recent history as the biggest example of firing cannonballs to kill mosquitoes (granted that these were causing the malaria of corruption), with huge collateral damage. 

Breathtaking insensitivity

Jayati Ghosh (Professor, Jawaharlal Nehru University, New Delhi)

The declared motivation of this drastic demonetisation keeps changing: from stopping “black money” to combating terrorist funding through counterfeit notes, to moving to a cashless society. But the welfare of ordinary citizens clearly forms no part of the government’s agenda. 

The flawed design suggests a basic lack of knowledge of the nature of the black economy, and an unwillingness to address the processes that allow parallel untaxed incomes.  To deal with counterfeit notes a more gradual withdrawal of old notes would have been possible. Instead, the blanket ban on the bulk of notes in circulation has abruptly denied liquidity to the bulk of the economy’s transactions, without providing a sufficient supply of new notes to replace them. 

The ensuing chaos has gone well beyond causing mere “inconvenience”, to immense and continuing personal hardship and even deaths among the worst affected; destruction of livelihoods in informal and formal sectors; terrible effects on farmers caught between harvesting and sowing seasons; contracting demand that impacts the macroeconomy.  

Constantly changing implementation rules point to more than inefficiency and lack of preparedness. They suggest that the government essentially has no trust in the citizenry. Therefore, the need for secrecy and the sudden strike; the constraints put on the exchange of old notes; the suspicion of deposits put into Jan Dhan bank accounts; the denial of exchange facilities to cooperative banks and other institutions run by state governments. The underlying premise is that anyone who is the holder of the now-delegitimised currency notes is either a criminal or acting on behalf of criminals. Effectively, only those using plastic or electronic money are “honest”. In this whole episode, the government’s arrogance and insensitivity have been breathtaking. But as the mess continues and the material damage grows, its ability to hoodwink the population cannot last for too long. 

Save economy from slump

Parikshit Ghosh (Associate Professor, The Delhi School of Economics, Delhi)

The sudden demonetisation of 86 per cent of the country’s currency stock, ostensibly to fight black money, counterfeiting and terrorist funding, is an exercise in Manichean economics. The decision seems propelled by a desire to project an epic battle against evil rather than any pragmatic weighing of costs against benefits.

Replacing one currency by another will not prevent the kind of cash transactions the parallel economy thrives on. Demonetisation will wipe out only a small fraction of the stock of wealth accumulated through illegal means, since most of it is held in gold, land and real estate. Fake notes are rare and the new ones do not seem to have vastly superior security features. The massive liquidity shock has predictably dealt a big blow to production and trade in a primarily cash-based economy. The agriculture and construction sectors, and textile hubs in places like Tirupur, Banaras and Ludhiana, are badly hit, as are day labourers, craftsmen, hawkers, migrants and 80 per cent of workers who earn a living in the shadow economy. The greater the delay in infusing liquidity, the more lasting will be the damage.

Although banks are now flush with new deposits, a large part of it comes from the informal sector’s transaction money, which will flow out as soon as withdrawal restrictions ease. It is, at any rate, egregious to recapitalise banks by raiding the cash reserves of the poor, while the informal lenders and microfinance organisations who actually lend to them are crippled by demonetisation. This should not be a magic pill for the Non-Performing Assets (NPA) in banks caused by corporate defaulters. Nor can it be justified as shock therapy for promoting financial inclusion and a cashless economy. Those are worthy goals better pursued with gradualism than paternalism. The government’s immediate priority should be to restore liquidity and save the economy from a deep slump.

Authoritarian quackery

Arjun Jayadev (Associate Professor, Azim Premji University, Bengaluru)

Until November 8, 2016 independent India had by and large avoided financial melodrama. Certainly there have been foreign exchange crises and some credit bubbles that broke nastily, but there has never been the sort of widespread debacle and panic that have been experienced in other developing economies. This makes the demonetisation decree all that more puzzling.  Demonetisations are really unheard of in the absence of a hyperinflation or a situation of war. It is perhaps the most explicit recognition of a failed state of affairs, an acknowledgement that the most basic universal dealings of human beings between each other have broken down and that the society needs a reset. Let us, for a moment, think of what has been shaken to the core. It is not “black money” or illegality. It is not a rearrangement of affairs in favour of cashlessness. It is the belief in the integrity of the monetary system—that legal tender will be widely accepted, that our “pay community” is meaningfully solid and not subject to the whims, however well-intentioned, of a small group of people. It’s important to think about what the rupee note has represented to people. Like very few of our social contrivances, it is universally accepted. The denomination, written in all the major languages, allows citizens of all creeds and backgrounds to make binding commitments to each other. A rural labourer with that note in his pocket can interact, coordinate and cooperate with people who might otherwise have nothing to do with him. It is this very basic trust that is in question. Already, rumours abound that the new Rs 2000 notes will be demonetised soon enough. 

If demonetisation is to work as an attack on black money, it will only work if it is done repeatedly to any means of settlement that is used for illegal activities, and illegality is of course, not limited to cash transactions. No form of settlement is then safe from the arbitrary fancies of those in power. This is far from either a “surgical strike” or a “dose of strong medicine”. It is quackery. Worse, it is authoritarian quackery that cannot help but do deep damage to the basic institutional understandings that underpin our society.

Will impose cost on economy

Arun Kumar (Retired Professor of Economics, Jawaharlal Nehru University, New Delhi; and author of  The Black Economy in India, Penguin (India).

The withdrawal of high- denomination currency notes from circulation is seen as a move to curb the black economy. Questions are being asked about its effectiveness and its economic costs. The immediate impact has been adverse and large.

The current size of the black economy is 62 per cent of the GDP, or about Rs 90 lakh crore, and what may be held in cash would be only a few per cent, say Rs 2 to 3 lakh crore. Reports are that businessmen have found ways of converting their cash into new currency so that hardly any black money hoard may be demobilised. Thus, the expected bonanza to the government may be marginal. Most of those who generate substantial black incomes may be untouched by demonetisation. Further, generation of black incomes in different sectors is untouched by demonetisation and will continue.

The heavy cost to the economy is becoming apparent. Households, farmers and businesses are being adversely affected as transactions have become difficult. A large part of the economy does not use plastic money or cheques. A black market has emerged for exchange of currency and there is a premium for gold and foreign currency, which will lead to loss of savings. Hoarding of currency is aggravating shortage of liquidity. Discretionary expenditure has dropped and this may persist, leading to demand shortage and dislocation of commerce and industry. This could aggravate NPA, and sickness in industry and unemployment, resulting in irreversible changes and hardship to the citizens even though most of them are not responsible for generating black incomes. Thus, while demonetisation will hardly impact the black economy, it will impose huge costs on the economy  especially on the marginalised. The way out is to restore liquidity in the markets by allowing the older notes to continue in circulation till enough new notes are printed.

Abandonment of reason

Prabhat Patnaik (Professor Emeritus, Jawaharlal Nehru University, New Delhi)

For a government to demonetise overnight 86 percent of the currency, when nearly half the economy runs entirely on the basis of currency transactions and gets crippled thereby, makes no sense. When it transpires that this was done when no new currency had been printed, against which the old could be exchanged, then this move betrays an abandonment of reason that is truly frightening.

This impression is not lessened one bit by the arguments advanced for the move. The first states that it attacks “black money”. But since the ratio of currency holdings to the volume of business in the “black economy” is extremely small, the profitability of engaging in “black activities” will be hardly affected by demonetisation, especially since only a fraction of the demonetised currency will be disabled anyway (the rest getting converted into new legal tender through a mushrooming of new “black avenues”). And since the “black economy” would continue, it would suck out the cash it needs, but which has been disabled by demonetisation, from the “white economy”, to the longer-term detriment of the informal sector. The second argument talks of moving to a cashless economy. Even if the need for it is accepted for argument’s sake, sudden demonetisation as a means towards it is like holding a gun to people’s heads to force them towards cashless modes of transacting. It is authoritarian and unacceptable.

The third argument concerns counterfeit currency which terrorists apparently have injected into the economy. But getting rid of counterfeit currency does not require sudden demonetisation. Even if the old notes were replaced in a phased manner, as has happened occasionally in the past, counterfeit currency would still have been eliminated.Whether the people accept the hardships induced by demonetisation is immaterial; a government imposing such hardships betrays astounding irrationality.

Neither necessary nor sufficient

M. Govinda Rao (Former Member,  14th Finance Commission;  & Professor Emeritus , National Institute of Public Finance and Policy, New Delhi)

The Prime Minister’s announcement invalidated 86 per cent of the currency with a sleight of hand, which has plunged the economy into a tailspin.  In an economy in which over 96 per cent of the transactions are carried out in cash, such a chaos is inevitable.  While nobody can find fault with the objective of curbing black economy, or ending terror financing or nullifying the counterfeit notes, the important questions are: first, whether this is the appropriate policy choice to justify the pain inflicted on the people and second, does the banking system have the capacity for implementing it to achieve normalcy within a reasonable time?

As regards the policy mix, clearly demonetisation of the type undertaken is neither necessary nor sufficient. First, the policy will not impact the incentives for, nor deter, the earning of illegal incomes and evasion of taxes.  The principal sources of the black economy in activities like political funding and election expenses, real-estate transactions, construction, tax evasion and bureaucratic corruption will continue.  Second, the stock of black economy does not get affected much for, only a small portion of black money is held in currency. Much of it is stashed abroad or held in real estate, and gold and foreign currency.  

It is obvious that the shock therapy of such a magnitude cannot be implemented by the banking system.  Over 30 per cent of the people employed in India are casual labourers who receive their wages and pay for their purchases in cash, and they have been put to severe hardships.  With trade, tourism and construction activity coming to a standstill and with agricultural sectors requiring but unable to get cash for purchasing seeds and fertilisers at a time when rabi sowing is on, the GDP in the economy will decelerate significantly.  This is a typical case of throwing the baby out while retaining the bathwater!

Avoidable human cost

Sanjay G Reddy (Associate Professor, The New School of Social Sciences, New York)

The government’s decision to scrap existing currency notes which make up a large proportion of those in use in transactions is an ill-thought out action which has little economic justification, and acts as a smoke-screen for the failure of the government to act in more fundamental ways to address people’s justified anger at ill-gotten wealth and ongoing corruption.   However, better alternatives existed to what the Supreme Court has rightly referred to as “carpet bombing” and not a surgical strike, including the gradual replacement of targeted notes.  The action has rightly been referred to as expropriation as it will lead to loss of wealth of many citizens who had trustingly stored their wealth in this form, either permanently or transiently, including the poor, thus also affecting economic activity.  At the same time, those supposedly targeted have very likely avoided serious damage through a variety of evasive techniques.  The question of whether the human cost is acceptable would be hard enough to answer if the move were somehow successful in addressing its supposed aims.  In fact, there is every reason to believe that it will be unsuccessful, which makes the avoidable human cost a tragic consequence of a cavalier or even cynical political calculation, or of poor economic ideas compounded by incompetence.  The loss of trust in the currency and in the ability of the government to manage the economy has, ironically, also dealt a blow to the confidence of the domestic and foreign private investors whom the government is otherwise keen to please. Despite its debacle, the government and its faithful, some pliant economists among them, will likely assert that it has advanced its aims, as it can always claim that things would have been still worse.  In such a case, there is no better recourse than common sense.

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