Currency crisis

Wrecking the system

Print edition : December 09, 2016

Vidya Ram, a farmer, exits a bank holding a new Rs.2,000 note in Dadri, Uttar Pradesh, on November 15. Photo: Anindito Mukherjee/Bloomberg

A roadside stall near VOC Park in Coimbatore offers customers the option to pay by paytm. Immediately after the announcement, companies offering financial services, especially e-wallet service providers, launched a media blitzkrieg. Photo: M. Periasamy

The liquidity crisis of unprecedented dimensions that the Modi government has unleashed shocks the economy, drives people to despair and ruin and threatens consequences that have not been fully fathomed yet.

PRIME MINISTER Narendra Modi surprised the nation on November 8 with his “master stroke” of demonetising the two central pillars of the Indian currency system—the Rs.500 and Rs.1,000 notes —in his war on the black economy. But within a couple of days even he must have been surprised by the utter lack of preparedness that pushed the country into a crisis of a kind the world has rarely seen.

As those at the helm dithered, revised, reviewed and modified the scheme, almost on a daily basis—changing the terms on which millions of Indians could exchange the dud currency they were saddled with or to simply draw cash to meet their everyday needs—it became evident that there simply was no plan. By the tenth day it became clear that those responsible for the massive self-inflicted upheaval—the Prime Minister, the Finance Ministry and the Reserve Bank of India (RBI)—were witless and clueless about how the exercise was unravelling. Above all, the government was shown to be callous, having utter disregard for either the nature of the Indian economy or how the people earn their livelihoods. The simple truth that cash is not the last refuge of the Indian scoundrel but the lubricant that drives the vast swathes of the Indian economy has been lost on the policy pundits, the bhakts seeking a techno-utopian fix to weighty and long-standing problems and the elite who see India in their own image.

Livelihoods at a standstill

It was evident from the start that the prime victims of the demonetisation exercise were ordinary people even if the move was portrayed as a war on black money. Vehicular movement in Bengaluru, famed for its traffic snarls, was smooth on the morning after the announcement. It was not difficult to comprehend why. In the media’s imagination the city may be seen as the IT capital of the country, but it is also home to a large migrant population—carpenters from Rajasthan and Bihar; plumbers and cooks from Odisha; domestic labour from West Bengal, Tamil Nadu and many other parts of the country; and security personnel from Nepal, Bihar, north-eastern India and elsewhere. Carrying dud notes in their wallets—having received their salaries in these very notes just a few days earlier—and not sure whether they would get paid that day, there was no reason for them to travel anywhere that day.

The timing was horribly wrong for those in rural India too. In many places the kharif crop had just been harvested; elsewhere harvesting was just about to commence when demonetisation hit them like a tsunami. In Hassan (about 180 kilometres from Bengaluru), for instance, ginger growers, many of them migrants from Kerala a generation or two ago, are postponing their harvest in the hope that they can ride out the crisis. But they have to pay a price for this wait because the roots will dry up and weigh less. Those unable to wait found that in the eight days since the demonetisation announcement, ginger prices had fallen from Rs.1,200 a bag (62 kg) to Rs.900 a bag.

Maize growers with small holdings, whose harvest is too small even in normal times to justify the costs of moving the produce to the local mandi, find that the local merchants simply do not have the cash to bail them out. The collapse in demand has resulted in the price of maize dropping from Rs.1,700 a quintal two weeks ago to Rs.1,350 a quintal, says Rajaiah, a maize grower in Boovanahalli, a village near Hassan town. Those waiting to commence the harvest have no cash to pay wages to workers. And meanwhile, if it rains, they will lose everything. Those who have harvested their crop and need to quickly prepare for the rabi season cannot buy inputs because no one is willing to accept the money they have.

Modi’s announcement, made with much fanfare, that banking correspondents (going by the nice-sounding name of “bank mitra (friend)” would extend the reach of the banks by delivering cash and enable exchange of the invalid notes in rural areas appears hollow. It has had no impact on the ground as they refuse to accept the just-outlawed currency even from women’s self-help groups. Hassan is also coffee country, with a predominance of small growers. But with the picking season just around the corner, growers are restive because they are unable to access cash to pay their workers. Although some workers do have bank accounts, B.A. Jagannath, a planter at Ballupete in Sakaleshpur taluk, asks: “What is the point in having the money in the bank if the worker is unable to purchase vegetables or groceries?”

As queues lengthened at the nearly two lakh bank branches and half of the country’s 2.25 lakh ATMs—the other half simply did not work in the first week anyway—reports of more than 50 deaths poured in from across the country. The simple question people were asking was, why should someone have to die in a queue to draw money that belongs to them?

A currency crisis of another kind

Faced with the massive unrest across the country, those holding the levers of power did what clueless administrators do all the time: plead for more time. After initially insisting that all was well and that every citizen would be able to withdraw his or her money, it took a full four days for Finance Minister Arun Jaitley to acknowledge that the new notes, including the new colourful one in the Rs.2,000 denomination, would not fit into the ATMs across the country. He promised that ATMs would dispense the new notes in the next two to three weeks. Modi, who was away in Japan soon after setting off the firestorm, surfaced in Goa and Belgavi to plead for 50 days’ time to restore a semblance of normalcy. But it is quickly becoming clear that normalcy will take a long time coming. The ever-narrowing scope for exchange of the dud currency and the difficulties in getting valid bank notes clearly show that a solution is not in sight. And, the phenomenon of people scurrying across to get their hands on the good old 100-rupee note—because they do not want to hold the 2,000-rupee note, and the 500-rupee note is nowhere to be seen—is indicative of a crisis that promises to fester for long. Here is why.

When Modi decided—it is very clear that the buck of the demonetisation fiasco stops with him—to unleash his magic sword, he was in effect pulling out of circulation denominations that were at the heart of the Indian currency system. The 500-rupee note accounts for a little less than half the entire value of the currency in circulation in India; add the 1,000-rupee note, and the two together account for 86.4 per cent of the value of all bank notes in circulation (see table). Add the 100-rupee note, and the three notes together account for 96 per cent of all the currency moving around—practically all of it.

A currency’s primary purpose is to provide liquidity; the various denominations are structured in such a way that they maximise this by providing options to citizens and other economic agents, which depend on the nature of the activity in the economy. The central pivot of the Indian currency system was clearly the 500-rupee note, much like the role played by the 100-rupee note a decade or two ago. In this currency scheme, the 500-rupee note played a central role by providing not only liquidity but a store of value that was available on call. The notion among armchair bhakts that the 500-rupee is a just a safe haven for ill-gotten wealth demonstrates an utter lack of empathy for those who have suffered most from inflation, especially of the basic necessities of life. A 500-rupee note is not even one and a half day’s wage for a casual worker in an Indian city. Or put another way, figure out how long it would last for a family of four to merely buy rice and dal. Seen from this perspective, the 500-rupee note is the pivot because it serves the requirement of convenience—a single note instead of many, but which is also fairly easily convertible—while also acting as a store of reasonable value in the context of income levels in India.

What was the role of the other relatively smaller cog in the currency system, the 1,000-rupee note? That bank note served the purpose of making relatively high-value transactions. In an economy in which at least half the national income is generated in informal activities, relatively high values do not necessarily mean high incomes. For instance, a small-scale cement trader in a semi-rural setting selling about 50 bags a day may have a turnover of Rs.15,000 a day, but his profit would be a mere fraction of this turnover. The 1,000-rupee note would be a convenient option for transactions such as these. The simple-minded—and now dangerous—notion that dealings in all such denominations are suspicious shows an utter lack of understanding of the nature of the economy; such pitifully inadequate understanding cannot even begin to fathom the role of the currency in a system like ours.

If the decision to replace the 500-rupee note with a fresh one was silly, the move to abandon the 1,000-rupee note and replace it with the new 2,000-rupee note was nothing short of foolish. Here is why. The distance in monetary value between the old 500-rupee note and 1,000-rupee note was much shorter; the introduction of the 2,000-rupee doubles that distance. This means that while the 2,000-rupee note may act as a store of higher value, its liquidity is drastically diminished. This is especially important when viewed in the context of prevailing income levels and average transaction values in the Indian economy. In any case, the new pink note with a higher value defeats the very purpose for which the Modi government has supposedly undertaken the traumatic exercise. Not for nothing is pink now termed the new black! It is not difficult to understand why most Indians who are now saddled with the new note want to get rid of it at the earliest opportunity.

While that is the problem with the 2,000-rupee note, 10 days after Modi’s announcement most Indians have not yet seen their most-favoured currency denomination, the 500-rupee note, in its new avatar. Meanwhile, the humble workhorse, the 100-rupee note, has borne the brunt of the escalating demand. Anecdotal evidence from bank employees and customers indicate that the demand has been so great that banks have put back in circulation even badly soiled 100-rupee notes that they had surrendered earlier to the RBI. In fact, the soiled notes have been responsible for jammed precision-engineered ATMs in many places across the country.

The mysterious absence of the 500-rupee note and the emergence of the 2,000-rupee note, which nobody wants (we want change is the common refrain), resulted in the 100-rupee note being pushed to plug in the gap. That turned out to be an impossibility as ATMs, now stacked with these notes, ran out much faster than they were meant to. Common sense ought to have instructed the mandarins in the Finance Ministry that asking a currency that accounted for less than 10 per cent of the value of currency in circulation to fill the huge void caused by the withdrawal of a denomination that accounted for one half of the value of all currency in circulation was like trying to arrest the flow of water gushing from a broken reservoir with a little finger. This is what explains the desperate, almost daily, announcements by the Union Finance Secretary of ever-increasing restrictions on withdrawals and exchanges, including the classic one that marks the finger of every exchanger queueing up at bank counters across the country. Thus, while the government had mud on its face, citizens had ink on their hands.

A long road ahead

Modi’s plea that he be given 50 days to sort things out is a desperate act of buying time in the face of criticism that the massive bungling at the helm, utter lack of preparedness and a complete disregard for the mechanics of a currency system are responsible for the ongoing crisis. Here is why the 50-day window sought by Modi is going to prove grossly inadequate. For that let us turn to the magnitude of the task at hand and the tools he has to address it. The simple replacement of the just-banned 500-rupee note—not accounting for the larger numbers that would be needed to accommodate the growth of national income in the current year—would mean the issue of 15.71 billion new notes.

The “master stroke”, that is, the introduction of the new 2,000-rupee note, implies that even though nobody wants to hold it—at least for now—the government needs to print just half the number of 1,000-rupee notes to replace them with the new currency. Since there were 6.33 billion such notes, the government needs to print just 3.17 billion, goes the logic of this bizarre move! In any case, the total now adds up to 18.88 billion new notes. But the numbers do not stop there because the introduction of the 2,000-rupee note implies that both 100s and 500s have to be printed in greater quantities because there is a huge gap created between the 500- and the 2,000-rupee notes. Extrapolating from the figures of notes printed in 2015-16 (available in the Annual Report of the RBI Board, which was submitted by Raghuram Rajan a week before he left as RBI Governor in early September), and assuming that the growth in number of currency notes would be the same as in 2015-16, at least 22.36 billion new 500- and 2,000-rupee notes would have to be printed. Similar projections of the quantities of 100-rupee notes, based on the assumption of a similar order of magnitude of growth in the current year, imply that 16.57 billion such notes need to be printed.

Apart from this, there is the issue of soiled notes, some of which can perhaps be squeezed into the financial system as a desperate measure but is surely unworkable for a self-respecting currency (ATMs can get jammed, for example). Soiled notes are no small matter; the RBI disposed of 16 billion such notes in 2015-16, of which almost half were in the now-prized 100- and 500-rupee denominations. Even if one were to assume the disposal of the same number of notes as in 2015-16, it would mean printing at least eight billion notes of these denominations. Meanwhile, the introduction of the 2,000-rupee note, which can only be justified in terms of the convenience (for quick printing) of the monetary authorities, causes a vacuum that requires to be filled by even more 500- and 100-rupee notes. In effect, the share of the new 500-rupee note is likely to increase further. But even without taking that into account, it is clear that at least 46.93 billion new notes have to be printed (22.36+8+16.57).

Now let us turn to what the system can produce, or, at the very least, what has been achieved in the last few years. The indent that the RBI placed for the current year was for 24.55 billion notes, inclusive of all denominations. This is not much higher than in previous years and can be seen as a capacity constraint. Bharat Reserve Bank Note Mudran Private Ltd, established as a wholly owned subsidiary of the RBI in 1995, manages two presses, one in Mysuru and the other at Salboni in West Bengal. According to the company’s website, the combined production capacity of the two units is 16 billion “note pieces” per annum working on a “2-shift basis”. Even if this capacity, which accounts for the more modern note-printing capacities in the country, increases by a third by adding an additional shift, it would still only amount to 24 billion pieces of currency in a full year. Security Printing and Minting Corporation of India Ltd, the oldest currency printing unit in the country, has two units that print currency notes—one at Nashik in Maharashtra and the other at Dewas in Madhya Pradesh. But these have much smaller capacities. Thus, the total capacity, working full steam, can print about 32.5 billion notes—about 2.7 billion notes a month. This implies that feeding the currency system to restore normalcy is going to take much longer than a year.

Effectively, the 50-day period that Modi has sought to restore a semblance of normalcy appears to be a pipe dream when set against these severe capacity constraints. Even more damagingly, the introduction of the 2,000-rupee note demonstrates an utter lack of respect for elementary principles that govern currency management in a large, poor and diverse economy like India. In short, it appears that the only reason for its introduction was the late realisation, after Modi decided to rush headlong, that this was a quicker way to overcome a capacity constraint.

In the absence of any information from the central bank and the virtual disappearance of the RBI Governor from public gaze after November 8 (even on that day, at the press conference, the Finance Secretary called the shots), it is evident that RBI Governor Urjit Patel has failed to bring to the notice of the government the scale of preparation that was required to undertake this mammoth task without destabilising the economy. Instead, the nation is in the throes of what is in effect a financial emergency. In effect, the people have a long and dark night ahead of them, which is unlikely to end any time soon.

It is abundantly clear now that Raghuram Rajan had not played ball with the Modi sarkar. In fact, he had clearly articulated the view that demonetisation would be an ineffective step to counter the generation of black money. Government sources have admitted that the printing of new notes started only after the new Governor assumed office in early September. With a Governor that it found easier to deal with, the Modi government started printing the new notes only after that, which explains the inadequate preparation.

But this still does not explain why Modi was in such a hurry, although market gossip in Mumbai and the chatter in media circles indicate that the government rushed into the move because it feared that information was on the verge of leaking out. In fact, when the issue was raised in the Supreme Court on November 18, Chief Justice T.S. Thakur asked: “What is the problem? Is it printing problem?”

Pipe dream of cashless society

Immediately after Modi made his announcement, a range of companies offering financial services, especially e-wallet service providers, launched a media blitzkrieg. The self-serving self-promotion, in the face of an unprecedented crisis that the people found themselves in, urged people to go cashless. This, they urged, is the way to go, suggesting that a cash-based society is one that is backward, underdeveloped and mired in corruption. This is completely untrue for two reasons. First, cash plays a large part in the Indian economy, but the country is by no means unique. Cash (currency in circulation) accounted for about 11 per cent of the Indian gross domestic product (GDP) in 2015, but in the eurozone as a whole it was marginally higher, and in Japan and Switzerland it was significantly higher. Even Singapore, which is often touted as the way to go for India, had cash levels (relative to GDP) that were only marginally lower than in India. The simple point is that arbitrarily plucking a statistic or variable and flaunting it as a sign of development or progress is simply wrong.

But even more amazing is the way the well-heeled are advising their much poorer compatriots in their hour of grave crisis to “go cashless” as if there is no cost to be incurred. Upper middle class bhakts, egged on by companies such as paytm, urge us all to proceed on this highway without any warning of the transaction costs that can be a significant proportion of the average person’s income. One recent advertisement urges us to pay our domestic workers using a service provider’s e-wallet service, without warning us that they would have to incur a transaction cost when they encash what belongs to them. Although this service provider has slashed service payments from 4 per cent to 1 per cent, it is clearly aimed at snapping up customers who are desperately seeking relief in the moment of crisis. The point is that it may be free for the well-heeled but costly for those at the other end of the transaction. Looking at the transaction from the workers’ point of view, the transaction costs for encashing Rs.8,000 (which is what a domestic help in a large metro may be earning) would amount to a non-trivial sum of Rs.320. Reports in the wake of the crisis indicate that the cash-on-delivery option offered by e-commerce sites has collapsed from 50 per cent of all transactions to less than one-third. This obviously indicates that even in online transactions, cash remains king.

There are many reasons why people prefer cash and this may have nothing to do with sinister motives like hoarding or amassing ill-gotten wealth. Even those who are comfortable buying online prefer to do so only within a range of values; they prefer cash for everyday low-value purchases, a credit card for higher value purchases and cheques for making payments that require proof of payment. The point is that forcing a particular choice by diktat limits options that could actually constrain economic activity severely. For instance, with poor mobile networks in many parts of rural India, it may not even work in a predictable and efficient manner.

The nuclear winter that Modi has unleashed points to the rise of a particular kind of techno-utopian fascination that has a ready constituency among a tiny section of the elites, which sees the world in its own image. The relentless implementation of the Aadhaar project, in the face of reasoned articulation of serious deficiencies in its design and scope, was one warning about the rise of such tendencies. Aadhaar was touted as a magic technical fix to rid the country of poverty. This constituency has no patience with either the niceties of democratic conduct or the practicalities of the Indian reality. “In a hurry always” appears to be its motto.

Time has been running out for Modi as he reached the halfway mark of his term. Many promises remain unfulfilled and the jumla that he raised in the run-up to the 2014 elections finally caught up with him. The country is paying a terrible price that has no parallels—in either scale or similarity—anywhere in the world. Even more scary is the prospect of what may be in store as he searches for ways to turn attention away from the wreckage he has caused.

With inputs from G.T. Satish in Hassan

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