Demonetisation

Blundering along

Print edition : January 06, 2017

An elderly account holder at a State Bank of India branch in Secunderabad on December 15. The country continues to reel under the currency crunch more than a month after the government announced demonetisation of high-value notes. Photo: Nagara Gopal

S. Gurumurthy, political and economic Commentator. Photo: Bijoy Ghosh

At a protest on Bank Street in Hyderabad on December 16. Photo: By Special Arrangement

The opaque manner in which the government has handled demonetisation has fatally damaged the framework of economic governance.

INDIA remains a nation in queues—at ATMs and banks across the country—as it lurches towards the 50-day deadline set by Prime Minister Narendra Modi when he promised a return to normalcy. The steady chatter that India has entered a “new normal” is at best a desperate attempt to rationalise the irrational; at worst, it represents a cynical attempt to push at gunpoint the vast, diverse and multilayered economy over the brim, into the utopian idea of a “cashless” world. Nothing has changed significantly since November 10, when the banks first opened after Modi announced demonetisation of the two central pillars of the Indian currency system—the 500- and 1,000-rupee notes two days earlier. Workers have lost wages and jobs and agricultural activity remains in limbo, characterised by a calamitous drop in prices, as the economy moves into a period of severe demand decompression and extreme uncertainty of what the future holds.

Meanwhile, incessant reports of the hauls of huge quantities of money, especially in brand new 2,000-rupee notes, by enforcement agencies from across the country, shows clearly that the war on black money had been lost even before the general moved his first pieces into the battlefield. Indeed, the utterly opaque manner in which demonetisation has been handled by the policy troika at the helm—the Prime Minister, Finance Minister Arun Jaitley and Reserve Bank of India (RBI) Governor Urjit Patel—has aggravated the crisis and fatally damaged the institutional framework of economic governance. The lack of transparency about the government’s plans, if any, and the paucity of credible and tangible information on the progress made in resolving the shortage of cash in the system have fuelled speculation that a nexus among business, bank officials (including those of the central bank) and politicians is thriving even as the nation has been put to the sword of demonetisation.

Utterly opaque

Speaking to newspersons after the RBI’s bimonthly monetary policy review on December 7, Deputy Governor R. Gandhi said 19 billion new notes had been “given to the public”. In a clever mix-and-match of values and volumes of currency released, he refrained from spelling out how much of which currency, especially of the new 500- and 2,000-rupee notes, had been released. He said the central bank’s “note printing presses are working at full capacity and as on December 5, notes worth rupees four lakh crore have been supplied to the banks”. The RBI release later put the exact figure at Rs.3.81 lakh crore. He also slipped in the fact that 1.7 billion notes of the new 500- and 2,000-rupee denominations had been released, which, curiously, was removed from the RBI’s press release posted on its website. The only possible reason for the removal of this vital piece of information, without even the basic courtesy of a clarification, suggests that this would expose the troika to criticism that it is unlikely to resolve the crisis in the near term. What prompted the central bank to withdraw this crucial piece of information from the public domain? The simple answer is any person with rudimentary arithmetic sense and knowledge of the RBI’s note-printing capacity can make a reasonable guess about when the country can be expected to return to normal. The fear that the public’s “guesstimate” would be far removed from what the troika has been promising possibly made the RBI withdraw this piece of information from the transcript of Gandhi’s press conference on its website.

Assuming that the RBI’s presses started printing the new currency in October after Urjit Patel took over as RBI Governor in early September, what this implies is that it took the central bank about two months to print 1.7 billion new notes even as it supplied—not necessarily printed —at its four facilities in the country. A subsequent release from the central bank, on December 13, updated these figures and said cash valued at Rs.4.61 lakh crore had been “issued”. Significantly, the RBI said it had issued 21.8 billion pieces of currency, of which 20.1 billion were in small denominations ranging between Rs.10 and Rs.100. Curiously, the second RBI release did not provide a breakdown of the various denominations that had been issued, unlike in its earlier release. Clearly, the game plan is to confuse volumes and values of currency issued but to never provide both simultaneously, which would expose the political and economic leadership to ridicule, anger and public humiliation.

However, reasonable conjecture based on the arbitrary information released by the RBI leads one to the conclusion that the overwhelming proportion of new notes issued are in the Rs.2,000 denomination. This is corroborated by the fact that almost two months after demonetisation, few people have even seen the new Rs.500 note, let alone get their hands on one. In fact, Department of Economic Affairs Secretary Shaktikanta Das said on December 15 at his press conference that the “focus” of the government would be on releasing the 500-rupee note. In an admission that makes a mockery of basic principles of money supply, Das admitted that the government’s earlier focus on the 2,000-rupee note was dictated by the logic of quickly filling, in value terms, the vacuum created by the suction of 86.4 per cent of the value of currency in circulation.

Significantly, Das claimed that 50 per cent of the value of the currency that was pulled out would be replaced by the end of December. He gave no logic or data about how this miracle was going to be wrought, but the logic of simple arithmetic suggests that this may take at least several months. Of course, the simple solution could be to print even more 2,000-rupee notes, which would lead to even more chaos, given that already the new pink note is a denomination nobody, except, of course, the hoarders of illegitimate wealth, seems to want.

Matters have been clouded by various comments from within the establishment and without. For instance, Jaitley remarked earlier that the move towards a “cashless” society may result in a situation in which the value of the currency that is replacing the ones it displaced need not be equal. In other words, fewer notes may need to be printed, seemed to have been his contention. Others such as S. Gurumurthy, well-known chartered accountant and ideologue of the Rashtriya Swayamsewak Sangh (RSS), predicted that the 2,000-rupee note may itself be demonetised later. In an interview to a television channel, Gurumurthy said that the 2,000-rupee note may only have a life as “a stop-gap arrangement”. While distancing his position from that of the government, Gurumurthy also indicated that the 2,000-rupee note may have been issued only to quickly fill the vacuum caused by the sudden and dramatic move to demonetise virtually the entire Indian currency system overnight. If that is indeed so, it is scary because it suggests that not only was the demonetisation ill-planned, it is an ongoing exercise that will last far longer than what the country has been told. Apart from this, it also indicates the undermining of the critical role of public trust in the stability of a currency regime.

While this pertains to the opacity of the system in terms of the sheer production of currency, at the distribution level there is even greater chaos. The fact that the RBI has not revealed the quantities and values of currency deployed by the different banks/branches and across States has led to widespread allegations that the distribution system has been whimsical and arbitrary, putting ordinary people’s lives and livelihoods in jeopardy. This issue is already assuming serious political dimensions, with people making allegations of “special treatment” to BJP-ruled States or to Modi’s parliamentary constituency, Varanasi.

Fallacious defence

Although many proponents of demonetisation have voiced their support for it, Gurumurthy made the first coherent espousal on behalf of the ruling establishment. Articulating the rationale for the move in The Hindu (December 13), Gurumurthy termed it as a “remedy” that was aimed at clearing the “accumulated filth” that had gathered during the previous years of Congress-led governments. Gurumurthy’s analysis is based on three premises, all of which are fallacious. The first is a comparison of economic growth under the National Democratic Alliance (NDA) rule between 1999 and 2004 with the performance of the economy in the period of the United Progressive Alliance (UPA) rule (2004-2014). The second is his claim that the inflation of asset prices, rather than actual better economic performance that is reflected in jobs and incomes, accounted for a significant portion of the growth story in the UPA period.

Any economist worth his salt would make the obvious point that comparing economic variables such as national income, gross domestic product (GDP), inflation, agricultural or industrial output or even jobs cannot be statistically compared to a nicety by choosing time points corresponding to the life of a political regime. There is firstly a problem of time lags, which, given the NDA government’s relatively short term, is particularly a problem when making a comparison with the Manmohan Singh government. The economic value of output, not only in agriculture but even in sectors such as infrastructure, is generated with a lag, which can make comparisons hazardous.

The second problem arises from the fact that Gurumurthy seems to consider the Indian economy in complete isolation, as if it is insulated from the processes of globalisation. Just one instance would highlight a critical omission from Gurumurthy’s analysis: global crude oil prices are independent of what either Manmohan Singh or Modi may wish for. The wider world of international commodity prices, or exchange rates, capital movements, interest rates and much more, are beyond the control of the political leadership. It is possible for the economic leadership to tackle these issues, but ignoring them, as Gurumurthy does, is not a viable or judicious response.

Gurumurthy’s most significant fallacy lies in his contention that asset price inflation was responsible for the apparently high rates of economic growth during the period under Manmohan Singh’s leadership. “The well-kept secret is that huge asset price inflation, not production, passed off as high growth,” he argues. The fundamental fallacy here is that although asset prices may have increased by much more than the average in the economy, the fact that there is no separate inflation-adjusted index for shares, bonds, derivatives, real estate, bullion and other assets means that a comparison is fraught with serious problems. His comparison of asset prices with nominal GDP thus arises from a serious misconception of economics. In effect, Gurumurthy appears to have applied firm-level accounting principles to national income accounting principles without comprehending the economic logic—much of it based on neoclassical economic foundations—that is the conceptual basis of these statistics.

Incidentally, many commentators, including regular Frontline contributor C.P. Chandrasekhar, who has written about this over the last three decades, have pointed to anomalies in national income statistics which reflect an apparent increase in national income even if these are merely grounded in government expenditures such as in the heads under “Defence” or “Public Administration” in the Indian national accounts statistics. Gurumurthy, interestingly, has no quarrel with the neoclassical foundations of such accounting principles. He makes the point about how participatory notes have been a prime vehicle for bringing back into the economy, through the stock exchanges, black money that has been siphoned out of the economy, but says nothing about the Modi government’s failure to curb the menace of anonymity that it offers to such investors. It is well known that foreign institutional investors (FIIs) have thwarted every single attempt in the past at restraining them by threatening to spook the Indian markets. From this fallacy, Gurumurthy lurches into another by making a tenuous link with cash as the prime mover of this kind of inflation. He compares money supply as a proportion of GDP and asset prices and concludes that since the latter grew much faster, “unmonitored” cash in high-value currency notes facilitated the bubble in asset prices. The connection between cash and an asset bubble has never been established anywhere in the world. Regarding the huge housing bubble in the United States, which collapsed in 2008, triggering the global economic meltdown, to date no one in his/her right senses has blamed cash as the vehicle for the bubble. Gurumurthy provides no figures for the extent of the asset price bubble; that is simply because there is no data on inflation-adjusted prices for the wide-ranging sets of assets that wealth holders possess. Currency with the public is a much more complex variable than Gurumurthy seems to assert. Curiously, for someone who makes such a strong case about the nexus between high-value notes, black money and asset price inflation, he does not regard the introduction of a 2,000-rupee note as a serious anomaly.

Moreover, asset price inflation has other routes that can generate returns. For instance, it is well known that many promoters of infrastructure projects, such as those in public-private participation mode in the power and road development sectors, pad costs that generate additional returns over the lifetime of the project.

The ‘go-cashless’ cabal

December is the season when e-commerce companies like Amazon launch a sales pitch for the new year. This year is different. It is not private companies but the government, its Ministers and various departments that have launched a blitzkrieg aimed at pushing Indians on to the digital payments highway. The National Institute for Transforming India (NITI) Aayog, the government's policy think tank, recently announced a lottery scheme with daily, weekly and mega awards for consumers and merchants to embrace digital payment systems instead of depending on cash. All forms of transactions through the unified payment interface (UPI), unstructured supplementary service data (USSD) through mobile phones, Aadhar-enabled payment system (AEPS) and RuPay cards will be eligible for the lucky draws. NITI Aayog CEO Amitabh Kant said the promotional scheme is expected to cost Rs.340 crore.

The expectation of a gigantic shift to a cashless world riding on a digital platform is misplaced, as Bhaskar Chakravorti, Professor at Tufts University, pointed out recently in Harvard Business Review. Modi’s drive puts the “cart before the horse”, he argues, because such a move hinges critically on an already existing “digital infrastructure” that can handle the volume of load that was done in cash earlier. More importantly, Chakravorti argues that “establishing a threshold of trust” in such a digital system is a prerequisite since cash provided that layer of trust through the guarantee of the state. He cites a study, which showed that India ranked 42nd among 50 countries in a Digital Evolution Index, to make the point that the country is utterly unprepared for the scale of transition that the country is being pushed into by fiat.

There are several aspects to the digital push. One is the platform—in terms of reliability of networks, extent and capability of mobile phones held by the population, and the basic infrastructure. Related to this is whether the population regards it as a viable, stable, secure, predictable and acceptable mode of making everyday transactions. Another set of issues pertains to the notion of cash, not in an abstract sense but in terms of what people think and believe it to be. Yet another set of issues pertains to the costs associated with alternative modes of payment.

Chakravorti makes the point that any currency, digital or otherwise, requires an “equilibrium mindset” which rests on the solid premise that it works predictably while also holding value. “If there is a shadow of doubt that affects one party’s trust in a particular form of currency, the other will prefer to not rely on it,” he argues. Incidentally, the 2,000-rupee’s current fate of being an unacceptable mode of exchange arises from the widely held perception that it is illiquid, the very antithesis of all that cash stands for. Chakravorti says: “This unfortunate crisis is a case study in poor policy and even poorer execution. Unfortunately, it is also the poor that bear the greatest burden.”

It does not take an extreme weather event like cyclone Vardah to demonstrate the unpredictability of digital payment systems, as was evident in Chennai recently when even telephone connectivity was down for many people for more than 72 hours. Basic issues such as power supply and backups and network availability and access are a challenge for most Indians even otherwise; it does not require a cyclone to paralyse such a system. Considering that no other single economic policy decision in independent India has had such a widespread impact as demonetisation has, what is truly remarkable is that these everyday realities are so far removed from the consciousness of those at the helm.

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