False step

Economic history is a harsh and unforgiving judge. While pronouncing its dispassionate, magisterial verdict on the efficacy of policy actions, it makes no concessions for earnestness of faith or the nobility of intentions underlying them. Nor does it make room for political calculations, however much spinmeisters may work overtime to project them as Chanakyan stratagems because they have, in the end, helped win elections. What counts in the end is success measured in terms of the stated goals of the policy.

Even a year after that balmy November night when Prime Minister Narendra Modi administered a shock to India’s monetary system with his dramatic television address to announce the demonetisation of high-value currency notes, it’s fair to say that sections of the economy still manifest symptoms of high-voltage electrocution.

In the couple of financial quarters that have elapsed since then, GDP growth has drifted downwards — even falling to a three-year low of 5.7 per cent in the quarter to June. Broad swathes of the informal economy have wilted, robbed of life-sustaining liquidity for a prolonged period. Farming communities have similarly suffered as the cash flows of market intermediaries were choked off. For sure, the economic slowdown had set in even earlier, but in many ways that secular, cyclical trend was accentuated by the ill-conceptualised, poorly implemented move that notebandi has inarguably proved to be.

Even if today a recovery is on the cards — and there are fleeting signs of it — the disruption that demonetisation wrought serves as a warning against hubris-driven policymaking that overlooks the systemic entrenchments that could trip it up.

The virtually overnight withdrawal of ₹500 and ₹1,000 notes, which together accounted for about 86 per cent of the currency in circulation then, induced a near-total seizure of the country’s predominantly cash-based economy. It was the nearest thing to a cardiac arrest for commerce. And it didn’t at all help that the surgeons and ancillary medical staff evidently had not thought things through and were ill-equipped to deal with the emergency they had themselves precipitated.

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And all this, to what avail? In his November 8 television address, an upbeat Modi had offered up the demonetisation exercise as a “mahayagna” that would exorcise the malefic spirits of “corruption, black money, fake notes and terrorism”.

The five-hundred and thousand-rupee notes “hoarded by anti-national and anti-social elements”, he said, “will become just worthless pieces of paper.”

Finance minister Arun Jaitley too claimed that “people who have used cash for crime purposes are not foolhardy enough to try and risk bringing the cash back into the system because there will be questions asked.”

Sadly, even established economists wilfully surrendered intellectual rigour and trotted out partisan, and wholly unscientific claims to the effect that anything from a 10th to a third of the ₹15.44 lakh crore in demonetised notes would not return to the banking system. Their somewhat fanciful argument was that if, say, ₹5 lakh crore in demonetised notes was “extinguished” in this manner, it would translate into “a killing” on the books of the Reserve Bank of India (RBI), which could then pass it on to the government as dividends. A government awash in this ‘black money’ bonanza could then ‘reward’ honest citizens in countless ways. Perhaps it was possible for diehard partisans to persuade themselves of the earnestness of the demonetisation enterprise, and even will themselves into believing in the inevitability of its success.

However, those with even a fleeting acquaintance with India’s previous experiences with demonetisation, and with the available body of economic literature on the subject, were not so easily persuaded.

Those misgivings were amplified when, even during the 50-day window that Modi sought for the demonetisation exercise to be completed, the RBI and finance ministry mandarins resorted to a tragicomic whack-a-mole, tweaking (on average, about twice a day) their rules for the note exchange and the deadline for it.

Even discounting the costs incurred in terms of human capital loss — over 50 days, millions of people across the country queued up for hours to exchange notes, leading to up to 150 unnatural deaths — the final balance-sheet of the demonetisation exercise, as drawn up by the RBI, bears thunderous testimony to its failure to accomplish its primary goal: the amount of notes that were, in reality, extinguished.

The RBI’s annual report, released in August 2017 — nearly 10 months after the demonetisation announcement — yielded the sobering verdict that ₹15.28 lakh crore in demonetised notes had been deposited with banks. That accounts for 99 per cent of them. In other words, all that strenuous exertion, all that agony, all those lives lost had, in the end, been in the service of extinguishing just ₹16,000 crore of purported black money. The mountain had gone into raucous labour, only to deliver a mite-sized mouse.

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The Modi government’s botched demonetisation exercise may have done grievous damage to the principle of a ‘less cash’ economy, but in fact the intellectual case for building such an ecosystem is not entirely without merit, and author Kenneth Rogoff makes just such an argument in his book The Curse of Cash .

Rogoff, a former chief economist at the International Monetary Fund, says that even today there are sound reasons — in India, and in many other countries — for gradually doing away with high-denomination currency notes as that will prove to be a dampener for tax evasion and crime.

For nearly two decades he has been explaining how such phasing out of high-denomination currency notes will make it progressively difficult for anyone to engage in recurrent, large and anonymous cash payments (which are typically correlated with crime, including tax evasion). Virtually every one of the criminal activities that Rogoff says are facilitated by the “curse of cash” — from corruption to tax evasion and sponsorship of terrorism to counterfeiting to human trafficking — applies with greater malefic effect to India.

In that limited sense, the foundational premise of Modi’s dramatic demonetisation announcement may have had some merit. And yet, it’s almost as if his policy advisers adopted an a la carte approach to Rogoff’s prescriptions, picking in whimsical, piecemeal fashion only those that appealed to them and discarding the rest. For instance, Rogoff argues that small-denomination notes can, and must be around indefinitely. And in the Indian context, he explicitly states that the country currently lacked the financial inclusion infrastructure that is a pre-requisite for transitioning to a “less cash” economy.

As Rogoff explains in a passage that Modi’s policy advisers evidently overlooked, “the speed of transition (in phasing out high-denomination currency notes) needs to be slow, stretching changes out over at least 10-15 years. Gradualism helps avoid excessive disruption… It puts authorities in a position to make adjustments as issues arise…” More crucially, Rogoff writes, “it is essential that poor and unbanked individuals have access to free basic debit accounts… and possibly also basic smartphones.”

In fact, that passage makes clear precisely where the Modi government erred in its note ban. Being a man in a hurry, and given the absence of certainty about even another five-year term (to say nothing of being in power for 15 years), Modi appears to have abridged the Rogoff-recommended transition time-scale to 50 days. Additionally, he and his policy advisory team made the cardinal error of putting the ‘demonetisation’ cart before the ‘financial inclusion’ horse. And their failure to foresee how corrupt entrenchments would leverage the gaping loopholes in the system (such as the tax shelter for agricultural income and for political donations below a threshold) reduced them to a bunch of ill-equipped fire-fighters.

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There is no doubt in anyone’s mind, except the most politically partisan or ideologically committed, that the demonetisation exercise was a failure. Virtually every one of the pillars on which the rationale for the enterprise, as articulated on November 8, 2016, rested — black money, fake currency notes, terrorism funding — has since collapsed under the weight of muddled implementation and unmet objectives. Even the political establishment’s post-facto attempt to shift the goalpost has run aground.

Indicatively, even during the ‘50 days that shook the system’, the Modi government began to soft-pedal on its stated ‘surgical strike’ on black money “hoarded by anti-national and anti-social elements”. It began instead, with the Prime Minister himself taking the lead, to roll out the narrative that the grand project was, in fact, to administer a policy ‘nudge’ — or, more correctly, a ‘shove’ — towards a wider embrace of the ‘digital money’ economy.

There is, of course, some merit in the ruling establishment’s claim that the mere return of ₹15.28 lakh crore in currency notes does not imply that it was all white money. (It is another matter that such a claim goes against the grain of Jaitley’s earlier proposition that money that is inherently tainted would not dare find its way back into the system for fear of inviting punitive attention.)

The money trail that has presumably been established in the deposit of these hitherto-unaccounted-for currency hoards opens up the possibility that the campaign against black money hasn’t yet fully run its course. But if it transpires, as it well may, that these transactions had been so channelled as to wipe out their digital footprints or otherwise game the system, the entire demonetisation exercise will have proven itself to be, as Opposition parties have termed it, a massive money-laundering scheme.

The unvarnished fact of the matter is that the campaign against black money and corruption is a non-starter if it fails to acknowledge its source in the funding and functioning of political parties. And for all the grandstanding, no political party has credibly addressed it. Modi himself made a passing mention in his December 31, 2016 television address, bringing down the curtain on the 50-day currency exchange window. Acknowledging that political parties and leaders and electoral funding figure prominently in any debate on corruption and black money, he urged “all parties and leaders to come together in prioritising transparency, and take firm steps to free politics of black money and corruption.”

However, such anodyne articulation of noble intentions and a syrupy call for high-mindedness when it comes to addressing the politically corrupt ecosystem sits incongruously with a leader who is manifestly keen to be seen as decisive and capable of taking tough calls. Particularly in one who staked — and squandered — so much of his political goodwill in the demonetisation exercise, it comes across as exceptionally tepid. In that context, the notebandi exercise extracted an enormous price in terms of a diminution of Modi’s image, one which he had crafted to perfection during his years as Gujarat Chief Minister, as a steady hand at the administrative wheel.

The blot has since been amplified by the chaos surrounding the problematic implementation of the Goods and Services Tax (GST), but it was the note ban that arguably exposed his fallibility, which even the electoral success in Uttar Pradesh has failed to offset.

And yet, for all the perceptions of Modi’s failings, it is countless ordinary folks across the country who bear the burden of the real wages of demonetisation. By every conceivable matrix of performance, it was a reckless policy venture that failed demonstrably to meet the very objectives it sought to accomplish.

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