It is difficult to tell whether Prime Minister Narendra Modi anticipated the chaos he would unleash by withdrawing currency notes worth over four-fifths in value from circulation last week. The frustration and anger visible outside bank branches as the aam aadmi waited for hours and days to collect his/her money from the banks indicated the bad planning, governmental arrogance and portend of a disaster that may follow. The stated reasons for withdrawing Rs 500 and Rs 1,000 notes from circulation were either farcical or only partly true. To say that Pakistan was printing high-value Indian notes to finance terrorists could hardly be the reason for such a massive exercise. It would have been simpler for banks to check all high-denomination notes presented to them and weed out the forged ones.
As for controlling black or tax-evaded money, of the roughly Rs 18 trillion currency notes in circulation around 86 per cent are of higher denominations. Only a small fraction of these are hoarded by the rich. The rest are in circulation among the poor or the middle class, who have suffered in the last week by not having money for daily expenses or traders. The major way black money is generated is by taking it abroad either by under-invoicing exports or over-invoicing imports. It is often brought back as investment in the stock market through dummy companies set up in places like Mauritius and this amounts to nearly half of all foreign institutional investment in the country.
Of this huge amount, which according to a government estimate was Rs 80 lakh crores to Rs 200 lakh crores (or Rs 80 trillion to Rs 200 trillion), only Rs 6,500 crores had been disclosed, according to the PM. Apart from using their tax-evaded profits to transfer money by the hawala route abroad, the rich use their black money to buy expensive property and gold ornaments, besides splurging on luxury goods or donating to temples (whose earnings are not taxed). One immediate effect of the move will be that money will flow into bank coffers. And this would shore up bank finances besides helping the government gather more taxes and avoid bailing out the banks. According to Moody’s, nationalised banks need Rs 1.25 trillion in capital infusion to help balance the huge Rs 6 trillion in bad loans, most of which is to the 10 largest borrowers.
An obvious but little noted reason for the demonetisation are the coming elections in Uttar Pradesh, Punjab, Gujarat and Goa, in all of which the BJP and its allies face challenges. Ruling at the Centre, the BJP has the ability to bestow favours on the richest and most powerful industrialists, all of whom keep their money in forms other than banknotes. Like during the 2014 general elections they are expected to fund the BJP lavishly, while its rivals, the Bahujan Samaj Party and the Samajwadi Party in UP and the Congress and the Aam Aadmi Party elsewhere, will be handicapped in their ability to gather funds from smaller industrialists after removing the higher-denominated notes from circulation.
This exercise in realpolitik, rather than desire to cut the supply of black money, seems to be the real reason for Mr Modi’s apparent concern for unaccounted money. He has shifted the debate from the state of the economy to a moral high ground of curbing the illicit generation of wealth. Even though the political Opposition has seen through his game, they are unable to say that their funding of elections in March has been stymied. Though Mr Modi’s gambit may seem unbeatable, several question marks remain. While the BJP will undoubtedly have greater financial resources than the Opposition, the mood of the people is all important. Mr Modi loudly proclaims that the demonetisation was done to clean the system from the parallel economy’s ill influence and he has promised the country that the attendant problems of short supply will not last beyond December end.
The problem is partly of logistics. High-value notes worth Rs 18 trillion will have to be printed and distributed in this time, or roughly Rs 500 billion worth per day. These notes have accumulated over the past 10 years, when the government presses were working. Can they be made to print at this accelerated rate to make up the shortfall or will they prove inadequate? Is it just a matter of bad planning and execution or is the scheme itself flawed?
In no other country at any time has an overnight change of the currency even been attempted. The time given is several weeks or even months. But then without a surprise shock the political Opposition would have easily met the shortage, and the BJP would have gained no material advantage in the elections to four states next March. The uncertain factor is whether the government will be able to convince angry and frustrated people that its decision was done with the altruistic intention to clean the system of tax-evaded wealth and not to gather funds mainly for itself in the forthcoming elections. Much will depend on the level of disruption in daily living that the lack of adequate currency brings.
Middle class frustration, amplified by TV coverage, can subside over a period. A riskier possibility is that of the wholesale markets being disrupted for any length of time because of shortage of money. That could lead to shortages and price increases of daily necessities like food. Then public anger would mount, the government would lose credibility and no amount of election funds could save it.
The writer is a Mumbai-based freelance journalist
