Demonetisation is government's war against people, not fight against black money

The reason why millions of common people of our country are patiently undergoing the enormous pain inflicted by the sudden proscription of Rs 500 and 1,000 currency notes announced by PM Modi on the evening of November 8, is because they have been led to believe that this will help in eradicating black money.

This is the reason why many opposition parties, while voicing dissent on the logistical unpreparedness of the government in dealing with the cash chaos, have not opposed the demonetisation decision per se.

While the government has also earned a rap on the knuckles by the Supreme Court, the concern with black money has prevented the apex court from staying the decision so far – despite the draconian nature of the decision.

But are we asking the most important question – how exactly will demonetisation help in stamping out black money?

The demand to demonetise high denomination currency notes to eliminate black money has been championed in recent times by a Pune-based thinktank, Arthakranti, which comprises a group of chartered accountants and technocrats.

This thinktank has other "radical" proposals to offer vis-a-vis "cleansing" the economy, like limiting cash transactions, routing all market transactions through banks and replacing all direct and indirect taxes including income tax with a single tax on all banking transactions.

Media reports suggest that the prime minister has certainly been influenced, if not entirely guided, by the Arthakranti prescription on demonetisation.

While there are several problems with the Arthakranti proposals, the most fundamental one lies in its very conception of an economy, especially an economy of India’s size and population.

The national economy is not simply like a company’s balance sheet, where liabilities are matched by assets. An economy is about macro-dynamic processes involving investment, consumption and trade interacting with each other to generate output and income.

Economic policies – whether fiscal, monetary, financial, industrial, agricultural or trade related – are based upon a basic understanding of the causalities behind these dynamic processes.

There are several debates and disagreements in economic theory over the direction of causalities, which get reflected in economic policy debates – like whether a widening of the fiscal deficit can enhance growth? Or whether a cut in the interest rate can cause inflation? But both sides in these debates are informed by a certain view of the causalities behind the macroeconomic processes.

The stakes in these debates are always high, because the economy is populated with a very large number of human beings and economic policies have great impact on their lives and livelihood.

The proposals floated by Arthakranti fail to take the macro-dynamic processes underlying an economy into account, confuse cause-effect relationships, and are hence unrealistic and impracticable. This should have been obvious to anyone who understands the basics of macroeconomics and economic policymaking.

Take the idea of demonetisation of high denomination currency. The proposition that has been floated widely through the mainstream and social media is that the "black money" held in Rs 500 and 1000 currency notes will either get "caught" by the IT department if it is deposited in banks by the hoarders, or will get destroyed.

It has been argued that in case all the Rs 500 and 1,000 currency notes do not return to the banking system by March 31, 2017, the RBI will "gain" because that part of its liabilities in currency notes will get "extinguished".

Given that the current value of all Rs 500 and 1,000 notes in circulation stands at around Rs 14 lakh crore, various figures ranging upto quite a few lakh crores have been suggested, as a possible "recovery" of black money which can then be transferred as dividend by the RBI to the government.

The argument that currency notes not returned to the RBI by end-March next year can be considered as "extinguished liability" is itself questionable, given that RBI’s promissory note contained in currency notes do not specify any end-date. Former RBI deputy governor Usha Thorat has recently clarified:

"Withdrawal of legal tender character does not extinguish the liability or the promise to pay by the RBI. Legally, as long as the old note is brought to the RBI’s counters, the promise has to be honoured. Technically, it is possible to reduce liability in the balance sheet under 'notes in circulation' but the consequent reserves created will have to be kept on the balance sheet to honour the promise any time the notes are surrendered in future. So there is no free lunch!"

Moreover, the former RBI governor C Rangarajan has stated in a recent interview :

"To me this is a liability which is getting extinguished therefore on the liability side of the issue department it is coming down and therefore what will happen is some amount on the asset side or equivalent amount on the asset side will have to come down. Therefore this is basically a balance sheet problem and it is not a profit in any sense of the term. The reduction in the liability side will be matched by the reduction in the asset side...I think the profits that are made by the RBI are essentially out of the current transactions. There is no capital gain or capital loss as far as the RBI is concerned. Therefore I would really say that there is no scope for any extra dividend to be declared to the government. Basically it is a simple adjustment on the balance sheet."

We are yet to hear anything concrete on this from the government, apart from the 50 days window which the PM has sought from us to fix the problems. However, if there is no fat cheque coming from the RBI to the public exchequer after March 2017, what would happen to the "recovery" of black money?

If the basic premise of the demonetisation "masterstroke" turns out to be an erroneous one, why did those 55 innocent Indian citizens have to die standing in the queues of banks and ATMs? The Supreme Court, Opposition parties and the media need to ask these hard questions to the government.

While the hollowness of the naive balance sheet reasoning behind demonetisation is becoming apparent, the hard macroeconomic logic of a sudden proscription of almost 86 per cent of the Indian economy’s currency in circulation is being learnt the hard way.

Faced with an unprecedented liquidity shock, markets are coming to a standstill. With the government and the RBI failing to ensure adequate supply of new currency notes in quick time, a deflationary spiral has already come into play, which will certainly cause a growth slowdown and may possibly precipitate a recession.

Millions of people across cities and villages are going to be affected, through losses of jobs and livelihoods. It is ironic that while the Indian economy could insulate itself from the worst outcomes of the global recession in 2008-09, an economic downturn now appears to have been caused by a government’s policy faux pas.

Having created extravagant media hype around demonetisation, there is now an attempt by the government and the ruling party to shift the goalposts of the debate, by pointing towards widespread instances of money laundering. That only goes on to prove the defective nature of the demonetisation plan itself, with the government having failed to anticipate and plug the plethora of money laundering avenues.

We are being subjected to the vagaries of frequent changes in cash withdrawal limits alongside kneejerk responses to high deposits under Jan Dhan Yojana accounts or surges in bookings of railway and air tickets. If this is the way to fight the "war against black money", the outcome is a guaranteed Waterloo.

Several economists and commentators, including this writer, had provided early warnings to the government in the aftermath of the November 8 decision that the demonetisation move will inflict high costs on the economy and the people, against very elusive benefits.

It was pointed out that a very small proportion of black money is hoarded as cash; most of it is held in benami properties in land or real estate, precious metals and offshore bank accounts.

Moreover, black money is generated through the myriad processes of tax evasion and other illegal activities by the big corporates and the financial elite, about which the government is doing nothing.

It has also been pointed out that the proportion of counterfeit currencies in total currency notes is too miniscule to warrant the proscription of entire denominations – no country in the world resorts to such excesses.

Also, an effective policy-push towards cashless transactions cannot be through coercion and impositions. That requires a much larger banking penetration among the rural and urban poor, besides greater access to electricity, internet and smartphones, than this government has even attempted to achieve.   

PM Modi has, however, turned a blind eye to such critiques. The hubris and obduracy of the government is converting the fight against black money into a war against its own people.

Also read: Demonetisation has turned India into world’s fastest slowing economy

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