18 Nov 2016 19:04 IST

Demonetisation: Has the BJP scored an own goal?

West Bengal CM Mamata Banerjee and former J&K CM Omar Abdullah lead a delegation of MPs from opposition parties in a protest march against demonetisation, on the opening day of Parliament's winter session | PTI

Short-term pain for the common man apart, experts warn of economic and political collateral damage

It has been more than 10 days since Prime Minister Narendra Modi, in a ‘shock and awe’ move, announced the withdrawal of ₹500 and ₹1,000 notes, replacing them with new ₹500 and ₹2,000 notes.

There is little doubt now that this move has led to a great deal of disruption in the lives of common people across the nation, despite its laudable objectives of flushing out black money and ‘purifying the nation’, as Modi said in his speech to the nation.

The move sent shock waves through all sections of society, not just those who have been hoarding black money. As the existing ₹500 and ₹1,000 notes became invalid tender, it set off a panic wave among the people. From the next day on, banks were flooded with people trying to exchange and deposit their old currency notes. The crowds hardly seem to have abated even after 10 days, which only shows how unprepared the government was to deal with the new situation. And spare a thought for the poor bank staff; they have been working non-stop since then, without even a day’s break.

Is the move justified?

So, given the severe disruption the day-to-day lives of large sections of the population, was the government’s move justified? Are the long-term gains worth the short-term pain? Is the current demonetisation really going to flush out black money?

Going by the government’s own admission, the demonetised high-denomination currency notes formed 85 per cent of all transactions in the economy. So, sucking out 85 per cent of liquidity from the system will surely affect the economy severely. 

Though the middle-class has also felt the strain of demonetisation, most ordinary folk seemed to be in favour of the move. But the issue of black money is a lot more complex and a simple demonetisation is unlikely to rid this country of this serious problem, as some people seem to believe.

Curbing black money generation

Columnist Swaminathan Anklesaria Aiyar, in his recent column, brings out succinctly how black money is both a stock and flow concept. That is, black money is not only stocked but it is also being continuously generated. So, though the recent demonetisation may make some dent in the current stock of black money, it will not stop black money from being generated in future.

For that to happen, the government will have to take a whole lot of other measures, such as dismantling the politician-businessman-bureaucracy nexus, cracking down on corruption, tightening the tax administration system, monitoring sectors where black money is generated and circulated in large quantities (real estate, films), putting in place a strong whistleblower policy, and so on.

Besides, even when it comes to the stock of black money, only a small proportion of it is hoarded in currency notes as much of it is invested in gold and property.

Some economists and analysts have been severely critical of the government’s move. Pronab Sen, former Chief Statistician of India, in a recent interview goes as far as saying that: “the so called black money serves a very useful purpose; most of it doesn’t sit around but goes back into circulation in the informal sector through activities such as money lending. If there is permanent destruction of black money, the impact on the informal and rural sector can be very large.”

Importance to economy

Now Sen is not trying to condone the existence of black money, as Modi supporters might be quick to suggest. The important point he’s trying to make is that the black economy, often mistakenly called the parallel economy, is not something that exists out there in a vacuum, but is intricately intertwined with the ‘white economy’ as much of the black money gets circulated and finds its way into the white economy.

Economist Arun Kumar, former professor at Jawaharlal Nehru University, is an authority on the subject of black money, having researched it for over three decades and publishing a book on it in the 1990s. In a recent interview with Caravan magazine, he says that it is important to differentiate between black money and black wealth. He says that black wealth is parked but black income is flowing and is categorical in saying that the recent move will not curb the generation of black money.

Kaushik Basu, Cornell University Professor and, until recently, World Bank Chief Economist, said in a tweet that demonetisation was not ‘good economics’ as its collateral damage would far outstrip its benefits. “GST was good economics; the demonetisation is not. Its economics is complex and the collateral damage is likely to far outstrip the benefits,” he said. 

Farmers are also likely to suffer hardship in the upcoming Rabi sowing season, given the shortage of currency notes they will need to buy fertilisers and other inputs, as brought out by several newspaper reports. Keeping this mind the government yesterday, in a relief to farmers, allowed them to draw ₹25,000 per week against crop loans.   

Will recovery be affected?

Now it will be interesting to see how the demonetisation move will impact the economy and polity in the medium term. Will the sudden contraction of liquidity curtail aggregate demand and sales of goods, hit economic growth and throw a spanner into the sputtering recovery?

Also, how will this issue play out in the political arena? The Opposition parties, led by the feisty Mamata Banerjee, have already gone on the warpath threatening to disrupt the Winter Session of Parliament. A number of State Assembly elections are due next year, including the crucial Uttar Pradesh. In recent weeks, the ruling Samajwadi Party in UP was wracked by very public infighting between Chief Minister Akhilesh Yadav and his supporters, on one side, and father Mulayam and uncle Shivpal Yadav, on the other, which the BJP was looking to exploit in the next elections.

So, will Modi’s kadak chai taste bitter even to his own party? Has the BJP scored an own goal by creating an issue that will galvanise the SP, BSP, Congress, and JD(U) against it in next year’s UP elections?

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