Note ban: The demonisation has begun

We are now well into the third week of yet another “surgical strike” (as described by BJP chief Amit Shah) by the Prime Minister’s magic wand attempt to cleanse the national economy of “black money” by demonetising two high-value currency notes. But by demonetising the '500 and '1,000 notes, the government sucked out almost 87 per cent of the money in the market. When Prime Minister Narendra Modi announced this demonetisation to rid the nation of “black money” — which really means income and financial transactions that didn’t realise for the state its rightful share of taxes — the entire nation welcomed it. The other reasons the government gave for this is that it wanted to purge the system of counterfeit notes and break the terror finance network.

With the benefit of cold hindsight, and with the comfort of not having to go against the now clearly-waning popular sentiment for demonetisation, it’s evident the government was clearly unprepared to embark on such a major “reform”. The nation has now witnessed the breakdown of the financial system and the severe pain it has inflicted on the hundreds of millions who sustain themselves as daily wage earners, small retailers of perishable goods and farmers who have to invest now to sow fresh crops and reap harvests of foodgrains and fruits and vegetables. The nation has thus belaboured the Prime Minister severely, and the PM, proud of his broad chest, has been reduced to tears at least twice in the past fortnight.

What went wrong? The first is very obvious. It should have had enough of the new currency notes for transfusion to replace the withdrawn lifeblood. It also didn’t build up meaningful stocks of the existing '100 and smaller denomination notes to make everyday transactions possible without much dislocation. That was not the case. It is now clear that the RBI will take many months just to replace the high-value notes. Till then the anemia will persist. There is bound to be economic costs for this prolonged anemia. On Thursday, former Prime Minister Manmohan Singh, less of a politician and more of a top-notch economist, estimated the consequential contraction of GDP to be around two per cent. Recently, I was in a discussion with several senior economists and the most conservative estimate was a drop in GDP by at least 2.2 per cent. That kind of sudden contraction, at about the halfway point of the financial year, will mean that the immediate contraction is going to be much more painful.

Consider this. Almost 40 per cent of the GDP is in cash transactions. As much as 31 per cent of adults do not have bank accounts. The Jan Dhan drive has indeed substantially added to the number of bank accounts. But nearly half of the additional bank accounts are “zero balance” accounts. Creative optical solutions being this government’s forte, all these accounts have now been credited with '1 each to take them out of this column.

With this looming contraction in the immediate future, one would not be surprised if the government will once again resort to creative optical solutions by “improving” national income accounting by putting new values to unrecorded production and services. For instance, by re-estimating the value of chappals made by village cobblers or the value addition of panwallahs. But then don’t compare it with earlier growth rates. The last such tweak gave this government an additional 2.2 per cent GDP boost, but was misused by it to suggest the train was moving faster.

Now look at the scale of damage caused. India has a workforce of close to 450 million. Of these, only seven per cent are in the organised sector. Out of this 31 million, about 24 million are employed by the state or state-owned enterprises, the rest being in private sector employment. Of this vast reservoir of over 415 million employed in the unorganised sector, about half are engaged in the farm sector, another 10 per cent each in construction, small-scale manufacture and retail. These are mostly daily wage workers and mostly earning less than the officially-decreed minimum wages. Thus, a good part of this so-called “black money” which the government has choked off — held in '500 and '1,000 notes — is actually money in flow. What the government is seeking to unearth is a smaller part of the money in stock, which is held by business people, politicians and bureaucrats. But in its professed anxiety to unearth this, the government has effectively thrown out the baby with the bathwater. The economy may not have ground to a complete halt, but in hundreds of million homes the cooking fires are not being lit. This is because most daily-wage earners are not getting paid in full or even in part. And even if they are paid with the old notes, and even if they can enter banks, where are the smaller notes or even new notes for the banks to exchange them with?

The amount of “black money” held as cash is only about five per cent of the total tax evaded income. The rest is held in cash abroad, land and property, and jewellery and gold. Unearthing this will take some doing and in doing so officialdom and its political masters will only generate more “black money”. And consider this: as much as 55 per cent of FDI investment coming in (about $44 billon last year) is actually Indian-owned money round tripping its way back from the economy it fled from. Is the government now going to look at this gift horse in the mouth by asking these ECBs to declare their origins?

So after not anticipating the scope of the economic devastation visiting the nation, Mr Modi has taken a new tack. He is now hollering that he is fighting for the vast mass of the poor who have been looted all these decades by the upper classes. He has thus demonised the upper classes and has fired the starting gun for class warfare that would have made Lenin and Mao proud. He has even started saying startling things like “meri jaan ko khatra hai” due to his newly-donned mantle of the class warrior. His claim of death threats to him supposedly due to this has generated much consequential mirth in the social media, with a play on the word “jaan”.

Till now Mr Modi has been largely immune from this. He enjoyed huge support, even without the bot armies and professional social media manipulators, while he has also been hugely vilified. But, of late, he has become a cause of mirth. With that he has entered politically dangerous waters.

Will Mr Modi now retrace his steps somewhat and extend the deadline for the exchange of high-value notes? Will he now order the massive buildup of '100 and smaller notes to relieve the monetary anemia? This will no doubt mean some loss of face. But that is still better than loss of head.

The writer, a policy analyst studying economic and security issues, held senior positions in government and industry. He also specialises in the Chinese economy.