Demonetization : An Analysis

Is demonetization a boon or a bane for India?

Background of the Indian Cash Economy 

The Republic of India still operates with the motto that “Cash is King” (apologies in advance to indignant feminists). Despite not having a monarch as our head of state, the treatment meted out to hard cash is the nothing short of a royal salute. Over eighty percent of all financial transactions throughout the country occur in cash, eighty six percent of this cash is in denominations of 500s and 1000s. This is quite unlike other developed countries where cash transactions are just under twenty percent of all financial transactions.

In India, paper currency is extensively used as mode of payment for small businesses such as restaurants, shops, vegetable vendors, and fish mongers. For public transport such as trains, buses, and taxis the preferred mode of payment is cash. Cash is also the mode of payment for daily wage laborers such as plumbers, carpenters and construction workers. Rural and small town economies in the heartland run predominantly on cash, this includes the farming economy and small scale industries. While this is gradually evolving due to the omnipresence of smartphones and high speed internet, it will take decades for our businesses to function sans hard cash.

Surprisingly, the preferred mode of payment for high end boutiques, jewelers and departmental stores is cash, this despite amounts being are rather large and the presence of credit or debit card payment facilities. In real estate,  reputed builders are known to openly demand payments in ‘white’ i.e. legitimate and trackable modes of payment such as cheques and in ‘black’ where the mode of payment untraceable, usually hard cash. To accommodate for the black amounts, even tax paying individuals are compelled to withdraw big volumes of money from banks. The official price of the property (that is taxed) is the amount paid by cheque. Many small and medium level businesses also operate in a similar manner, i.e. part white and part black. Professional such as doctors, lawyers, private tutors and accountants still prefer cash as payment.

Cash is also used to fund unsavory activities such as bribing officials, criminal activities such running prostitution ring, gambling, extortion, contract murder and the sale of narcotics. Hard cash is also used to fund terror activities. Jihadist groups have managed to penetrate hawala system all over the world in order to transfer funds for their activities without being detected. These funds that usually originate from the Middle East eventually end up in India via Pakistan. Also, infiltrating terrorists usually come armed with millions of counterfeit currency that is impossible to distinguish from genuine currency. Naxal terrorists also operate in an almost identical manner. The cash used is always of higher denomination and is often stashed in concealed locations.

In a vast country such as India, it would be impossible to track down each and every small business or professional that deal in cash for tax evasion purposes. Perhaps in some cases the benefits would be far less than the effort. Similarly, tracking terror networks and their funding also takes a great deal of time, effort and money. Since the funding occurs in a clandestine fashion from abroad, it may be beyond the jurisdiction of Indian laws. By the time proceedings are initiated to go after these forces abroad the trail usually turns cold. The army and intelligence does their best but despite their efforts, there will always be one that slips through and causes catastrophe.

The only way to convert this seemingly unrealistic target of fighting crime, terrorism and tracking black money into an achievable objective is to stop the blood supply that enables these monsters to thrive. The blood supply in all cases is hard cash. To invalidate currencies is perhaps the quickest, most cost effective and easiest way to bring criminal and terror activities to a grinding halt. It will also compel those operating in cash to evade tax to turn in their illegal money.

Thus demonetization is sterling idea and must be lauded by everybody. But a great idea is worthless without great implementation. For a great implementation there needs to be a clear understanding of the magnitude and the complexity of the problem and the impact it would have on 1.2 billion people in India.

The following is an attempt to examine the successes, the failures and challenges related to this demonetization exercise. In some cases the same action may have elements that worked and elements that did not. 

What Needs Attention...

Communication

In this era of instant communication, it seems almost unthinkable that the government would take a step such as this without setting up proper communication channels. Call centers should have been setup to answer basic queries, resolve doubts and counter misinformation from the opposition, the media and conspiracy theorists. A lot of people queuing outside banks and ATMs did so owing to misinformation, having an active channel of communication would have saved a great deal of bother to a great many people. This service should have been be toll free, multi-lingual, and accessible via all phone services all over the nation. This number should have been advertised across all media. On social media, dedicated accounts should have been set up to perform a function identical to the call centers.

In fact the government should setup permanent accounts on social media to fact check the many falsehoods from the media and the opposition

Unsuitable Replacement

The rule is rather simple, before withdrawing any essential item, provisions must be made for an equivalent replacement. When plans were made to withdraw old notes of 500s and 1000s, there should have been a plan in parallel to print 100s and 500s, also to disburse them to the banks. Prior to initiating the demonetization, an inventory of the currency should have been done to verify if there was enough and equivalent new currency to replace the outgoing currency. But instead during the initial phases, notes of 2000s were offered as replacement, which was unacceptable everywhere for the simple reason that the currencies of change were either scant or invalid. For many the 2000s, seemed like a cruel practical joke.

ATM Mismanagement

ATMs are the only round the clock service for withdrawal of cash especially in emergency situations. Arrangements should have been made to ensure a quick and seamless transition of ATMS to accommodate the new notes. A feasibility study should have been performed to understand the time taken to recalibrate the machines, also an understanding of ratio of the number of trained service personal to the machines. But in reality there was a considerable amount of downtime that caused massive queues outside ATM centers.

Handling Repeat

It was obvious that owing to the limit on the cash exchange and withdrawal, attempts would be made by the same people to withdraw money repeatedly. Also people with illegal wealth would pay their employees to proxy for their bank activities.  It would have made sense to have a centralized system to be setup that would prevent individuals with the same pan card or Aadhar card from exchanging or withdrawing money. This centralized system could also lock an account for a specific period the moment a specific account is withdrawn.

Cash Problems for Foreign Tourists 

The people most hit by this were foreign tourists who suddenly witnessed all their cash reduced to nothing. The government could have had banks collaborate with various embassies and travel agencies to facilitate easy exchange of cash.

Effective Distributing

The biggest problem was the interminable queues outside ATMs and Banks. As suggested by Dr. Swamy, the government could have worked with the major employers such as corporate houses and public sector institutions to facilitate easy distribution of cash for employees. There are several villages all over the country that still do not have adequate banking facilities. To resolve this and the problems of distribution in general, distribution vans could have been set up all by various banks.

Addressing the lack of Government Issued Identification

There have been reports of individuals without government issued identify cards and bank accounts. Prior to implanting demonetization, the government should have conducted a national survey and made it mandatory (not just a recommendation) that individuals have identity cards and Jan Dhan bank accounts.

Addressing the potential Global Impact

With initiatives such as ‘Make in India’, India desires to be the service and manufacturing hub of the world. But this demonetization drive, however noble the intensions may, could send signals of capriciousness on behalf of the government and a general economic instability. The government should reach out via it’s ambassadors in various countries to the global community to educate them about the virtues of demonetization and how it will eventually enable ease of business and transparency.

The Timings

According to the Hindu calendar, this is season for weddings, where a great deal of arrangements are made via cash. Despite making provisions to exempt individual involved in wedding ceremony from the limits of withdrawal. There is no denying that this demonetization exercise is quite troublesome. Also, exempting one group may make another group feel that they have been treated unfairly. The government must be transparent with the people about the reason behind the timing of demonetization.

Democracy and Capitalism

In a free society individuals should be allowed to do whatever they want with their money, as long as no laws are broken. By applying caps and restrictions even on citizen, the state is walking into dangerous territory of playing big brother. While this may be for a worthy cause, people with clean finances have every right to complain about the restrictions, especially those who had genuine need for money. It is also very wrong to presume that all stored cash is dirty money, there are genuines cases of people stocking clean cash at their homes for emergencies. Encouraging citizens to participate in banking is a great idea, but this seems is a compulsion. 
It also brings up questions the role of government in the lives of citizens. Does government have a right to influence behavior? Is this encouraging the binary thinking mentality, i.e. anyone who supports demonetization is an honest patriot and anyone who doesn’t is a black money holding traitor?  It this demonetization the beginning of more compelled morality exercises by the state? These are serious questions to ponder over.

Work Worked...

Money in Banks

For the country to function properly, it is essential that every citizen participates in the legitimate economy and the role of the informal economy is curbed. This means all the money not being actively used is deposited in the banks for circulation and taxation. It also earns the depositor an income in the form of interest. After demonetization, every Indian will be compelled to deposit amounts in the bank, this includes Jan Dhan accounts many of which had no balance at all. Judging by the amounts that have come into the banks this mission has resoundingly been accomplished.

Defaulters No Longer
Demonetization has compelled serial tax defaulters to clear their dues and even pay their advance taxes. Many compulsive defaulters of electricity and telecom bills have also been compelled to pay their long running dues. This undeniably is a boon. 

Prior warning given.
Despite claims by the media and the opposition of the abruptness of this move. The Prime Minister during his radio address to the nation had urged people to disclose their undisclosed income by 30th September, there was also a warning 'difficulties' upon failure to do so. While many have termed this move as draconian and unconstitutional, it proves that defaulters had plenty of time to clean up their act.

Forced Modernization for small businesses

The unintended short term victims of demonetization are small businesses that deal strictly in cash. Consumers have had no choice but to turn to departmental stores to conduct their purchases owing to their facility of digital payments. In order to be competitive, it will be essential for these small business adopt digital payment facilities. They will also be compelled to register their business which will give them legitimacy. This will benefit them in the long run and enable them to compete with even the biggest of departmental stores.

Taking on even their own

While the government launched its campaign to cleanse the nation of black money, a former minister hosted a lavish wedding of with an estimated cost of Rs 500 crores. This drew severe criticism from all corners, some even suggested of complicity. A few days ago there was an IT Raid at the host’s offices. If it is established that the money used was indeed illegal and the culprits are punished, it will prove that this government believes in equality for all and favoritism towards none.

Controlling the fiscal deficit

The money coming in will doubtless play a major role in reducing the fiscal deficit that is crucial for the economy.

Counter Terrorism

It is well known that Pakistan has pumped in millions rupees for fomenting terror across India. These funds were spent on training, communication, purchasing of arms and ammunition for local terror cells. This de-monetization exercise that has rendered all big currency notes in possession of terrorists and their patrons absolutely useless. A similar effect has been observed for the left wing terro groups such as the Maoists and Naxalites.

We have already witnessed a stop in ‘agitations’ and terror activities in the Kashmir valley. The counterfeiting of notes will also come to a stop, for some time at least, as it will be very difficult to create replicas of new notes owing to their complex design. In order to prevent new notes from ending up the the wrong hands, the government must ensure tight security for banks in terror prone areas.

Clean Up Dirty Money in politics

After this demonetization exercise, we have seen major political parties withdraw from elections and scale back on political events, proving that illegal money is widely used to fund election campaigns. There have been many politicians who have gone berserk in the reaction against this move, proving perhaps it is personal. 

The Future...

This demonetization exercise will only be a success if it is regarded as the first phase of a massive undertaking to drain the swamp. Despite seemingly insurmountable opposition from every corner, other tough measures will have to be implemented summarily, as alerted offenders may be actively planning other ways to beat the system. 

The government will have to track accounts where there have been movements of large sums of money during the demonization period to investigate possible wrong doings. There must be a systematic inventory of all property values versus the income of owners, benami property must be impounded immediately. The government must continue to actively collaborate with foreign governements to obtain lists of Indian national with monies stashed in banks abroad. 

This is also the right time to clean up our political campaign finance system. Anonymous donations must be made illegal, any party found accepting such donations should be suspended for a specific period. Every political party must be compelled to declare all their donors and their respective donation amount, this should be open to independent audit. 

The government must make it mandatory for pan card copies to be submitted for purchases above a certain limit, this should be irrespective of the goods or services being purchased or the place of purchase, this rule must also apply to donations

There is no denying that the average citizen has had to go through hell over the past few weeks as they queued for hours to exchange, withdraw and deposit their hard earned money. But it is said that everybody has to go through hell to archive their paradise. The functioning of a democraty is always two tier one tier is the government and the other is the citizen. Hence for the paradise to be achieved the citizen and the government will have to fulfil certain basic obligations. The citizen will have to practice great restraint and not ‘help’ anybody to convert dirty money into legitimate money, no matter what the incentive or inducement is. The government will have to show the citizen clear and tangible benefits from this demonetization exercise within a specific time frame.

Some of the clear benefits should be a reduction in essential taxes such as income tax and sales tax on goods, an abolition of gratuitous taxes such as Swatch Bharat Tax and Kisan Vikas Tax. A considerable reduction of inflation. This hopefully will compel builders to bring slash down their prices and conduct business in legally. It will hopefully compel all those dealing in dirty money to clean up forever.

Despite its flawed implementation, this demonetization doubtlessly was the morally right thing to do. In an era of blatant populism it is rather brave to push for cleanup exercises such as this, which could potentially upset voters. Hopefully when the benefits of this exercise are reaped, the people will be forgiving of their troubles and this government will go down in history for its moral courage to drain the swamp despite impediments, obstacles and ugly noises from corners.