Demonetization in India – An impartial analysis


Demonetization is the hot topic in India now and the same is being discussed world over by media. Most of our media, including press and social media, is discussing the situation in India and the news is taking political colors as most of the opposition parties are all set to utilize this situation. Are they wrong or right? (read about one of my previous blogs about media going after trivial issues here). It’s essential at this juncture to make sure that we get an impartial analysis of this policy measure and it’s implication.

You’ll definitely get an impartial analysis in this blog as there are no mention about the political drama going on in India and no detailing about the extreme incidents pro & against this government decision.  It’s just going to find out the merits and potential flaws of this policy decision from an impartial perspective (read my thoughts about writing responsible and impartial opinionaires).

Black money in India – refers to funds earned on the black market or transaction, on which income and other taxes have not been paid. The total amount of black money deposited in foreign banks by Indians is unknown – some reports say it is of the order of more than a trillion US dollars. Black money once created, gets rotated across various markets and asset classes in search of better returns to the holder and in some cases go round tripping to come back as FDI to India.

The incentive to create black money mainly comes from two reasons. First, a major portion of the tax revenue collected by the government gets spend on sub-optimal projects (money pumped to level losses made by public enterprises like air india) or gets eaten up by the middle men and politicians involved in these projects – resulting in common man losing faith in the taxation system and it’s benefits. Second or a more important reason being the fact that we all are taught to look after ourselves before caring for others, which justifies evading tax by any means and being the shrewd wolf among the crowd.

During the last central government elections, one of the major manifesto focus by the current Prime Minister, Narendra Modi was a strong action against black money holders and to bring back all the black money deposited abroad by Indians back to India for the country’s betterment. Post elections, this became the most common weapon used by opposition parties against the BJP government as it came to power. Government has been making attempts to seize the corpus in foreign tax havens, but was not successful due to the intricacies in the international laws and regulations around transfer of information. In parallel the government also went with the attempts to clean up the Indian black money market – the final of that series of steps, at present being the currency demonetization of high denomination notes, viz., 500 and 1000 notes.

The intent of the Government of India in this move to demonetize the high value denomination notes were completely positive. I have summarized it in the below picture.

goi-intent

So overall it was aimed at:

  1. Giving a blow to the terrorism/anti-social activities
  2. Increasing the tax revenue
  3. Bringing down inflation
  4. Increasing monitoring and taxation efficiency
  5. Reducing physical currency costs (printing, security, distribution and currency chest costs)
  6. Increasing savings in banks and hence increase the investments in industry
  7. Reviving the brand image of government

I don’t think anyone will have two thoughts about the above objectives; as a country India wants to achieve these objectives and set itself on a strong growth trajectory to future.

Coming to the current situation (almost 10 days post demonetization), we have mixed response coming from all corners. Depending on the financial literacy, access to liquidity, and age group – the responses are varying and changing day after day. A potential illustration of the same is given below.

people-view

Benjamin Franklin’s quote “it is better 100 guilty Persons should escape than that one innocent Person should suffer” will make you think about the current scenario were both the innocent and the guilty are suffering – which is mainly because of the way this scheme is implemented. An overnight quashing of the RBP governor’s promise to honor the value of currency, have chances of bringing down the self esteem of the clean guys in society, which brings much criticism on the democratic government.

It is true that demonetization has achieved it’s objectives at least for the short term, in spite of the difficulties for common people. But over a longer time period this impact will mostly fade away, as illustrated below.

long-term-impact

This wouldn’t have been the case if the policy makers would have incentivized  the move to a cashless economy first, created necessary infrastructure in place and then demonetized high denomination currency notes overnight. A potential implementation approach that could have been more efficient is depicted below.

better-implementation

Most of the steps in the above plan is initiated and just the drive to get it popular (as in the case of Aadhar, JDY etc.) was only missing from government. So the potential plan could be:

  1. Aadhar UID – KYC and authentication mode for most citizens
  2. Jan Dhan Yojna – To get majority into formal Banking space
  3. Cashless transaction cost – Reduce the card transaction fees passed to Customer
  4. UPI Based Payments – To make everyone transact just like they email
  5. Low cost, wireless POS machines – Promoting kiranas to move into cashless mode
  6. Mini ATM – Wireless machine in Rupay network with mobile Moneyman based on Aadhar Biometric authentication. This could have been very effective in reducing long queues in front of banks
  7. Storing 200 notes in chest – Print & load Rs.200 notes in currency chests (secret move as in the case of 2000 notes). At least 50% of demonetization value is to be arranged to handle shortage in economy (assuming 50% moved cashless due to above steps). Demonetization will take away almost 86% of money, so that shortage needs to be handled
  8. Demonetize 500, 100 notes – Removing 500, 1000 notes from economy

In conclusion, move to a cashless economy should be incentive driven than a forced move. People will be willing to take any surprises as long as enough alternatives and preparations are in place for them. Remember government is the union for common man (read my previous blog on this topic here) and should implement positive policies with enough preparations.

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2 Comments

  1. Comment from a friend via whatsapp; pasting it here as its very relevant to this blog.
    ================================
    A quick feedback. I have been to 3 remote regions in Jharkhand,. Bihar, UP in my 13 year career. Accessing cash in an ATM has been a pain and still is a pain. I do a lot of internet banking, but for routine cash payments I am dependent on the institution I served/serve through cash advances. Whenever I make the 30 km journey to access ATM, I end up helping at least 2 people to access the ATM. And that is usually to check balance and not make withdrawal. 75℅ of the time, there would be no money. Today, I went to market. Wholesale business is down by 50℅ (but their previous payments are all stuck), medium business to 25℅ and very small businesses are either closed or has not more than 10℅ business. Cloth shops, tailors, shoe business – almost zero business.

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