Surgical Blow That Backfired

Set painful adjustment aside, long-term effects of monetary shock on our economy could be severe; large proportion of marginal firms may not survive loss of fortnight of income


People cueing outside their bank ATMs even though the bank has ran out of money, indicates about the bad management post demonetization — a stroke which was aimed to do good for the people of India. Even though people are patient as they still have faith into the leader who has taken this step against the black money — a major promise in his election manifesto — had there been a better management things won’t have gone past the control of the system. The Banking officials who were given time to tighten their belt for 48 hours after the announcement of the decision failed to meet the expectation of their Prime Minister. 

The ATM failure has made an important decision which requires a lot of courage into the leadership, a badly managed system. One fortnight after India’s sudden declaration that 500- and 1,000-rupee notes were no longer legal tender, the economy is in chaos. And that’s perhaps because the policy was designed as much to shock and awe observers with the government’s command of the Indian economy as to control India’s “black money” problem. What seemed at first to be a masterstroke by Prime Minister Narendra Modi now looks like a grave miscalculation. 


Modi is beginning to sound like he may agree. His recent speeches on the subject have been frankly bizarre. In one, he seemed to laugh at those inconvenienced by the ban; in another, he broke down while speaking of the “sacrifices” he had made for India, and warned that he might be assassinated by “forces” desperate to protect their “loot.” 

What’s changed in a week? Well, for one, it’s become clear that the government was simply too cavalier in its planning. Now that 86 percent of India’s currency is no longer valid, the central bank has struggled to print replacement denominations — and the new notes are the wrong size for existing ATMs. Modi’s asked people to be patient for 50 days, but the process could take as long as four months. 

You have to wonder if Modi truly sought expert advice, or relied once again on a small and trusted set of politicians to determine policy. India’s simply too big and complex for shock and awe. Large parts of the rural economy use cash for 80 percent of transactions and have been hard-hit. In seafood-mad West Bengal, for example, the fishing industry is in a state of near-collapse; in the wheat-growing states of the northwest, farmers halfway through the sowing season have run out of cash to buy seeds.

Few villagers have access to an ATM. Most have to trek to a bank branch to change their cash, which means losing out on crucial days of labor. Many Indians, particularly women, still don’t have an active bank account. Finance Minister Arun Jaitley wondered aloud how many poor people would even have 1,000-rupee notes — probably a rhetorical question, but surely it shouldn’t have been. Someone should’ve sought the answer before shutting down India’s financial system. 

Among India’s middle class, Modi’s “surgical strike on black money” still appears to be popular. It’s the old “vegan fallacy” — if something tastes terrible, it must be good for you. Enough Indians are suffering that they believe it must be in a greater cause. It’s a moral project, not an economic one. Stand in line, we’re told, and you honor our brave soldiers at the border. 

But will that support last? The government’s plan is likely to be ineffective in the long term. Economists agree it will have no effect on the generation of black money through corruption. 

Meanwhile, estimates of the amount of black money that will eventually be recovered vary widely. The optimists (wrongly) think enough cash will be destroyed by hoarders that the central bank will be able to pay a hefty dividend to the government. Others point out that a very small fraction of black money tends to be held as cash and that there are a dozen ways still available to launder that fraction. The government has largely failed to close these loopholes. Worse, rumors of the demonetization were reportedly circulating before Modi’s announcement, leading to suspicions that the well-connected may have had time to dump their cash piles. 


Even in the best case scenario — that a significant proportion of the outstanding currency is destroyed — there’s no reason to suppose it was all black money and not the savings of regular citizens scared of harassment by tax authorities. Modi has dropped dark hints that this is just the beginning, raising fears that business should now worry about of constant tax raids and the reopening of decades-old cases. In fact, that dark new age may already be here.

Even setting aside the painful adjustment, the long-term effects of this monetary shock on India’s informal economy could well be severe; a large proportion of marginal firms may not survive the loss of a fortnight of income. The informal financial sector — unregistered moneylenders who provide loans to businesses worth 40 percent of total bank lending — will be decimated. 

The costs to the government could be equally high. Modi’s administration has put political considerations over economic detail once too often — and this time, it’s severely dented its image for efficiency and practicality. Even if the long queues vanish in the next few weeks, that damage to the government’s reputation is permanent.