Demonetization Policy in India

Shiva Chakravarti Sharma, MPP, Staff Writer, Brief Policy Perspectives 

On November 8, 2016 Prime Minister Narendra Modi announced that high denomination currency value of 500 and 1000 rupees will no longer be legal tender. In the days following the announcement, bank and ATM lines stretched hundreds of people long. Now, the lines have subsided, but the raging debate around the policy has not. The bold policy aims to fight “corruption, black money, and terrorism” in India by replacing the old currency notes with new currency notes to invalidate the unaccounted stock of money, and counterfeited currency used to fund terrorist activities. The decision also strives to move India towards a “cashless society.”

Like every Indian citizen, I started my journey of deciphering the policy through conversations, news, and media debates. As a first year public policy student, a policy on this magnificent scale is of special interest to me. The public, political, and scholarly world seems divided on the issue. My social media feedsare filled with rhetoric for and against the demonetization policy. Where some have problems with the policy’simplementation, others are severely critical of the policy itself. Yet others still, in linewith the growing trend of divisive nationalism, have begun declaring anyone skeptical of the policy as unpatriotic. After a week of exasperating attempts of reading various articles and opinion pieces in most dailies, I was still perplexed.So, I took it upon myself to try to make some sense of the policy by extensive and thorough research. I found that the policy does not account for major infrastructural and bureaucratic lags, and the costs of the policy outweighs its aspirational benefits – which might not be realized anytime in the near future.

Demonetization is the act of stripping a currency unit of its status as legal lender. The policy tool has been used in many countries. For instance, the European Union, when adopting a single currency, demonetized the local currency of member countries. In 1984, the Nigerian military government, led by MuhammaduBuhari, also used demonetization to fight corruption by installing a currency swap, which led to an economic collapse. In 1982, Ghana demonetized their high-value notes to tackle tax evasion. Myanmar employed a similar tactic, but the economic disruption created by demonetization led to mass protests that killed several citizens. Needless to say, this is a significant policy move. The government strongly argues that the policy tool will “transform” the nation’s thinking and trigger a mindset change.

Scholars are divided on the issue. Scholars in favor of the policy, like Columbia University Professor Jagdish Bhagwati and John Hopkins University Professor Pravin Krishnan, argue that demonetization is a courageous reform that will bring substantive benefits by strengthening and digitizing the banking system. This would severely hamper counterfeiting operations. On the other hand, scholars against the policy, like the Nobel laureate Amartya Sen,  have called the policy despotic, saying it undermines entire economy of trust. He argues that the action erodes citizens’ trust in institutions like the banks and the currency system. Cornell Professor Kaushik Basu also deems the policy a “mistake” by the Indian government.

And so the primary question is: Will demonetization end corruption, clear out black money, and block the supply of money to non-state violent actors?

It is not entirely clear how this policy will affect black money. Top experts in the country estimate that cash accounts for only about 1/20th of the black economy. A large amount of black money is stored in gold and real estate property, and so is unaffected by the demonetization policy. However, proponents argue that demonetization will bring more money into the banking system and formalize the economy in the long run. A formalized economy with transaction transparency will likely lower corruption, and thus the stock of black money. But, the policy clearly ignores the “institutionalization” of black money in the Indian system. The policy simply swaps the old tools of corruption with new tools. Continuing corruption is evident by the seizure of new currency notes in large sums. Since the policy was implemented, 242 crore (2.42 billion USD)in new currencyhave been seized from different parts of the country.

Another criticism of the policy is its implementation. Even supporters have recognized this as problematic. In the past month, several thousand people stood in lines in front of banks and ATMs to swap their old currency for the new. In addition to the wait, they had to cope with daily notifications that changed the withdrawal rules. With apolicy this big and bold, one would hopethe government factored in all the costs associated with the policy. However, the government’s daily notifications and changes have made many skeptical of the policy’s thoroughness. For example, the policy was introduced during sowing season for farmers, a time when they need lots of cash on hand. The government did not seem to account for this, and waited a full week to raise the withdrawal limits for farmers. Another drastic notification preponed the date of deposit of old currency notes from December 30th to December 15th, which was later withdrawn. This frenzied rule-changing by the government further adds to the trust deficit created by the government.

Most arguments for effectiveness of the demonetization policy (reduction of black money and counterfeited currency) rest on the digitalizing of the economy, which will lead to a more transparent system. The Finance Minister argues that Indians should not miss the digital revolution, and the demonetization policy is a move in that direction. However, India does not have the infrastructure for a digital revolution. Only 20% of the population has access to the internet. Additionally,majority of Indians are employed in the informal sector, and 35% of the population lives on less than $3.10 a day. These Indians still rely heavily or exclusively on cash and are not digitally connected. Forcing digitization so quickly could leave millions of Indians behind, creating severe impacts on the poorer segments of society. For India, to digitalize its economy, the government cannot rely on restricting the cash in the economy, but must work on creating a sound digital infrastructure, which can support the digitalization of the economy.

Last year, I travelled to the trading posts on India’s border with its neighboring countries. A single-window system policy was implemented on border check posts to facilitate trade. A single window system promotes ease of trade by letting traders submit administrative documents for multiple agencies at a single online platform. However, the absence of internet connectivity on some of these check posts made the policy ineffective. In other words, without the relevant infrastructure and efficient implementation, the policy of demonetization, like that of the single window system, faces severe issues of effectiveness.

I strongly agree the menace of corruption and black money need strong and effective counter-measures. I also agree that the demonetizationcouldhelp prevent a certain amount of black money in circulation, but my pressing question remains:

Are demonetization’s aspirational benefits equal to the costs?

At this point, I do not think so. I argue that the demonetization policy might be successful in altering the stock of black money; however, to alter the flow of this black money, the country needs strong measures to disrupt the “institutionalization” of these transactions.

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