Demonetization – The Big Picture

By now a lot has been said and done about demonetization. We have seen reactions both caustic as well as euphoric. Sadly, though, most of the ‘intellectual’ deconstruction of demonetization has been partial and ideological rather than dispassionate and logical. Policy like real life cannot be divided into binaries. This would only narrow down our horizon and convolute the analysis.

On November 8^th of 2016, PM Narendra Modi announced that Rs 500 and Rs 1000 denomination currencies will no longer be legal tender. This sent down shockwaves in the economy. To put things in perspective, 86% of the total currency in value terms was denotified in a single stroke. To add to that, 95% of all the transactions in a country like India take place via cash. Therefore, this is a move unprecedented and unparalleled in scale and size anywhere in the world.

Pains of Demonetization

Admittedly, there were a lot of teething problems as one would expect in a cash-based economy. Such a disruptive move was bound to have after-effects. The reason why some of the problems were magnified is because the banking system wasn’t prepared for a currency swap owing to the secrecy with which the whole plan was carried out. This led to long queues outside banks and ATMs.

It was common knowledge that new currency notes were in the offing but one hardly anticipated a sudden demonetization. The sudden burst of euphoria was because of the perception that this is a fight against “black money” – more on that later.

Slowly, the euphoria gave way to uneasiness as the execution of demonetization became a herculean task. The demand for fresh currency was a lot more than the supply. Owing to the change in size of the new currency notes, the ATMs had to be recalibrated. Most of the ATMs were running dry within hours of pumping in money.

The most affected in demonetization have to be the daily wage workers, the kirana stores, the beedishops/chaiwallahs, the housewives and most of the MSMEs. Besides, there were the short-term problems of weddings and other ceremonies which are mostly funded by cash. The transition has been palpably painful.

Having said all that, while admonishing the government for all of their incoherent planning and flip-flop decision-making since, we must consider the objective of demonetization, hence the title, “Demonetization – The Big Picture”.

 

What demonetization aims to achieve?

There has been constant criticism that the government has been constantly shifting goal-posts, that the measures have been hap-hazard, the follow-up and implementation leaves much to be desired. Whilst all of this is partly true, the bigger picture is being missed. The critiques pose the question whether demonetization was for reducing/extirpating black economy or is it about a transition to cashless and digital economy. They go on to say the former is not possible and the latter is not desirable in the current circumstances.

Well, here’s where we are missing the point. All the above criticisms can be countered by stating that goals/objectives are unfolding as we move along and there are strong inter-linkages between desirability of a white economy and a digitized economy. Let us also allay all the short-term fears of a digital divide. A ‘less-cash’ economy is what is mooted by the present government which is par for the course. While the transition is a challenge, but the goal of good management is to convert challenges into opportunities. We shall deal further with digital economy and its challenges in the later segments.

On the front of parallel economy, there are fundamental challenges on 4 major fronts:

• Black Money
• Corruption
• Counterfeit currency
• Terror-financing

The reason for the secretive approach towards demonetization, one would presume, has to do with the principle of ‘catching them off-guard’. Still, a lot of black money hoarders have reportedly converted their currency using various NGOs, agencies as conduits. But the quantum would have been a lot more had they been given time.

Now, the black money is either pumped back into the economy due to demonetization or flushed out. Believe it or not, both are beneficial to the economy. We shall see how. If the hoarded black money is either burnt or thrown to the sewers, then remember that this portion of the economy was artificial anyway and unaccounted for. It was leading to inflation without any taxation benefits to the government. If the black money is somehow pumped back into the economy, at the very least, it’ll be part of the banking system and therefore formalized. If the black money surreptitiously makes its way to the Jan Dhan (No-frills) accounts of the poor people, at least, there is a more equitable distribution of wealth in the country.

Corruption has plagued the country since pre-Independence times. They say “corruption has the maximum benefits with the lowest risk”. The audacity with which it prevails makes it almost an accepted norm. Bribery, in effect, is a part of the tradition when it comes to service delivery. Now think about all those who’ve been harassed due to corruption in public offices. While it’d be simplistic to imagine that corruption can be brought to a standstill because of demonetization, but a transition to a digital economy will make corruption either infeasible or too much of a risky proposition. Moreover, the move of demonetization will instill the fear of God into cash-hoarders which again strikes at the roots of corruption.

Counterfeit currency or FICN (Fake Indian Currency Notes) is another issue with its roots both inside as well as outside the borders. There are reported cases of FICN from Pakistan and Bangladesh which makes its way in our economy. FICN is even worse than black money as it is worth nothing, not even the promissory value. It is just fluff which is inflating the economy to the common detriment of all.

The issue of terror-financing should concern us all. The enemies of the State are being funded by this parallel economy to devise attacks against the country and its citizens. The cash-based economy is fertile grounds for their proliferation, as they will not be traced. The menace of terrorism can be tackled by hitting at their roots – money.

Digitalization of Payment systems

The next objective is the purported digitalization of the economy. Critics have proffered that digitalization is neither possible nor desirable for the wide disparities prevalent in India. Such pessimism is expected from data-backed risk-averse economists. A disruptive change is bound to flutter feathers. But the question here is, whether we need it and whether it is feasible.

Digital infrastructure in India still lacks the wherewithal to have 1.3 billion people connected. So far optical fiber cables have been laid down in over 65000 Gram Panchayats, from a total of 2.5 lakh Gram Panchayats. Moreover, active broadband connectivity is lacking even where optical fiber cables have been laid. Therefore, there is still a long way to go before we have internet in the rural parts of the country much less hinterlands.

Mobile internet and mobile telephony therefore would lead the way in a transition to the digital economy. At a preliminary level, 5-pronged approach has been mooted to catch as many as possible in the digital payments net:

• UPI (Unified Payments Interface)
• USSD (Unstructured Supplementary Service Data)
• AePS (Aadhar enabled Payment Systems)
• M-wallets
• Debit Card payments

As per government data, about 100 crore people have Aadhar registration and consequently their biometric data is stored with the government. This Aadhar data can become an instant KYC (Know Your Customer) which would help enable those without a bank account. Detachable biometric devices can be attached to the mobile phones to enable instant payments.

UPI will act as a gateway for payments using mobile internet. The issue here is the mobile app has to be downloaded which can be done only in smart phones which still has a limited penetration in the country. To offset the problem of smartphone or mobile internet-based payments, USSD is in place. This is SMS-based payment which would cater to huge base of 1 billion mobile phone owners for cashless transactions.

With the advent of Rupay Cards, debit cards are no longer a privileged banking service but are becoming more commonplace. It is given along with each Jan Dhan account some of which are even zero-balance accounts. Therefore, there is, at present, a whole range of options available even for beginners to make the switch. None of this goes to say the many miles that we have to travel before we reach optimality.

Challenges to digital economy

The major hurdle comes in initiating the people to the digital economy because of the inertia. This inertia is not just custom-based but also backed by statute. People are too accustomed to cash-based transactions and this has led to a habit of hoarding cash instead of depositing in banks. Government of India through the NITI Aayog has launched a couple of reward schemes like Lucky Grahak Yojana and Digi-Dhan Vyapari Yojana to incentivize both customers and merchants to adopt cashless payments. Besides, Digi Dhan melas are being launched across cities to spread awareness.

Given the spirit of enterprise among Indians and their ability to adapt to changing conditions, the transition to digital economy maybe sooner than you think. Necessity, after all, is the mother of all innovations. The demonetization has probably given it the impetus it needed.

The next hurdle comes in the form of digital security or more pertinently security of the online payment systems. The number of credit card frauds is on the rise. The online payment gateways have a 2FA (2-Factor Authentication) as a digital firewall. To ease into digital economy, 2FA has been done away with. While this simplifies the process, it may also lead to breach of security. India is still at nascent stages and any major security breaches can cast a shadow on the whole transition.

Therefore, robust digital firewalls have to be set-up. CERT-In, the coordinating body for digital security has to play a more pro-active role. As it is, with 100 crore Aadhar enrollments, personal details of so many people are at stake.

Hence, while digital economy is promoted, cash should not be completely out of the system. In fact, the government should stick to its target of bringing down cash-to-GDP ratio from 12% to 6%. In that pursuit, a ‘less cash’ economy is more desirable. This would also not alienate sections of society like old people, tribal people, differently abled, etc., who either do not have access or will take time to adapt.

Other Reforms Needed

The long shot of demonetization is the transformation which can shape our economy for the better. The budget in the coming year will tell if there are any taxation benefits to the people. The next review meet of the RBI will tell if the interest rates are going to be slashed.

But actualization of GST law will definitely be a shot in the arm. With direct taxes slashed and indirect taxes streamlined due to GST, there will be twin benefits of lower taxation and higher tax compliance. In fact, the cost of tax compliance should be equalized with the cost of non-compliance to disincentivize tax evasion.

As far as conversion of black money is concerned, most of the currency does not remain in cash. “All cash is not black and all black is not cash”. It is in real estate, gold and foreign currency. Each of them has to be tackled separately with active efforts to retrieve already converted currency. There needs to be stricter imposition of law to check agents, NGOs, etc. who act as conduits of black money.

Finally, it is most important to hand-hold the ones who are genuinely affected. This analysis has to be revisited and revised in the days ahead. For the moment, let’s be optimistic.