India’s recent cash crisis was the result of a good decision implemented poorly and has cost the country financially and politically
The decision by Indian prime minister Narendra Modi to withdraw 500 and 1000 rupee notes from circulation overnight, a move called demonetisation, was a measure designed to cut down on corruption and ‘black money’. In theory, it was a drastic but necessary measure to tackle an age-old problem in India and is technically still the right decision. But the rapid implementation of the decision in a largely cash-based economy has led to disastrous consequences for the country as a whole and placed Modi’s premiership under self-inflicted pressure. The lack of an appropriate modern financial infrastructure, such as bank accounts, use of credit and debit cards, and contactless payments like Apple Pay, has further exacerbated the negative effects of demonetisation.
The term ‘black money’ applies to funds which are hidden from tax authorities and are, therefore, illegal. For instance, when someone is attempting to buy a house in India, the seller may offer the property for 120,000 rupees, but when the property is sold he records the sale down officially as 100,000 rupees – pocketing 20,000 rupees for himself. He will only be taxed on the first 100,000. As the transaction is conducted purely in cash, the money is hard to track, and once the cash is circulated back into the system through everyday spending, the illegal activity is virtually untraceable. This sort of illicit transaction happens on different scales all over the country and is a known, and essentially accepted, part of the Indian economy. The percentage of those who pay income tax differs depending on which source you refer to, but it is usually less than 5 per cent of the population, and in 2013 it was only 1 per cent according to official government figures. This is frighteningly low in a country with a population of around 1.2 billion people.
Given that the black economy accounts for up to 20 per cent of India’s GDP, it is not surprising that this problem has been tackled through similar demonetisations in the past. In 1978, under then Prime Minister Morarji Desai, the government decided to remove 1,000, 5,000 and 10,000 rupee notes. Prior still, in 1946 the 1,000 and 10,000 notes were withdrawn. Modi’s decision is therefore not without precedent. Negative consequences were also seen back then as a result of the removal of the notes. In 1978, the Times of India reported the rising prices of agricultural products such as edible oils, while India Today reported a 5-10 per cent drop in prices of gold and diamonds.
Prime Minister Modi’s decision
On the evening of 8th November, 2016, Modi announced the surprise decision to demonetise the 500 and 1,000 rupee notes and render them illegal to use as cash. They were replaced with new 500 and 2,000 rupee notes. Overnight, people found their money was worthless.
The high value 500 and 1,000 notes were chosen for withdrawal because they were the notes most frequently used as black money, but also because together they made up 85 per cent of the cash in circulation. This meant that everyone from the humble tea seller to the high-ranking business executive was left less able, and in some cases completely unable, to pay for anything.
What’s more, as people attempted to exchange the withdrawn currency for the new tender, many banks struggled to cope with the increased demand and ATM machines ran dry of money. Huge queues and crowds ensued, as well as some stampedes and scuffles, as people scrambled to exchange their cash.
The lack of a modern banking and financial infrastructure in India is likely to pose longer-term struggles and consequences as this decision trickles down. For example, only 27 per cent of villages reside within 5km of a bank and nearly 40 per cent of Indians have no access to any financial services at all. As a result, the country needs to spend time, money and effort to actually be in the correct state for the demonetisation policy to have its desired effect. Ultimately, the few that do pay tax already have bank accounts and avoid black money benefit. The majority of the population, especially the poor who rely on cash to survive, look to be facing a period of financial hardship. Whether the measure will actually reduce corruption is also far from guaranteed.
The future for Modi and the BJP-led government
Prime Minister Modi and his party now face a lot more scrutiny and pressure. For a country which ranked 76 out of 168 in Transparency International’s Corruption Perception Index, the reasoning behind his decision is logical. On the other hand, the speed and extreme nature of its implementation calls into question whether the appropriate research was conducted and the measure wholly thought through. It is unclear why the government did not stagger the withdrawal of the notes with, for instance, the 500 notes first and the 1,000 later.
Modi has since defended keeping the decision secret, which is understandable, given that an announcement would have allowed some to skirt around the change. Yet there is no reason the necessary element of surprise could not have been maintained with a staggered approach. Other measures could have been used to implement demonetisation more smoothly, such as introducing the new 2,000 rupee note first, circulating it into the system, and then declaring the 500 and 1,000 notes withdrawn. A further measure could have involved utilising and expanding new technologies, such as Payse and others, prior to getting rid of the notes. This would have also benefited India in the long term by accelerating the country to a better financial infrastructure. This can and is being performed now, but much of the damage has already been done. The prime minister then put himself in a fragile position by calling for 50 days to allow the government to sort things out, but if he doesn’t his opposition will be ready to pounce and it is possible that his time in office could come to an end.
It is clear that India is currently undergoing a period of massive instability and change as the decades’ long fight against corruption and black money reach a significant milestone. Modi took a huge gamble in his effort to try and reduce this problem, but there was a clear lack of critical thinking in the process. Of course, India is not the only country to struggle with corruption, but it is the way that corruption has seeped down to every section of the populace which makes it such a big problem. From paying off a policeman to avoid a traffic punishment to Bollywood stars using their fame and fortune to escape serious crimes, corruption is visible and widespread. The demonetisation strategy may be drastic, but it is extreme measures like this that may be necessary to vanquish corruption once and for all.
Image from: http://on.wsj.com/2fwFer9
Reclaim Your Stage:
The Platform is a groundbreaking blog that provides current affairs and cultural commentary. Our pieces offer challenging opinions from a range of spectrums; that’s why we love hosting a platform for them.