Demonetization: A Plan For Future Triumph

Glow of a 1000 Rupee note when exposed to UV light

If near him (enemy), he should strike in his weak point (p. 76, Corporate Chanakya)

Although the Govt. of India reasons that the legal tender of High Denomination Bank Notes (HDBN) of Rs. 500/- and Rs. 1000/- stands cancelled “with a view to curb financing of terrorism through the proceeds of Fake Indian Currency Notes (FICN)” as well as to negate their employment “for subversive activities such as espionage, smuggling of arms, drugs, and other contrabands into India”, yet I am constrained to believe that there is more than what meets the eye. And this gets revealed once one reads up the history of demonetization drives in India.

The first reported demonetization drive in India happened after World War II. Although the stated motive of the Government for such an exercise then was to curb black market operations and arrest tax evasion, yet relying on the observations of Sir C.D. Deshmukh, the then Governor of RBI, I believe the real reason was to curb inflation that followed the War. In fact, demonetization was the flavor of the time. It was being embraced by many European countries like France, UK, Belgium, etc. post-War to get their economies in shape. However, the RBI was not very enthusiastic about such a move. Specifically, the Governor wondered whether the “considerable administrative difficulties” involved in covering the 5700 offices of the scheduled and non-scheduled banks was worth undertaking. He was specifically concerned that an honest person may be harassed, thanks to the absence of foolproof measures to categorize the presented HDBNs as “the life savings of the hard working man….or sordid gains of a black marketer”. Further, he was unsure about the collection of at least Rs 10 crores of additional tax revenue from this event. Additionally, he expressed his dissatisfaction on any absence of questioning or enquiry of the Princely States when they presented the HBDNs for exchange. Viewed critically, the demonetization exercise was argued to be more of a conversion, with the Governor labeling it as “not a revolutionary measure,” during his Dadabhai Naoroji Memorial Prize Fund Lecture address. While Rs. 143.97 crores were issued by the bank, only Rs. 134.90 crores worth HBDNs were exchanged by the end of 1947, thus being a failure. That demonetization was being used to counter inflation by the Govt. can be further argued, when in Sept 1948, rumors spread that to combat inflation, the Govt. was considering demonetizing the 100 rupee notes. It is a different thing that the Govt. never went ahead.

The second demonetization drive was initiated by the Morarji Desai Govt. on 16th January 1978, although the recommendation for it was provided by a committee led by Justice Wanchoo as early as 1971 to curb black money. One important observation of the Wanchoo Committee report was that black money should be regarded as a flow, and not as a hoard. Hence the then Finance Minister mentioned in the Parliament that demonetization was being done to make HBDNs unavailable “for financing transactions which are hurtful to the national economy or for illegal purposes”. Again, the RBI (led by Governor, I.G. Patel) was critical of this exercise. In his book, Glimpses of Indian Economic Policy – An Insider View, he writes, “The idea that black money or wealth is held in the form of notes tucked away in suitcases or pillow case is naïve. And in any case, even those who are caught napping—or waiting—will have the chance to convert the notes through paid agents as some provision has to be made to convert at par notes tendered in small amounts for which explanations cannot be reasonably sought”. Thus “it’s much work and little gain” that “seldom produces striking results”. In fact, the demonetization exercise of 1978 had tempers, queues, and long working hours for the bankers to complete the picture. But little success with the Finance Minister unable to provide any statistics to support his claim of it being successful. Moreover, in many quarters it was convincingly argued that the Government viewed demonetization as a political tool specifically targeted at the allegedly corrupt predecessor government. This was a great chance to empty the coffers of the Congress Party and reduce it to non-existence.

Is it difficult then to understand the hidden motive of the Modi Govt.? It’s more about attacking the black money financing their competitors (I will not use the word opposition) than anything else. With the dawn of 2017, seven states of India (Goa, Manipur, Punjab, Uttrakhand, Uttar Pradesh, Himachal Pradesh, and Gujarat) are going to elections, with the BJP defending itself in Punjab, Gujarat, and Goa, while attempting to wrestle Uttar Pradesh from the Samajwadi Party. In a country that is divided by caste and religion and with BJP being perceived as a representative of the Brahmins (which is largely untrue), it ‘s hard to fight on issues, that are largely identity-based and less issue based. Thus it’s time to play smart and attack the root of these parties’ existence. Not the ideological but the financial roots, which are arguably “black”.  Both the Sanathanam Committee Report (1964) and the Wanchoo Committee Report (1971) had shed light on black money infiltrating the political system, which resulted in the then Govt. (led by Prime Minister Indira Gandhi) to declare corporate financing of political parties illegal (not the case anymore since September 2003). In fact, this was largely motivated by her fear that the Swatantra Party, which espoused free market policies, will be favored more by the business houses. Thus, parties finding themselves bereft of legal sources of funding to run their organizations and election campaigns had resorted to illegal sources for financing. Further, the high tax rate coupled with the highly regulated economy (that required licenses and permits for every type of economic activity) allowed bureaucrats and politicians to exercise considerable power. Therefore businesses did not refrain from paying kickbacks to politicians for getting hassle-free licenses, and other favors, to outsmart their competitors. More than two decades of economic liberalization have not changed the situation much. The Central and State Govt. still retain various powers to regulate economic activity, especially in the State where sectors like real estate and land acquisition are still highly regulated. E.g. a recent study by researchers at The Centre for Global Development attempted to uncover the builder – politician nexus in election funding. They argued that politicians invested their illegal wealth in the projects of the builders, for which the latter remains grateful. During election time, the builder returns the cash ceasing all economic (building) activity. Therefore, India is being rocked with decibels since this third wave of demonetization (8th November 2016) from parties such as Shiv Sena (which is in coalition with BJP) in Mumbai, Aam Aadmi Party, Trinamool Congress, and Congress. It will not be wrong to say that these are cries of fear and not the concern for the poor.

Last, India is about to implement GST, effective from April 2017. This has the potential to increase inflation, which the Government will not want considering that the next Union Elections are roughly two years away. Hence, demonetization will help remove excess money from the market, limit its availability, thereby restraining inflation. Hence the limit on withdrawals. This is in line with the inflation targeting approach of RBI, initiated by its former Governor Prof. Raghuram Rajan. Probably, this is why we have not seen any opposition from the current Governor, Dr. Urjit Patel, towards the demonetization exercise (recall RBI was historically opposed to this?)

So demonetization is an attempt for pan-India supremacy of BJP, politically and economically. The Prime Minster is sharp to use history to his advantage. How successful will this be is difficult to predict at this stage. But then going by the secrecy and suddenness of the move, Chanakya once again comes to mind. He says,

“Others should not know about any work sought to be done by him. Only those who undertake it should know (about it) when it is begun, or even when it is actually completed” (p. 68, Corporate Chanakya)

[All references to be provided upon request]