http://www.freepressjournal.in/analysis/demonetisation-short-term-brilliance-long-term-pain/973092

Policy Watch

Will demonetisation work? Or will it erode the rupee?

Rn bhaskar

On the night of 8 November, Prime minister Modi dropped a bombshell. He announced through a national TV address that the government was demonetising Rs.500 and Rs.1,000 notes from that midnight. The stated objective was to unearth and impound stockpiles of black money.

2016-11-17_demonetisation-devilryjpgBut most savvy people realised that demonetisation had two specific short-term objectives.  The first of them was likely to be immensely successful, and critically relevant, with the precision of a surgical strike. It was essentially political. In a single stroke, the government rendered useless all the piles of cash that had been amassed for horse-trading and voter seduction/intimidation by political parties. This would have a major impact on the forthcoming elections in Uttar Pradesh (UP) and Punjab.  Conventionally, UP elections set the political climate for the entire country. Money- (plus muscle-) power rules here.  It is the same in Punjab as well, where the huge piles of money are usually built through illegal trade in drugs.

This was confirmed by the former chief election commissioner (CEC) S.Y. Quraishi in a TV interview. He admitted that he could see no other way to curb the use of black money in elections in the short term.  Long-term measures would require reform in election funding.

The second target was to decapitate Pakistan’s machinery for making counterfeit Rs.500 and Rs.1000 notes.  Around Rs.400 crore [Note: a crore is 10 million; a lakh is 100,000; hence a lakh crore is 1 trillion] of such fraudulent notes are believed to be in circulation; barely 0.024% of the total money in circulation (Rs.16.4 lakh crore).  Thus, this objective could have been met through simpler methods as adopted in the past.

What about demonetisation being a deterrent to black money and corruption? This is where many prefer to keep their fingers crossed.  The objective is commendable.  But . . . . .

Consider how the government has still not prosecuted the 8 lakh assesses who have collectively declared abnormally high agricultural incomes of Rs.876 lakh crore in just four years (1010-2013)). The chart alongside explains how the average agricultural incomes declared soared, and the number of declarants zoomed (http://www.asiaconverge.com/2016/07/indias-biggest-laundromat-agriculture/). Submissions before the Patna High Court are reported to have alleged an even higher figure of Rs.2,000 lakh crore.  Yet, even at Rs.876.5 lakh crore, India could have met its highest tax collections for 126 years.

Demonetisation is expected to impound black money worth Rs.5 lakh crore.  That is a pittance (0.46%)compared to Rs.876 lakh crore.

The present demonetisation will therefore affect those who are smaller generators of black money.

Ironically, demonetisation itself has spawned a lucrative system of laundering Rs.500 and Rs.1000 notes at discounts ranging from 10-40%.  Hundreds of thousands of zero-balance accounts have registered deposits of over Rs.40,000 overnight.  A new white-washing mechanism has been discovered.  Clearly, demonetisation may not curb the generation of black money significantly unless the sources of generation are also addressed.

There are, unfortunately, two sorry outcomes that arise from such a large-scale demonetisation of currencies that account for almost 85% of all transactions in India.

First, it will bring trade and commerce to a grinding halt for some time.  It is expected that almost 30% of the money (Rs.5 lakh crore) will not get deposited in banks, and will therefore have to be cancelled off in RBI’s books (https://www.youtube.com/watch?v=W-Bjw_SFNdM). But the reduction of money supply could hurt small traders and businesses brutally.  Expect GDP growth to decline for the next two quarters.

The economy could rebound smartly if other measures are taken quickly.

This includes several things:

These measures will help staunch corruption far more effectively, and give a phenomenal boost to the economy.

Second, demonetisation strikes at the very root of confidence in a country’s currency.  One does not hear of demonetisation in China, or the US or  the UK.  That is because confidence in a nation’s currency is sacred.  Listen to traders today. They have already begun telling each other that it is safer to hoard cash in US$ and in gold than in rupees.  Predictably, the unofficial premium on the dollar has begun climbing. Restoring confidence in the rupee will have to assume immense significance.

People often forget that faith in a currency is as crucial as faith in the country.  Both are inseparable.  Demonetisation can hurt both.

 

Sources:
http://taxguru.in/income-tax/verification-agriculture-income-1-crore.html
http://www.firstpost.com/politics/demonetisation-atm-chaos-pm-modi-should-have-gone-after-8-lakh-wealthy-farmers-not-common-man-3104572.html
http://www.s3solutions.in/f-no-dgitsdits-3astpil-matteragricultural-income972015-16624-1-4-2016/
http://news-express.in/news/farms-grow-massive-incomes-for-select-few-37792/;
http://www.business-standard.com/article/current-affairs/income-tax-department-probes-crorepati-agriculturists-for-evasion-116031300249_1.html; http://timesofindia.indiatimes.com/india/No-plan-to-tax-agricultural-income-Govt/articleshow/52529462.cms;
http://timesofindia.indiatimes.com/business/india-business/As-crorepati-farmers-mushroom-tax-officials-go-digging-for-evasion/articleshow/51377186.cms; http://www.thequint.com/india/2016/03/19/even-as-farmers-die-trillions-laundered-as-agricultural-income;
http://m.thehindu.com/news/national/fincome-tax-departments-reveals-agriculture-sector-figures/article8371424.ece
http://www.thequint.com/india/2016/03/19/even-as-farmers-die-trillions-laundered-as-agricultural-income
http://timesofindia.indiatimes.com/business/india-business/As-crorepati-farmers-mushroom-tax-officials-go-digging-for-evasion/articleshow/51377186.cms

http://m.thehindu.com/news/national/fincome-tax-departments-reveals-agriculture-sector-figures/article8371424.ece

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