On 8 November, Prime Minister Narendra Modi announced the withdrawal of high

denomination Indian currency. Over the next couple of weeks, the ‘fight against corruption
and black money’ transformed into a push for a digital economy. It made perfect sense. India
is a land of mobile phones. Among the largest market in the world. It is estimated that India
has a little over a billion mobile phones.

Internet penetration in India is increasing at a phenomenal rate. In fact, over the next 5 years,
Internet penetration in India is expected to grow by close to 40 percent. As per And what
better fillip can the devices and financial transaction segment receive in a market of 1.25
billion citizens than a move to a digital economy.

Given the demography of the Indian Internet landscape, ecommerce and mobile transactions
ought to be of utmost priority. On one hand, it seems like the best move that we’ve restricted
cash and placed a great deal of emphasis on digital transactions. Users ought to have adapted
mobile devices considering it would be the preferred mode of payments and transactions.
However, according to recent reports, reality presents us with a stark contrast. Foxconn,
Micromax, Intex, Lava and Karbonn are reportedly witnessing either a rise in inventory (or a
fall in sales).

Although the country is moving towards digital modes of transactions including Internet
banking, and e-wallets, the simultaneous ban on high value currency notes has hit sales in
several sectors. The worst hit, it turns out are budget devices that sell via brick-and-mortar
channel set-up. It’d be interesting to see how brands such as Xiaomi and OnePlus have
performed since the days of demonetisation, especially considering that Indian brands such as
Karbonn, Lava and Intex are going through a bad patch.

The report says between 10 to 40 percent of the workforce has been put on bench. We
reached out to 3 Indian device manufacturers – Lava, Intex and Karbonn. There has been an
apparent impact of lower volumes and a general overall decline in the smartphone market in
India. According to an IDC report, the smartphone market declined for the second
consecutive quarter, yet managing a 5 percent growth year on year.

A difficult market

The mobile devices space is a difficult market to be in. It’s an overtly saturated market, which
is currently battling it out – not on the specification front, but it’s an all-gloves-off price
battle. The constant churn of mobile phones, coupled with the sheer number of brands
competing against each other makes it a ferocious battle to win. Brands such as OnePlus,
Xiaomi or LeEco have been focussing on mass online sales through major ecommerce
players such as Amazon, Flipkart or their own online channels. Typically, transactions
through portals have been driven through plastic money or Internet banking. Since the
crackdown on high denomination cash, ecommerce companies have halted the popular cash
on delivery option. These factors together also could impact the order rate of devices through
online channels.

cash, the preferred mode of payment

We spoke to a couple of mobile phone sellers, and the pattern is varied. For low value
devices, the preferred mode of transaction is usually cash. This is possibly due to limited
access to plastic money (debit and credit cards). Now that cash is a precious resource, the
availability of cash to splurge on gadgets seems like a luxury. However, in large format retail
stores, sales patterns don’t seem to be impacted as a result of demonetisation since most
transactions are digitally enabled.

We reached out to Lava, and they were rather candid about the challenges faced, and
responded to our queries. The official spokesperson said, “Due to impact of demonetisation,
we have halted the production of mobile phones for next 10 days. The staff, at the
manufacturing units, has been sent on leave for this period. We are monitoring the situation
closely and hoping it to improve – which is primarily dependent on government’s strategic
plan to infuse sufficient cash in the system or make the country digitally enabled. We are
waiting and watching and will plan our next course of action based on how situation
improves or deteriorates.”

Commenting on the move of demonetisation, Intex said, “The demonetisation process is an

unique initiative undertaken by the government. Although, the process may have a short term
impact across sectors, however, we are confident that in long term the process will bring
numerous positive benefits to the economy, impacting positively across all sectors. We
believe that initiatives like digitalisation of currency is going to drive an increase in the
demand for mobiles & smartphones across country including rural housing India. We are
very positive that the economy will bounce back as the benefits of demonetisation drive start
coming in with more money in circulation and in banks, better distribution of income and a
vigilant and honest system in process which is pro development. We also believe that the
cluttered market will be more organised after this step.” The company refused to divulge any
number or details regarding employees placed on bench.

Even the PC segment seems to be hampered due to the cash crunch. Lenovo reported a fall in
PC sales by up to 20 percent. The series of patterns draw attention to ripples in the
technology industry, and indicate a fall in business. Currently, fintech seems to be the only
sector gaining from demonetisation, consumer facing businesses are seeing a lull in sales
due to lesser disposable cash. Hopefully, this problem would ease with widespread adoption
of digital POS systems or mass adoption of e-wallets. As of now, cash – or the lack of it –
seems to be a reason for concern.

Consequences of demonetisation: All you want to know

Expect some pain for unorganised labour, the service industry and the farm sector in
the medium-t

The inconvenience was conceived in terms of the honest man or woman standing in queues to
follow the rules of the game for the larger cause of unearthing black money.

When the bold step to demonetise existing 500- and 1,000-rupee currency notes was taken
last week, the ‘little inconvenience’ that went as a suffix pointed to the adjustments that had
to be made by households which had to convert these notes into deposits or partly back into
cash with the new currency notes. The inconvenience was conceived in terms of the honest
man or woman standing in queues to follow the rules of the game for the larger cause of
unearthing black money.

It wasn’t hence exactly a demonetisation exercise—as it does not dispense with the value of a
note—but one that simply replaces the existing notes with new ones, thereby addressing the
issues of counterfeit currency and black money. In countries where currency notes are
demonetised, the denominations simply disappear from the system. While it has been argued
at various fora that we need to move away from a cash economy to a virtual one, this
particular move does not really connote the same as theoretically one can, over a period of
time, exchange X number of old 500-rupee notes for the same number of the new 500-rupee
notes.

It is true that when such measures are taken there would be distortions in the equilibrium.
Also, all possibilities cannot be addressed, and while the issues concerning households’ cash
management was paramount in the government’s mind, there are other challenges that have
come to the fore which need addressing.

The first is agriculture. This is one sector where all transactions are in cash and, given the
values involved, involve the higher denomination notes. The withdrawal of the old currency
notes has put pressure on the mandis; farmers are having problems in selling their produce as
both the parties have to agree on the mode of payment. This has the potential to lead to
localised shortages which would not really matter but for the fact that it can lead to price
increases that can reverse inflation’s downward trend of the last few months. At the broader
level, the fact that this sector is monetised through cash—and is mostly not tech-savvy—does
flag the issue of the grand design of having a common market for agricultural products,
which will not really take off until these loose ends are tied.

The second is the unorganised manufacturing sector that falls in the category of SMEs. These
units work on the basis of cash, with purchases being made through this mode; all do not
have access to credit and their creditworthiness could be of a lower grade. These units would
find it a challenge to convert their currency—any time-lag in their operation can affect their
functioning and hence there is a concern here. Wage payments, mostly made in cash—as
labour in this segment is unorganised, and employed on a daily basis—also becomes a
consequent problem. The shortage of currency notes and the restrictions on withdrawals have
a short-term impact on these units which must strive hard to meet these requirements.

The services segment is probably the one that is impacted with greater intensity as the decline
in business levels is irreversible. Restaurants, transport operators and trade in particulars are
witnessing lower levels of activity which will not increase once normalcy is restored. Hence,
unlike consumer goods, where there can be a deferment of demand to normal times, a meal
excluded today will not be carried forward. The same could hold for tourism too where plans
would not be deferred by regular tourists. Foreign tourism, in particular, will be affected the
most as several tourist spots in the country do not accept cards and insist on cash, which
becomes a nuisance for tourists. This is one area that will probably take some more time to
recover, thus impacting overall production levels in the country.

Therefore, the mission to remove old notes and substitute these with new ones has to be
accomplished fast so that the negative impact on these sectors is reversed. The government
did time it well to ensure that it did not come in the way of the festival-demand season so that
growth impulses would remain in the manufacturing sector. However, the present
demonetisation period coincides with the harvest season which goes on till December;
farmers will find it testing while selling their produce. There had to be a trade-off since
almost any time-period would be associated with specific economic activity.

To the credit of the government, it must be added that the entire Jan Dhan Scheme laid the
foundation for ensuring that everyone had access to a bank account so that monetary
transactions are lowered and funds transferred to these accounts. However, this habit has not
yet caught on. This has led to the present challenges in the farming sector in particular.

This clean-up operation would cause some dislocation and discomfort for the economic
agents and households, but would, in one stroke, remove black money from the system,
though the actual quantity will be known only by the end of the year. Black money is not held
in just currency, but also in property and gold. Hence, this would be just one part of the story.
In the medium-term, there could be correction in prices of property, though overall inflation
should remain neutral as cash was not being used in a big way to spur demand of non-food
items. The price of gold could decline to an extent, but given that we are price-takers in
bullion, this will still be driven by the relation between gold and the dollar. GDP growth
would get affected in Q3 and probably also in Q4, but should mean-revert in FY18. The
speed of recovery will depend on whether or not the system stabilises after the 50-day period
following the announcement. The government too may not really be affected much,
considering black money would not come forward to be taxed and penalised.

Therefore, this exercise—probably the first of its kind given the scale—is more of a strong
signaling mechanism, one that sends out a warning that the government will spare no effort to
cull out black money in the system. It will definitely move people to the system of using
plastic cards and other online and mobile applications in course of time and hold less cash.
Currency will probably be held now onwards more for ‘precautionary purposes’ and not
‘transactions purpose’ or ‘speculative purpose’ as defined by conventional macro-economic
theory. This will be good for efficiency

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The demonetisation effort being led by PM Modi in India is that idea that Rs 500 and Rs
1,000 notes should be declared no longer legal tender, to be replaced by other notes of
different designs and in one case, denominations. The aim is to wash the stock of "black
money" out of the economy and get it into the licit, banked and taxable, part of the economy.
The microeconomic effects here seem, as I've said before, to be beneficial. There have long
been concerns about terror financing through forged notes for example. There's quite
obviously substantial tax revenue going uncollected. And perhaps the biggest effect is, as I've
said, that large portions of the population feel that the basic system is unfair. They're locked
out of that easier world where matters are settled in large amounts of cash, where tax is not
paid and where favours are bought.
However, we should also think about the macroeconomic effects here. And that's difficult--
because we're not even sure what the sign of the effect will be, positive or negative, let alone
the size of it. It's actually possible for this to run either way:

Ambit Capital, a respected Mumbai-based equity research firm, has officially estimated that
the demonetisation-driven cash crunch will result in GDP growth crashing to 0.5% in the
second half of financial year 2016-17. This means the GDP growth for six months, from
October 2016 to March 2017, could decelerate to 0.5%, down from 6.4% in the previous six
months.

Further, Ambit Capital estimates that during the October to December quarter that we are
currently in, the GDP growth may contract, thus showing negative growth. However, Ambit
is hopeful that a strong formalisation of the informal economy will ensue through 2017 until
2019 and this disruption could also crimp GDP growth in 2017-18 to 5.8 % from their earlier
estimate of 7.3%.

That's perhaps the case for the prosecution. The disruption to the economy will be such that
there will be, possibly, not just no growth in this last quarter of the year but actually a
shrinking of the economy.

"The demonetisation-driven cash crunch that is playing out in India will paralyse economic
activity in the short term. We expect a strong 'formalisation effect' to play out as nearly half
of the non-tax paying businesses in the informal sector (40% share in GDP) will become
unviable and cede market share to their organised sector counterparts. We expect this
dynamic to crimp GDP growth in India in FY18 as well and hence we have cut our FY18
GDP growth estimate to 5.8 per cent YoY (from 7.3 per cent)," Ambit economists
RitikaMankar Mukherjee, SumitShekhar and Prashant Mittal said in a note.

It's a possibility, certainly. But it's not a certainty. For economies are complex things with
many moving parts. I've already pointed out that the inflow of money into bank accounts will
reduce interest rates and that has a stimulatory effect upon economic growth. And we're
reducing the budget deficit as some of that black money gets taxed, which will reduce
inflation--again beneficial. But there's yet one more thing we need to consider and that's the
effect upon the money supply. Which is surprisingly difficult to work out:

In mathematical terms, velocity of money is the ratio between GDP and money in
circulation—which RBI estimates to be around 1.3 for India. However by ‘money’, it does
not mean the cash that we exchange in day-to-day transactions (part of something called high
powered money or M0). Instead it is broad money (also known as M3) where you also
include bank deposits, post office savings and other bits and pieces of financial savings.

M3 and M0 in India are linked by a factor of 6—so roughly speaking, R1 of cash in

circulation, ultimately adds up to R6 worth of broad money. So, if velocity of money
calculated using broad money is 1.3, then it equates to six-times the amount, or 7.8 with
respect to cash in circulation. So we now have a measure of how quickly transactional cash
changes hands in the legitimate Indian economy.

It's worth reading that analysis in full as it is very thought provoking. And the thought it
provokes in me is that we just don't know. We don't even know, again, what the sign on the
effect will be, positive or negative, let alone the size of it.
We've the two types of money, M0 and M4 (to use the English terms) base money and broad.
One is just cash and central bank reserves, the other is that multiplied by the velocity of
money and the actions of the banking system. We're taking some portion of base money out
of the system--whatever portion of black money simply vanishes as a result of
demonetisation. A decrease in the money supply is contractionary upon the economy.
However, look at our problem here. We've got a good idea of what V, velocity, is in the
formal economy. And we don't know what it is in the informal or black economy. And we
really don't know, we've not a clue, not a scoobie.

Which is something of a problem because we can surmise it either way. We could assume
that those who commit their nefarities with black money quickly move that on so as to be
able to gain more. V in the informal economy would be high therefore. We might also
assume that people stash the cash nuder the bed and it stays there for years. V would be very
low therefore. In fact, we will, obviously, assume that some people do the one, some the
other, and many do either dependent upon their whims. Which means that we've simply got
no idea at all, not that scoobie, about what the overall effect is.

If V is very much lower in the informal economy then even with the loss of some of that base
money and the move of the rest into the formal banking system then the broad money supply
will expand as a result. That's stimulatory. If V is higher in that informal economy than in the
formal then the demonetisation move significantly reduces the broad money supply and that's
contractionary. And we've not that scoobie about which way it will go.

All of which rather brings us to Hayek's point, that we can't plan an economy. The major
reason being that it's too complicated and we can never gain enough information to be able to
do so. More than that, the only thing we've got which can calculate an economy is the
economy itself. The effects of change are emergent from the system itself, not something that
we can determine beforehand.

Thus we just don't know what the macroeconomic effect of demonetisation is going to be. It's
something we've just got to wait and see about

n spite of several inefficiencies, fortunately, India never witnessed a bank-run or monetary

crisis parallel to the scale in Europe or America. However, the chaos and long queues that
engulfed banks across India now perfectly mirror the plight the Greeks faced last year, albeit
for different reasons.

Demonetisation is a rudimentary monetary instrument of the pre-digital era used only in case
of extreme financial exigencies to control income, consumption and usage of currency.
Authorities avoid taking such drastic monetary steps because demonetisation puts the whole
economy and society under a great deal of inconvenience.

As we dig deeper, demonetisation not only appears to be an enormous logistical challenge for
the Reserve Bank of India, government and the banking system, but also inflicts huge
collateral damage on the economy, struggling to gain momentum.

Financial events always come along with unintended consequences; and we cannot afford to
ignore them.

Crushed consumption
Demonetisation has damaged India’s consumption growth story, for the time being. India
turned into a shining economy amid global slowdown only thanks to burgeoning
consumption in the country, but the recent currency ban has now sucked Rs 14 lakh crore
from the system and thus self-engineered a recession of unexpected consequences.

Currency printing and distribution is a slow and technical process. RBI has limited capacity
to print currency and depends heavily on imports for technology and material related to
security features of notes. In fact, no central banker in the world can exchange currency to the
tune of Rs 14 lakh crore overnight, which has been printed and circulated over the last many
years. Consequently, India’s consumption is likely to stay reduced to the level of subsistence
buying for a longer than anticipated time.

Demonetisation generally dampens consumption spirit and pushes people towards safer bets
like gold. Incidentally, as much as 25 tonne of gold was reportedly bought in the last four
days. The real productive consumption may take months to come back to normalcy.

A man gestures he doesn't have money for food as he waits in line to exchange cash at a
bank. (Photo: AP)

Questionable curbs

The demonetisation strategy apparently goes against the ethics of currency management in
economies running smoothly. Currency is legal tender, which promises full realisation of its
value to the carrier. Currency cannot be put under conditional transactions i.e. being allowed
for medicine but not for food.

As the RBI, not government, is primarily responsible for money supply and management of
currency in circulation, the politically enforced decision to demonetise currency has come
across as an impingement upon the RBI’s sovereignty.

No central banker in the world approves of demonetisation in normal circumstances as

currencies have become the most sensitive instrument in an integrated global economy.
Currency curbs suggest financial calamity and badly hit credibility of host currencies.

India is well exposed to global financial markets and demonetisation has definitely not
augured well for the credibility of the rupee against global currencies.

Bold shot but in dark

Demonetisation is not the boldest move against black money, but a bold shot in the dark
having collateral damage on law abiders. The revenue administration was expected to burn
the midnight oil in analysing annual information returns with the help of technology for
cracking the whip on tax cheaters, while lawmakers were expected to plug loopholes of co-
operating, accounting, political funding and tax laws to effectively tackle the problem.
However, the government chose to suffocate the house to eject murky mice.

Black sheep

The effectiveness of demonetisation against the black economy is always debatable as the
measure does not hit the root causes of generation of black money and is largely limited to
inflicting penalties on those who hold their black wealth in the form of cash at the moment of
demonetisation.

As there exist avenues for converting high-value notes into lower denominations at discount
or hiding cash into business books through intermediaries, it disturbs only temporarily the
black economy and gives a chance to stakeholders to be on guard in the future.

Way back in 1989, National Institute of Public Finance and Policy (NIPFP) concluded, in a
working paper titled 'Aggregate Demand with Parallel Markets' that “demonetisation curbs
the white economy and will also curb the black economy in a credit constrained regime".

We are witnessing unequivocal harsh curbs on the white economy while its impact on the
black economy still remains a subject of claims and estimates.

The economy has now come to a standstill just because demonetisation is too harsh an
instrument to be used as a disruptor, particularly in cash-driven economies.

The damage is already done and recovery may be long and painful.

Indian government’s demonetisation causes mass hardship and economic chaos

At 8PM on Tuesday November 8, the Hindu-supremacist BJP government led by

NarendraModi made a shock “demonetisation” announcement invalidating all Rupee (Rs.)
500 and 1000 currency notes (approximately $US7.50 and $15) as of midnight that day.

The government set a December 31 deadline for depositing the withdrawn currency bills into
bank accounts and fixed a daily Rs. 4,000 limit for the exchange of old notes for new
currency. This limit was later decreased to 2,000 rupees per day.

The social impact has been immediate and widespread with lengthy lines forming outside
banks across the country. Tens of millions of people, many of them on a daily basis, are being
forced to spend hours at a time to either deposit their old bills or exchange them, severely
disrupting daily life and economic activity.

Bank ATMs all over the country have repeatedly run out of lower denomination currency as
people desperately try to obtain money to spend on everyday purchases.

In rural areas and in small towns where banks or even an exchange mechanism do not exist
the effect has been nothing less than catastrophic, with people unable to purchase daily
necessities such as food and fuel. In addition, small farmers have been unable to sell their
perishable produce to middle-men, since these transactions are almost always conducted in
cash.

The greatest impact has been on the working class, other toilers and the poor who comprise
the overwhelming majority of India’s 1.2 billion people. On the morrow of the November 8
announcement, many were unable to eat as they did not have valid currency for making food
purchases. Others were unable to obtain urgent health care.
According to press reports, at least 55 deaths since November 8 are attributable either directly
or indirectly to the disruption caused by demonetisation. The Modi government has
maintained a stony silence on the reported deaths, undoubtedly viewing them as inconvenient
but acceptable “collateral damage.”

So contemptuous is the Modi government of the suffering masses, that Urban Development
Minister Vankaiah Naidu claimed that any disruption and hardship was "temporary pain for
long term gain.”

Such callous political indifference brought a caution from the Supreme Court. At a hearing
on an emergency motion for the demonetisation to be suspended, India’s highest court
warned the government that if it does not take immediate steps to allieviate the mass distress
there could soon be riots.

Donning the guise of a corruption fighter, Modi, a self-styled Hindu-strongman and

unabashed political agent of big business, has presented the government’s shock
demonetisation as a “surgical strike” against “black-money,” tying it metaphorically to the
unprecedented, illegal and highly provocative military strikes India carried out inside
Pakistan in late September.

“For years,” declared Modi in a nationwide televised address, “this country has felt that
corruption, black money and terrorism are festering sores, holding us back in the race towards
development. To break the grip of corruption … we have decided that the currency notes
presently in use will no longer be legal tender from midnight tonight.”

The pliant and sycophantic corporate print and television organizations have fallen over each
other to hail this move as a “masterstroke” against what is termed as black money, i.e.,
monies that are undeclared to tax authorities and kept hidden in the form of real estate, gold,
cash hoards and overseas or even domestic bank accounts.

The vast majority of India’s “black money,” as is commonly known, is held by the most
privileged sections of Indian society: businessmen, rural moneylenders, politicians and the
upper middle class. This was effectively admitted in an Indian Express column by the
businessman and neo-liberal economist Surjit S. Bhalla. He argued that the rise of “black
money” was an understandable, even laudable, response to the high-tax rates imposed on the
rich and well-to-do by Indira Gandhi’s Congress Party government in the late 1960s and the
regulatory powers of government bureaucrats.

Modi’s “demonetisation” scheme will have little to no impact on these layers and their illegal
fortunes.

The posturing about cracking down on corruption is a smokescreen. The government’s real
aim is to further shift the burden of the capitalist crisis onto the masses—to prop up India’s
banking system at their expense; and increase, as with the BJP government’s push for a new
nationwide 18 percent Good and Services Tax, the tax bite on working people’s incomes.

Not surprisingly, Indian and international big business have hailed Modi’s demonetisation.

“We support the measures to fight corruption and illicit financial flows in India,” declared an
IMF spokesperson.
“Demonetising high denomination notes can be an effective means of checking accumulation
of wealth in cash," said Confederation of Indian Industry (CII) President Naushad Forbes.

Federation of Indian Chambers of Commerce and Industry (FCCI) President

HarshavardhanNeotia congratulated Modi and his government for “an extremely bold move.”
It “will have,” claimed Neotia, “a debilitating impact on the parallel economy in the country
as well as deal a body blow to terror financing.”

Far from being “high-value,” as the cheerleading corporate media and business
spokespersons claim, the targeted currency notes make up the overwhelming majority of all
currency in circulation and are indispensable for daily transactions. The demonitised 500
rupee notes comprised 47.8 percent of all currency in circulation and the 1,000 rupee notes a
further 38.4 percent.

The first aim of the government’s demonetisation scheme is to inject desperately needed cash
into India’s mainly state-owned banking sector. The Public Sector Banks (PSBs) are hobbled
by mounting “Non-Performing Assets” (NPA), primarily business loans that are not being
repaid or paid only sporadically. Because the threat from their NPAs is so large, India’s
banks have cut back their lending to India’s capital-starved and already overstretched
business houses. The paucity of lending threatens in turn to gut economic growth, which has
already declined sharply in key sectors including industrial production, IT, and merchandise
export.

As of June 2016, the banks’ total NPS stood at Rs. 6 trillion ($90 billion), but these figures
probably grossly understate the problem.

In any event, by November 14, just 6 days after demonetisation, total new Indian bank
deposits already exceeded Rs. 4 trillion ($60 billion). Although most of these deposits are
expected to be withdrawn for spending, the head of the giant State Bank of India, Arundhati
Bhattacharya, estimates that about 10-15 percent of these deposits will be retained within the
banking system.

By compelling cash-holders to deposit their funds into the bank, the government is also
hoping to collect a tax windfall so as to help plug its large fiscal deficit. The government has
warned that if the total of demonetised-currency deposited in an account exceeds Rs. 250,000
($3,700) before December 31 and there is a “mismatch” between income and deposits, the
account-holder may be subject not only to paying additional tax, but also to penalties of up to
200 percent.

It is also estimated that about Rs. 3 trillion ($45 billion) out of the Rs. 14 trillion of the Rs.
500 and Rs. 1,000 notes that were in circulation prior to November 8 will not be deposited or
exchanged for new bills. This sizeable sum can be marked as a credit on the balance sheet of
the Reserve Bank of India, then transferred to the government exchequer as a “dividend.”

A third benefit, from the standpoint of the avidly pro-big business BJP government and the
ruling elite, is that the demonetisation scheme will compel greater popular participation in the
banking system. Large numbers of people in India do not have a bank account. This either
because they do not have easy access to a bank—banks do not exist in many rural villages—
or because they are so poverty stricken that they have little if anything to deposit.
As a result, most economic activity, even in urban areas, is carried out in cash. By forcing
people to open bank accounts the Modi regime is trying to “modernize” India’s historically
belated, backward capitalist economy by strengthening the Indian bourgeoisie’s banking
system and its reach. The BJP government has already made clear that one of its principal
goals moving forward will be to privatize large parts of the banking system.

To what extent the BJP government and India’s elite will realize the true, surreptitious goals
of their demonetisation scheme remains to be seen. Whatever palliative impact it has on the
Indian banking system and government finances in the short-term, demonetisation is further
fueling mass popular discontent and under conditions where India’s economy,
notwithstanding Modi’s claims of a high-growth rate, is being battered by the world capitalist
crisis. Last week Indian President Pranab Mukherjee admitted that India, whose labour force
is growing by 10 million people per year, added less than 150,000 jobs in all of 2015.

SUPPOSE that one day the government of a large and fast-growing economy became
convinced that its highest priority was to purge the country of black-economy millionaires
hoarding piles of illicit cash. Seeking popular approval, it sent the printing presses into
overdrive, hoping to inflate away the value of these secret piles of wealth. It worked: rising
prices struck a blow against the undeserving rich, and by egging on others to deposit their
money in banks (where it could at least earn interest), the shadow economy shrank. The
government could plough the newly created money into tax breaks and public-works
schemes.

Critics, rightly, would stand aghast. Inflation would affect everyone who held cash, law-
abiding or not. Much of the wealth of those enriched by the black economy would be
insulated, because lots of their lucre is held not in cash but in property, gold or jewellery.
Such heavy-handed measures could undermine the credibility of important government
institutions. Fear that they might be used again in future could weaken confidence in the
currency as a store of value—paving the way for some broader institutional failure, like
hyperinflation. Long-run trust in the judgment of the state might be threatened.

On November 8th India’s prime minister, NarendraModi, announced a course of action just
as radical as that described above, if the converse of it. He declared that all 500- and 1,000-
rupee notes—making up 86% of the cash in circulation in India—could no longer be used in
shops. More financially mature economies than India would struggle to cope with such a
scheme, but this one floundered at once. Though Indians have until the end of the year to
swap their defunct bills, the roll-out of new ones has been bungled. A broad cash crunch and
broken supply chains threaten a sharp economic slowdown—albeit one that will abate, at
least in part, as the cash squeeze is alleviated. India’s “demonetisation” is a cautionary tale of
the reckless misuse of one of the most potent of policy tools: control over an economy’s
money.

Unlike most currency reforms, designed to boost confidence in the currency, Mr Modi’s
motivation is different. The primary aim of demonetisation is reasonable enough: the
government hopes to improve the functioning of the economy and boost its tax take by
cracking down on the shadow economy. The vast majority of transactions in India take place
in cash; many escape book-keepers’ notice. Economists reckon that India’s black economy
accounts for at least 20% of GDP. Such off-the-books activity shields fortunes from taxation
and allows corruption to flourish. Past efforts to attract black money into the light—using tax
amnesties, for example—have had little effect.
Demonetisation forces the issue. Indians can swap their hoards of useless bills for useful
ones, but those that cannot present paperwork accounting for their cash piles will receive
unwanted attention, and tax bills, from the government. Demonetisation also increases use of
electronic and bank-based payment systems, which will make record-keeping easier and more
common, allowing government better to track and tax the proceeds.

Yet the government also reckons it can profit from bills that are not turned in. In economic
textbooks, money is considered a liability of the central bank—a debt. In most modern
economies that debt sits on its balance-sheet, and is offset, on the asset side, by holdings of
securities like government bonds. The old and unreturned notes, if they are recognised as
cancelled liabilities, would therefore create a huge positive asset position on the central
bank’s balance-sheet. The Reserve Bank of India could, if it chose, create new currency
liabilities (that is, print money) and transfer that money to the government to spend. Some
economists hope the money will be recycled back into the economy through a fiscal stimulus,
which might help soothe some of the pain caused by demonetisation.

The status of this would-be windfall is uncertain. If the government allows Indians to redeem
dead notes for live ones indefinitely, it is not clear when or if the RBI might recognise
cancelled liabilities on its balance-sheet. So far, Indians are depositing their money in the
banking system with impressive haste. Of the 14trn rupees ($207bn) invalidated by
demonetisation, an estimated 8.5trn has already been deposited. Still, as much as 3trn rupees
could remain in the wild as a potential government windfall, reckons a recent analysis by
Credit Suisse, a bank.

The other rupee drops

However clever the plan looked on paper, it is both extraordinarily blunt and risky.
Demonetisation will probably make only limited strides in shrinking the black economy
while affecting all of India’s 1.3bn citizens, the poorest most of all.

In much of the Indian economy, and especially outside big cities, where cash transactions are
most common and financial infrastructure least developed, the sudden invalidation of a vast
amount of outstanding currency represents a significant monetary shock. Not all of India’s
shadow economy—which provides real employment and income, if not real tax revenues—
can migrate quickly and easily above board. Whatever cannot easily be shifted represents a
potential loss of economic activity, and a drag on broader Indian economic growth. Similarly,
if a cash crunch forces small firms without access to credit to shut down, the eventual
alleviation of the cash shortage might not lead to an immediate and complete revival of
economic activity.

Managing an economy’s money is among the most important tasks of the government.
Clumsy use of monetary instruments comes with high risk. John Maynard Keynes, an
economist, was echoing Lenin when he wrote in 1919: “There is no subtler, no surer means
of overturning the existing basis of society than to debauch the currency.” Trust is fragile,
and precious.

The dire consequences of India’s demonetisation initiative

Withdrawing 86% by value of the cash in circulation in India was a bad idea, badly executed
The term demonetisation has become a household name since the government pulled the old
Rs 500 and Rs 1,000 notes out of circulation. While as per dictionary demonetisation means
"ending something (e.g. gold or silver) that is no longer the legal tender of a country", one
needs to see if there is anything more to the word. ET shares details of the word that has got
all India.