‘Your money will remain yours”, said the Prime Minister Narendra Modi yesterday in a dramatic and equally unexpected primetime address to nation. He insisted that it was the only way he could control “the disease” of unaccounted for income or “black money” as it is called in India.”Your money will remain yours as long as you get around depositing it in the post offices and banks”, he assured the stunned countrymen.
Will Modi’s big idea work? India is keeping its fingers crossed. There are definitely advantages in going cashless as black money is certainly a huge problem in India. Indian economy is as much informal as it is formal as most of the establishments work under the regulatory authority and legal atmosphere. A significantly large portion of Indian national income is unaccounted for which is roughly one-fifth of India’s GDP which should be in access of $450 billion.
Narendra Damodar Das Modi was elected in 2014 with high hopes and was expected to take transformational decisions. Unfortunately, he hasn’t been full of such decisions and his performance in last two and a half years has been less than average but with yesterday’s historic announcement he showed that he was certainly capable of taking path breaking decisions.
The decision to ban the existing series of 500-1000 currency note has certainly an economic logic. The absence of large denomination notes will make it difficult for people to keep it as black money in hand. It is at the same time not an easy task to find out the actual quantum of black money in circulation as liquid money, as there are other avenues also like gold and real estate in which the presence of black money is rampant.
But the reason behind Modi’s announcement was nothing to do with the change in the modalities of keeping the black money. It was more about him, his strong leadership and the message he wanted to give to the country. In that respect the historic step was a sign of desperation as well as a master stroke of brilliance. Modi is now reaching that point of his present term when the promises made in the 2014 Parliamentary elections have begun to haunt him.
During entire last week he mostly occupied the center stage on discussing one rank one pension issue which he thoroughly politicized. His record on OROP has been abysmal despite making huge statements and ex-servicemen openly showed their dissent. The suicide of an ex-soldier was the culmination of an issue which was simmering since long and Modi was looking for something big and the announcement to ban the existing high currency note should be seen in that backdrop.
Modi knew that the accounting of his extravagant promises made during the election trail of 2013-14 was overdue and he was looking for a political jackpot considering the coming UP and Punjab elections. The timing was too perfect to be missed. Some of Modi’s more ideologically eccentric bedfellows have been openly advocating a ban on the existing high currency notes to force the informal economy towards more formal and structured economy in order to bring them under the tax net.
For example, Baba Ramdev of Patanjali fame has been agitating for years against high denomination notes in circulation. The ex-CEO of Standard Chartered Bank wrote in a paper this year urging the G-20 countries to ban 500 Euro, $100 and 50-pound notes. Even a group of retired judges whom Govt of India appointed to examine the issue of black money suggested cutting down on the cash transactions. Of late across Asia countries are moving away from high-value notes and South Korea has grand plans to go totally cashless by 2020.
The plan to ban the high-value currency notes must have been planned well in advance and it is remarkable that Govt. was able to maintain a shroud of secrecy around this decision as even the seasoned financial pundits were shocked with the latest measure taken by the Govt. Modi’s exceptional organizational skill was in full display as his cabinet made the decision and the Prime Minister lost no time in addressing the nation and the Governor of Reserve Bank of India followed him shortly on TV with a calm and calculated message. And the most incredible thing about this whole exercise was that all this happened without even a hint of plan leaking out in advance.
Modi was in fact forced to adopt this strategy of shock as his hands were tied up on account of making tall promises in 2014 election speeches to “bring back black money’. And with this announcement on restricting the flow of black money Modi turned his political liability into a political success. There isn’t a voter who won’t think that their Govt has indeed taken a huge step against hoarders of black money. Modi, in spite of number of press releases and a much-hyped amnesty scheme, couldn’t live up to the high expectations of voters. The IDS 2016 amnesty scheme was not much of a success and brought only a tiny fraction of estimated black money.
As per RBI estimates currently 17,54,000 crore of notes are in circulation and out of this 500 currency note share is almost 45% while 1000 note constituted approx 39%. However, when we talk of volume, 100 Rs and 10 Rs notes constitute around 53% of the total notes in circulation. So by this Govt’s unexpected decision almost Rs 6, 32,600 crore in circulation which is primarily in the form of 1000 Rs note would immediately become an illegal tender. In order to replace this 1000 Rs note, Govt will introduce 2000 Rs note which will be limited in supply.
There is an another interesting aspect as the RBI data showed that approx 6,50,000 counterfeit notes were detected in commercial banks and of which 4,00,000 were in the 500 Rs and 1000 Rs category. Hence the Government wanted to remonetize the 500 Rs note while demonetizing the current 1000 Rs note. The number of 100 Rs counterfeit note was around 2, 00,000 this year and 86% of currency by value in India are of 500 Rs and 1000 Rs denominations.
The initial effect may well be heavy deflation as people who have amassed money through illegal means like corruption, smuggling and bribe would think twice before approaching banks to declare money under apprehension that they might be prosecuted by Government and the Income Tax department. Deflation, in turn will increase the value of money as the total supply of currency will be restricted while the commodities and other goods available in the market will not go down.
The banks in long run will be strengthened by the inflow of legally earned cash which will be deposited in banks and that will have a ripple effect in increasing the bank’s lending. Hopefully, credit should become easier and as a result interest rates may come down which increase money supply and eventually may prove inflationary. But whether this will happen slowly or immediately, the future holds the answer.