Demonetization and what the experts are saying

On November 8th, as I watched polling begin in the U.S., India lit up in the middle of the night, with shops and businesses staying open till 4 a.m. next morning. In a surprise move, my Government declared circulation of all ₹500 and ₹1000 banknotes as invalid and announced the issuance of new ₹500 and ₹2000 banknotes in exchange for the old banknotes. To what has been a subsequent discussion of panics, rumours, and insinuations afterwards, I had my eyes and ears open to what economists and market strategists thought of this demonetization move by the Modi government. Soon enough, various articles, interviews, and debates emerged and I for once was luckily distracted from the aftermath of the U.S. elections; distracted from the depressing thought that the reality in the U.S. has become a burlesque of the television show, The Simpsons, rather than it being the other way around.

As expected, the demonetization policy has gathered mixed reviews from researchers. There are few words of praise written calling this as a bold move by the incumbent Prime Minister which will have positive long-run effects. But most are of the opinion that demonetization is just a dramatic move rather than being a proportionally effective move taken by the government in the fight against counterfeiting and black money. The main point of contention is that this policy treats black money to be as ‘cash stuffed under the bed’ and has no effect on the dishonest money that is being invested back into the system through real estate, gold etc. purchases.

Demonetization, would “demobilize the stock of black wealth or a part of it, but it will not stop the flow” says Arun Kumar, Retired JNU Professor and a persistent pursuer of the problem of black market economy in India. “…if the black economy is 62 percent of GDP that means it is systematic and systemic… not anecdotal.” Only via higher accountability and strong whistleblowers’ bill can one truly tackle corruption and black money in the system. Parikshit Ghosh, Associate Professor at Delhi School of Economics, also calls this exercise of demonetization to be like hitting a “reset button,” as the policy looks back (trying to control the existing black money) rather than looking ahead (incentivising against future accumulation of black money).

Amongst the ones praising this move, Kenneth Rogoff, Harvard economist and author of ‘The Curse of Cash’ considers this to be a step in the right direction. “The short run costs are unfolding, but the long-run effects on India may well prove more than worth them” he wrote. (See his blog here).

Former RBI governor D.Subbarao and his colleague, former RBI Deputy Governor, Subir Gokarn, have also welcomed this move by the Modi Government. Dr. Gokarn believes that ‘the long-run benefits of demonetisation are huge” and the added short-term risks can be managed. Dr. Subbarao, similarly believes that this “‘cleansing of the system’ will be positive for both savings and investment”, pointing out that one of the points driving this decision to demonetize was an “uncharacteristic expansion of currency in circulation, clearly out of line with the pace of expansion of economic activity.” (See articles here and here).

Contrary to the views of the former governor and deputy governor on demonetization, Ajay Shah, Professor at NIPFP, Delhi and Rajeshwari Sengupta, Assistant Professor at IGIDR, Mumbai believe that demonetization is going to adversely impact economic growth of the country.(See articles here and here).

The experts have also criticised this policy on the grounds of it distressing the country’s low-income class. Prominent economist Jean Dréze has vociferously criticised the government’s move, calling it a burden on the already downtrodden in this country (Read the whole interview here).

“… it has imposed a punitive cost on those who held their black assets as cash, and completely missed those who had converted their cash into real assets and foreign holdings…it has penalised virtually the entire informal sector, and perhaps damaged it permanently… it has done absolutely nothing to curb either corruption or tax evasion. And all this at the cost of Rs. 12,000 crores in printing new notes…” writes Pronab Sen, Country Director for the India Central Programme of the IGC, all the while expecting this move to be effective in eliminating terrorist funding through counterfeit currency. In a follow-up article, he contends that the government needs to address supply side woes rising in sectors like agriculture, (informal)manufacturing, trade and transport by redirecting new notes towards production purposes rather than providing liquidity for consumption.

Lastly, there are two interesting reads analysing the political ramifications of this demonetization move by PM Modi.

In their article in The Mint, K.Subramanian and Prasanna Tantri who are associated with Indian School of Business, tear apart the opposition party’s condemnation of this policy based on how it inconveniences the poor. Using NSSO survey, they argue that “the poor are likely to have visited a bank branch at most once to exchange their earnings in the old currency notes to new currency notes.” The long queues, according to them, seem to stem from either the “richer folks” exchanging honestly earned savings or those who are acting as “agents for the dishonest.”   

The second article is by Maitreesh Ghatak, Professor of Economics at LSE, where he calls this demonetization move as Modi’s campaign pitch for 2019 election, all the while maintaining that it is “likely to be ineffective or even counterproductive” from a policy point of view.

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Shivangi Chandel is currently a Lecturer at Meghnad Desai Academy of Economics. She did her masters in Mathematics from Indian Institute of Technology, Kanpur before joining Indira Gandhi Institute of Development Research, Mumbai for PhD. in Economics.

Her research interests lie in Microeconomics theory, IO and Game Theory, with a focus on Auction theory and its applications.