The Meghnad Desai Academy of Economics (MDAE) played host to a fascinating panel discussion on Demonetization. The panel composed of a many a distinguished speaker from a mix of professional backgrounds – Prof. Rahul Menon of St. Xavier’s College, Dr. Suchitra  of G.N. Khalsa College, Dr. Yadnya Pitale, Research Director at the World Trade Center and Mr. Toshi Jain, an economist at JP Morgan (India). The discussion was moderated by Prof. Indradeep Ghosh of MDAE.

To briefly paint a picture of the environment that demonetization has occurred in – an overwhelming 86% of all cash transactions in India were made with the now discontinued INR500 and INR1000 bills. These two denominations accounted for a mammoth 10% of India’s GDP, and smaller denomination notes made up an extra 2%. Mr. Jain of JP Morgan (India) observed that the ideal cash to GDP ratio would be in the range of 8-9%. Additionally, it is no secret that the mammoth black economy itself equals between 40-50% of India’s GDP.

To begin with, each panelist spoke their mind on the rationale for, the implementation of and the potential future effects of Demonetization.  Unsurprisingly, this led to a wide spectrum of contrasting views – from being heralded as a well-planned ‘strategic strike’ on unaccounted wealth, to being poorly executed due to a severe lack of critical infrastructure and finally, to being a policy that was a product of poor judgment of the authorities that failed to adequately weigh the potential pros and cons of such an action.

A rare point of consensus among the panelists emerged. Clearly, the short term pain the economy would endure would be significantly longer than initially anticipated. Post November 8th and with the subsequent re-introduction of new currency bills, the cash to GDP ratio has plummeted to 3.6%, and will most likely take 5-6 months to recover sufficiently to once again spur aggregate demand.

Broadly, the major points of contention lay in the role of demonetization in reduction of black money in the economy, its promise to “shock” the system into going cashless and the implications it would have for the banking space. Mr. Jain was largely positive about the move and felt that this bold step by the government would pave the way to move towards an 8-9% cash to GDP economy. Further, he felt it had “put the fear of god” into those who laundered money and maintained unaccounted wealth. Despite estimates showing that cash is a small fraction of black wealth in the country, he felt that there is scope for positive gains in the long term, particularly in terms of pushing greater financial inclusion and stemming the generation of black money. Since the 8th of November, nearly INR 4tn has been deposited with the banks, strengthening their balance sheets and flushing their coffers with liquidity. These funds could further be used to fund development projects and vital infrastructure, however, there is a lack of agreement on the issue of legality of such a step, and whether this was the only way to fund essential infrastructure project, that Prof. Suchitra Kumar later referred to as a new form of ‘deficit financing’.

Dr. Pitale was not as optimistic of the impact this move could have on the economy, given the major bottlenecks and infrastructure challenges that exist across the country. Having had a significant amount of experience in primary research, Dr. Pitale  was of the opinion that this move would hurt those in India who do not have access to bank accounts and who can often not readily go cashless (such as in the case of poor connectivity or high rates of illiteracy).  Mobilising these sections of society to undertake regular banking would be unlikely without a greater provision of infrastructure.

A key point to Dr. Pitale’s argument was that there was little reason for the government to issue INR 2000 currency bills if this was to be a serious attempt to curb the black money menace. In her view, the state’s social welfare responsibilities should have taken precedence over the stated issue of printing costs. Further, she felt that financial reform in India was an uphill battle without the provision of adequate associated infrastructure, both physical and social, rationalisation of the tax structure and the improvement of tax compliance rates that presently stand at measly 11% for income tax. Interestingly, she noted that introduction of an INR 2000 currency bill was implicit acceptance by the government that the rates of inflation are too high.

Prof. Suchitra Kumar echoed Mr. Jain’s sentiments that in totality demonetization is a good move. It has eased pressure off the NPA-ridden banking system although the professor agreed that in the short term both GDP and aggregate demand would suffer and “tighten the economy”. The degree of tightening would have to be closely monitored.

Lastly, Prof. Menon of St. Xavier’s College presented a contrarian view regarding the politics and economics of the decision to discontinue INR 500 and INR 1000 currency notes. He believed that the discourse surrounding the demonetization neglected the threat a short run slowdown could impose on India’s longer term growth trajectory, in particular through a loss of jobs, i.e.  Increasing unemployment across the country during an extended credit crunch, that is largely a result of “credit rationing”. This could lead to a permanent reduction in aggregate demand and a fall in incomes. In the near term, the lowering of the velocity of money would cause a fall in demand that is significantly greater than the amount of currency that has been removed from the system.  Carrying on from what Dr. Pitale had said, Prof. Menon’s concerns regarding demonetization prior to the requisite infrastructure being in place stems from the potentially catastrophic impact it could have on those already marginalized members of society, or “those without a safety net”.  Somewhat comically, the weaker sections of society have felt a certain sense of justice while the well-off have been made to struggle over the past few weeks, particularly in UP which is set to go to the polls next year.

Another important issue that came to the fore was the notion of “collateral damage”. Undeniably, the demonetization move has led to significant discomfort for many people. Prof. Menon was alarmed that the majority of the population is increasingly desensitized to the suffering that marginalized groups must face, and is often too eager to embrace strategies that appear revolutionary, without building a fuller understanding of the costs and benefits.  In his view, the challenge of black money and counterfeit currency must be met by strengthening institutions over the long haul and giving regulators more power to exercise vigilance.  This is not a view that went unchallenged, with some audience members stating that collateral damage is part and parcel of any public policy, and that it was a price worth paying to combat black money and other illegal activities that are inextricably intertwined with our money supply.

The only thing that is truly safe to say about demonetization, is that it is a far from a settled matter. Only time will tell how this move will play out.