Hollow Policy Sham: Why Demonetisation Fails the Modern Economy

Honest and corrupt persons alike feel that criticism of the policy might make them suspect in the eyes of others.

11 min read

Many Indians think that withdrawal of Rs 500 and Rs 1,000 notes from circulation is good policy, poorly implemented.

Honest and corrupt persons alike feel that criticism of the policy might make them suspect in the eyes of others. So they go along with this view, without asking how it is going to reduce black money. I have been trying to think it through logically and here are my findings.


Not All Black Money is Bad for the Economy

Income earned from unlawful occupations like bribe taking, drug running or prostitution is bad, but income earned from lawful occupations like buying and selling property, gold and other items, generates enormous economic activity, investment, commerce and employment, even if a part of it has not gone to the government to pay for public services and has not been deposited in banks.

One-time removal of large currency notes from circulation was done in the past to remove black money held by hoarders.

Note denominations that were taken out of circulation were the Rs 5,000 and Rs 10,000. At that time, these were not generally used or kept by most people, whose economic activity continued as usual when the policy was implemented. As a result, there were no legal notes in circulation higher than Rs 1,000 when the present drive started.

The value of the rupee has diminished twenty to thirty times since 1978 so that today, every Indian uses notes of Rs 1,000 and Rs 500. How can removal of these two denominations be targeted mostly to black money holders?

Again, as Arvind Kejriwal and others have pointed out, these denominations are being replaced by the same or higher denomination notes, which means that the logic behind the move is totally faulty.

Demonetisation: Past and Present

There is another significant difference between 1978 and 2016.

Now, big fund transfers and deposits are not done through cash; modern methods are more sophisticated, using electronic and online transfers. One-time removal of some note denominations will simply not affect such transfers.

Proof again of the hollow sham that is the current policy.

The proportion of Indians who do not file income tax returns or deposit money in banks is high.

The first All India Rural Credit Survey of the 1960s recorded that only one-third of Indians were covered by the banking sector.

At that time, many households were transacting business by barter, particularly in agriculture (since agricultural labourers were paid in grains, etc). Today, the country is far more monetised.

When I became Secretary (Institutional Finance) in Karnataka in the 1990s, I found that the percentage of Indians covered by the banking sector was still one-third. The figure has hardly improved despite schemes for encouraging people to open deposits and enter the banked world.

By the way, the percentage of the population covered by banks in China is double that in India; in China, two-thirds of the people have bank accounts.

And this has happened despite the economic confusion created there during the Communist Revolution.

Poverty, Banks and Elitism?

Poorer households do not keep their money out of banks by choice. I surveyed street vendors in Lajpat Nagar in Delhi while working with Madhu Kishwar.

Everyone interviewed told me they would love to open bank accounts in the two to three branches of that area.

When we talked to bank staff, they told us: ‘We cannot let people like this sit next to our customers!’

In Bangalore, I opened an account for my housemaid with the nearest bank branch (quite some distance from my house and hers) after fighting with the branch manager, who would not accept her ID proof (she had been living in the locality longer than me) and wanted me to guarantee her authenticity (and open an account myself with him, which I refused to do).

When I tried to pay her with cheques, she walked to the bank, waited and was pushed around, told to return later, etc. just to withdraw her own money. I do not want that on my conscience anymore, so nowadays, I pay her cash.

She is saving to buy a house and educate her son.

She does not borrow from the bank at normal interest rates, but puts her money in a chit fund from which she draws it, paying interest at 3% per month (36% annually).

The number of households who function in this manner is very large in India. Can we blame or harass them for not depositing money in banks? They would if they could!


Many income earners in India do not file income tax returns or pay tax. Most of them today actually have PAN cards and use it to prove their identity.

I have met poorer groups in Bangalore city, particularly when I was working in education and solid waste management. The man works as driver, security guard, mason, carpenter, electrician and the like, the woman does household work, cleaning and sales.

Even if all their income is declared in two returns, it would be below the minimum taxable limit.

All of them receive Rs 500 and Rs 1,000 notes, save them and use them. We see around us the havoc created in their legitimate economic activities by the recent move of the government.


Income Tax Offices No More Welcoming Than Banks

Dr Arindam Das Gupta, an international expert in tax compliance who was Dr Raja Chelliah’s right hand man, while working on tax policy reform once told me that Chartered Accountants refused to be interviewed by him about their experiences with this department.

Finally, he got many of them to speak to him anonymously, but could never do a proper academic survey.

His finding was that a taxpayer has to spend more than one rupee to pay one rupee of income tax in India; his report was suppressed by the government.

We can endorse this from our own experiences, despite the computerisation of tax return filing and processing.

Intelligent, number-savvy persons, who slave to clear a tough exam to become Chartered Accountants, soon become experts in bribing tax officers by interaction with income tax authorities.

Unwillingness to pay taxes can be considerably reduced by taxpayer-friendly procedures, but we have not seen any moves by the Finance Minister or Prime Minister to achieve this.

Modern Economy: A Gamble That Paid Off

You do not have to be an economist to know the importance of money as the vehicle of the economy. It is the greatest economic invention that enabled human beings to live together.

Replacing barter with coins and finally with scraps of paper that are valued simply because we trust the promise written on them is a great gamble that has paid off over the ages.

No economist or financial policymaker would willingly tamper with this trust without good reason and without anticipating all the possible consequences.

Fiddling with people’s trust in money is a very dangerous game, because we buy and sell our goods and work for money, invest and save in money. Monetary policy focuses on increasing or decreasing availability of money in each of its different forms and it is modified with care when required.

For the first time perhaps, (not due to any great policy initiatives of our government, but because of the effects of worldwide recession in countries like China), India might be the fastest growing economy of the world (our growth rate is around 7%, higher than the “Hindu rate of growth” of 3.5%, but far lower than our dream of crossing 10%, which we did achieve for some years in the past).

We have two major things in our favour, which other countries would do anything to have now: a young population and a great unsatisfied demand for infrastructure, goods and services. These advantages have not been leveraged to produce the spurt in economic growth that our people crave and deserve.

Instead, aspiring, productive households are the very ones whose occupations have been disturbed and disrupted. The greatest economic tragedy of our people is their unrealised growth potential.


Intended and/or Unintended Consequences

Monetary policy is formulated by the RBI and currency is issued in close collaboration with the Finance Ministry.

One day, when the history of the current fiasco is written, we will know what advice was given by the RBI Governor, Economic Advisers and that strange body that has now replaced the Planning Commission – were they even consulted? 

They may have done their homework but the decisions lay with the Finance Minister and Prime Minister, who will have to answer for the consequences today and for the future.

I have tried to imagine a few of these consequences; they might be intended or unintended; you and I may like or dislike some of them.

Big holders of notes withdrawn from circulation, who have underreported incomes and cannot account for the notes, will discount them for the new notes with those who still have head room in their bank accounts to explain the deposit of cash.

This will shift some purchasing power from the original hoarders, to those who pay taxes and it will bring the money into banking channels.

Some people may lose their savings and investments held in the withdrawn denominations, and many of them may have earned it through legitimate economic activity.

Those who lose faith in paper currency will move to other assets and means of commerce, which will also reduce currency available for transactions. This should reduce the money in circulation, leading to (self-induced) recessionary conditions –dampening growth, investment and employment all around. Own goal for India, I think!


The economic activity of people who are used to cash transactions will be severely disturbed. Many of them are the very poor; others are small traders and businessmen who have remained outside the tax net so far.

The entire economic ecosystem of people who live and work outside the banking and tax channels will be affected, and this will greatly affect the economy inhabited by taxpayers too, since the two worlds touch all the time.

Persons in the unbanked groups are entering banks today, because of the withdrawal of the two denominations of currency and (I sincerely hope) that bankers will be trained to value them and deal with them as legitimate customers and devise products to suit their needs.

Those who are already banked will move to automatised services like credit and debit cards – not an unwelcome development.


Banks in Overdrive Dangerous to Economy

Bankers who are dealing with public queues have become agents of the central government for some days now.

Our exasperation with bank strikes has been replaced by admiration for the tireless work being done by the staff in branches outside office hours and without holidays.

Normal banking activity has come to a halt – very dangerous for the economy. The consequences are bound to be seen in investment and transaction results for the quarter when the year ends, (assuming that these statistics will actually be honestly revealed to the public).

The inflow of cash will reduce borrowing costs for banks but lending, which is already low, will be further affected because banks have not been able to do regular bank work during this month. Interest rates should fall, with macro and micro level consequences. 

Remember, however, that few economic results are good for every group. A fall in interest rates is good for borrowers and bad for savers. Since all of us are both borrowers and savers, we can do our own sums.

What will happen in sectors like real estate and jewellery, where transactions in unaccounted cash prevail, is fascinating to contemplate.

These sectors generate employment directly and indirectly across all income levels. 

Please do send in your speculations; I am still thinking this through.


Corruption Won’t Go Away With One Stroke

The present policy is being promoted as a one-time attack on corruption. But there are no one-time solutions here, as we all know.

Reducing corruption is not rocket science; to do it well and in a sustainable manner, systems, untouched by hand, must be ruthlessly instituted in every major area that affects people’s lives. Solutions for this are lying around us everywhere but are being routinely scuttled.

Land transactions is one major area. An example: we gave a simple, totally workable method for automatic khata generation in BBMP, but I don’t see anything happening.

Political corruption, which justifies and tops the corruption pyramid, can be reduced if political parties take donations in cheques and publish details openly on party websites.

We know which party does this and the rest who don’t.

Nothing prevents political parties from stopping the practice of bribing voters on election day (by the way, will voters be entitled to Rs 2,000 instead of Rs 1,000 in future elections?).

Quick and certain punishment for those who are caught giving and taking bribes is a major deterrent against corruption.

The list of people with Swiss accounts and those disclosed through the Panama papers has disappeared from the government’s radar. 

Please watch the BBC’s Panorama program, which is being aired currently, focusing on bribes paid by Rolls Royce in many countries, with details about bribery to sell aircraft in India.

And both BJP and the Congress have systematically prevented better-intentioned governments from formulating workable Lok Pal bills (even if this cannot be a panacea for tackling corruption).


Details of how disclosure or deposit of withdrawn notes will be converted into increase in income tax revenue and reduction of corruption have not been explained.

Have bank staff been trained or advised to check existing accounts, refuse to open new accounts and eventually forward details to income tax authorities? Is the income tax authority geared up to examine the new information sensibly, quickly and effectively?

We can look forward to computerised tax notices issued to all and sundry for nondisclosure of some bank account or the other, and these will lie at the bottom of our rubbish pile, like all the mindless, inaccurate notices we receive today from the tax computer centre.

(By the way, I have discovered that those who ignore the computerised notices are persons working in the income tax department – they know that nothing will happen!)


Why Did Demonetisation Happen Now?

One last question: Why? Why was this policy formulated, and why now? It’s a surprise that we Indians – who love conspiracy theories – have actually generated very few of them about the currency withdrawal.

Let me offer some (wild) speculation.

Perhaps, withdrawal of notes was an item high on the hidden RSS agenda for implementation by the BJP when “our person” rose to governorship of the RBI – as illogical as demolition of mosques to build temples, “ghar waapasi” and cow protection. (Let us remember that core RSS ideology abhors financial corruption).

The people of India at all levels are getting impatient with the pervasive bribery culture and are demanding cleansing of government and political transactions.

We have already seen in our agitations in Bangalore how lip-service is paid by professional politicians to public demands and all efforts made to pretend to respond to them, hoping that we will be fools, easily taken in by the shadow, not the substance.

And many of us have reacted as expected. We believe that withdrawal of these currency notes will solve corruption, without asking ourselves how.

The biggest insult to citizens is to ask them to behave like soldiers “sacrificing themselves” for the good of the country. Logical thinking will show who will actually benefit from the new policy and how much the country and its people will be damaged. 

The timing of the decision is also interesting.

There are some elections like Goa on the horizon, where corruption is becoming a determining issue. A loud-sounding but hollow move at this juncture pretending to attack corruption is the master tool of disinformation, totally Goebbelsian!

Please think through the implications of what has been done. It may be difficult for us law-abiding, honest persons to do this, but let us put ourselves in the shoes of those who are corrupt and evade taxes and work out how they would handle the present threat.

This should give us insights into how black money operators and hoarders will tackle the attack on their assets and way of life and show us how they will circumvent it.

New notes for old is then not good policy, badly implemented – no, not at all. It is a bad, stupid and dangerous policy, that is totally unimplementable.

(The author is a former Secretary in the Cabinet Secretariat in the Government of Inida. This article first appeared as a Facebook post on the author’s daughter’s timeline. The views expressed above are of the author’s alone and The Quint neither endorses nor is responsible for the same.)

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