Between the time that the PM made the announcement and 12 PM barely a time of four hours - the entire stock of gold/silver jewelry was sold out (close to 100 crores) in Indore alone.
It is also a fact that India sent a record $4.6 billion as outward overseas remittances a spectacular jump of close to three times the figure sent last year.
People ofcourse are trying various means to convert notes including depositing notes in the accounts of their maids and other employees. It is expected that these amounts will be converted into cash in new denominations within anywhere between one to twelve months.
According to the Finance minister Rs. 2 Lac crores was deposited in the banks in just two days of announcement of demonetisation. It would be interesting to study how much of it was deposited in the newly opened Jhan Dhan accounts. Even when these accounts were opened at a crazy pace - it was pointed out by experts that these accounts may not be controlled or operated by the actual account holder but may be used for parking black money. Now it is a real possibility looking at the flood of money deposited in the banks.
The point is - demonetisation may have done very little to destroy the black economy. As the new notes increase in circulation the black economy may start thriving again unless the Government further cracks down on the three larger ticket items - Gold, Real Estate and Foreign accounts with black money. The PM on his Japan visit hinted that the next attack on black money may happen on "benami" properties. However, in this very post, I try to make a case for why the Government may find it very difficult to crack down on them.
Demonetisation by itself may end up reducing the size of the black economy by 5% at the worst and 10% at the best (assuming at least 1/3rd of the cash will still be rescued by several means).
Given that we have launched a higher denomination note of Rs. 2000 it is difficult to see how demonetisation is a major effort in addressing the black money problem.
Our legal cash economy might actually be far bigger than this figure. And people who are unable to pay because of demonetisation may have been depositing the money in desperation. On a gut people with black money have no hurry to deposit their cash in the bank so soon, except when they get accounts of trusted people to deposit amounts upto 2.5 lacs each. They must be currently looking for ways to convert in the grey market and once they fail in achieving this objective they might deposit the money in last ditch attempt. If this conjecture is true largely we may see a surge of deposit at the fag end of December.
The other assumption that is wrong is that Rs. 500 note is a high denomination
note (it forms almost 50% of the currency available in the system) and that most poor do not have money in these denominations. What appears to be more true is that the poor saved whatever small amount in these denominations, while their routine transactions may have been in smaller notes. Retired old people may have their small savings in these notes too.
If so, the demonetisation has probably created a huge inconvenience to millions of people out there who need daily cash.
No, I am not cribbing about the inconvenience of standing in a queue of ATMs or for notes conversion. Any exercise of such a magnitude is expected to create these scenes and I think there is no panic currently. I expect the crowds to fizzle out as larger denomination notes (specially the 500 Re value note) circulate more and more.
The inconvenience I am talking about is that we have clubbed a genuine citizen in the white economy with those in the black economy vulnerable to interpretations of and harassment by officers. This is expected to be played out in the coming months.
It is an economy that produces and consumes. So it achieve the basic aim of distributing wealth (admittedly it is nowhere near equitable distribution - so also legal economy isn't). Meting out sudden death to this economy may create huge problems to these sections of the society. It may lead to stagnation in some parts of the economy - with consequences that I cannot probably fathom in this post.
What was possibly a better idea was to gradually merge this economy into legal one as has been happening over the last two decades and has only accelerated due to digital economy happening and growing fast.
To understand this point better be reminded of a basic lesson in Economics. Money is just a medium of transactions. To treat the disease of black money - squeezing out money from the system can kill transactions and hence impede distribution of wealth. One has to appreciate that the reason for black economy is not currency - the reasons are somewhere else - read the post further to understand those reasons as well.
economy. The real estate sector which runs on black money to a minimum extent of 40% in each deal is going to go through a big adjustment cycle which may bring prices down and bubble burst effect may happen. We may expect that people will try to protect liquidity and hence discretionary expenses may be initially deferred. I wrote in the earlier post that inflation will cool down - the real fear is that it may cool down too much - leading to a temporary deflation. One can not predict the intensity but in all probability a short term slow down in the economy may happen. People who are preaching taking pain for the larger good of the economy may not have yet gauged that the real pain of this decision is yet to play out. That pain is NOT the queues that the common man is standing in currently. That pain would come from a decline in his business for no obvious reason of his own.
Add to this uncertainty inherent in the implementation of the GST from 1st April 2017 which is expected to increase indirect tax levels and would go through its own teething troubles that any new system goes through. This may cause more severe short term pain. Together, you have a sure recipe for a slow, dull and chaotic year ahead of all small businesses.
One hopes that in the middle term it will be positive to the economy - that of course is based on the assumption that the govt. will stick to its firm stance on black money and that it will not chicken out after the UP Elections.
I already mentioned that the black economy isn't going anywhere due to demonetisation alone. Because demonetisation puts temporary brakes to a well oiled black economy which can start moving again quite quickly if we do not attack root causes. In fact, there were many effective ways to curb the black economy without causing so much pain due to demonetisation. So here is what HAS TO BE DONE if this attack on black economy has to be lethal and of long deep impact.
1. An attack on Benami Properties as already promised by the PM in an address
2. A surgical strike on the unaccounted gold kept idle as black wealth
3. A ban on Paticipatory notes. It is well known that a lot of black money is routed through PNs in the stock markets. This was once done away with under Dr. Manmohan Singh but ban was later revoked because it resulted in a sharp fall (bear market) in capital markets.
4. An immediate ban on all political parties to accept cash donations. All donations should be either done through cheques or online transactions. If the Government is sincere about killing black money and about creating a cashless economy - this should have been the first step - Leadership by setting examples. BJP spokesperson on the TV when asked flatly about this gave a lame "I am not the right person to answer this question".
5. Tax agricultural income beyond a certain limit (maybe higher than current exemption limits). It is well known that many top politicians and very rich people in India have status of farmer on books. Because agricultural income is not taxed in India. Both Modiji and FM are on record in saying no tax on agricultural income.
6. Implement the Direct Tax Code which was proposed by the UPA-II government which offered Income tax exemption for people with income upto Rs. 10 Lacs. This would bring better tax compliance.
As you were reading through these steps you may have realised that curbing the black economy is a very long haul and a politically very risky one too. On this path any Government will end up making almost everybody its enemy (or at least will upset everybody).
If the PM did not walk this talk for whatever reason then we will have to accept that this demonetisation was a staged event to achieve some short term political gains only and not a long term economic vision.
The corrupt bureaucrat, more than anyone may lose more substantial part of
their ill gotten wealth because they cannot obviously deposit it in the bank even on a penalty. So, one can expect a major part of the babudom feeling upset. The Government may come across (and this is purely conspiracy theory) bigger hurdles in implementation at the bureaucratic levels. The currency conversions was largely handled by banks who are salaried employees with little or no black money. They happily served the cause - that may not happen with the bureaucracy.
Another possibility is a spike in the harassment and bribing by the babus, due to losses they might end up booking, many of whom have paid a fortune upwards to receive the posting they are in.
Whether it be demonetisation, or GST implementation or crack down on the property market - a lot depends on the bureaucracy and to me it remains a black box ready to spring surprises.
On the other hand there is another solid support base of the PM Modi - the young educated lot who are vocal on social media and are largely start up entrepreneurs and/or salaried classes. Add to them the existing middle aged middle class salaried people - who are actually happy about the demonetisation. This group is, I believe, expected to consolidate behind the PM/BJP. In fact many fence sitters in this group may finally move over to the BJP.
There is another group that was traditionally not a BJP supporter but were gradually moving closed to the party - The Indian housewives (Remember that they were the reasons for BJP's resounding defeat in the Bihar elections). In one stroke Modiji upset them because the notes that they accumulated over the years from often legitimate income of their husbands became worthless (to them) and was allowed to the extent of only Rs. 2.5 Lacs. I can vouch for the fact that over something like two decades a typical indian housewife ends up accumulating far more. This group can feel strongly anti-bjp just for emotional reasons.
However, in then medium term the positives of all this disruption may also start
kicking in and people may start feeling that the Government actually did something positive to the economy. Assuming that the BJP will keep promoting its whatever achievements, with the same deftness as it has done till now - this can be a big positive for reelection of modiji - the PM in 2019 (or maybe not if the medium term does not play itself out in two years). It may however affect the Punjab/UP elections adversely for the BJP.
The counter theory of course is that demonetisation actually conducted a surgical strike on parties like BSP, SP & Congress in the UP elections running them dry of cash to run an effective election campaign and that may actually benefit the BJP. The jury is still out.
Whatever be the truth - it is a fact that politically modiji/BJP has taken a huge gamble. To that extent Modiji has to be applauded for being the risk taker that he is generally known to be. I said on the 8th Evening after the demonetisation
We may be pretty far from cashless economy
The same applies to cashless economy as a concept. Cashless economy will not get created by simply squeezing cash out of the system. It will have to be replaced by mechanisms to pay electronically or by plastic money. An estimated 80% transactions in India happens on cash. A very large number of them are small transactions 200 to 1000 rs range. Millions of Indians do not have bank accounts. Many who have newly opened jan dhan account currently do not know how to use them. They are scared entering a bank and are treated badly at the branches. Point of purchase do not have enough swiping machines ready. Those which are available are hardly fail safe. and I am not even talking about unprepared police and judicial system who will face a flurry of online and card frauds.
I just bought one thing in the last five days (today is 15th Nov.) a pair of lenses for my son's spectacles. The bill turned out to be Rs. 1450. I offered my card to the shop owner - he swiped it and the transaction did not go through. I checked my wallet - it had many 500 Re notes - but just 850 in small cash. He tried multiple times and failed. I offered my wife's card - did not work. I offered my credit card - failed again. He tried his own card (probably to save me the embarrassment that my card might have been deactivated ;-) )and failed. we looked at each other awkwardly. Finally, I offered him four 500 Re. notes to be kept as deposit till the time I can bring him small cash and take those notes back for depositing in my account. He was immediately shaken and simply took three notes and returned me a 50 re. note mentioning that I was too reputed a person for him to get into such an arrangement. Now think, how will cashless economy work without a fast, efficient and fail safe plastic and electronic mechanism in place in every nook and corner. Are we ready for it - my gut says no.
Another problem with the plastic money. Transactions through them are chargeable in most cases to the extent of 2.5% of each transaction. My card carries an annual maintenance fee. This are issues to be debated and resolved before a cashless society gets into top gears. Otherwise we will be saddled with a bumpy and costly cashless economy. The black economy is actually encouraged by such low levels of preparedness.
All in all prepare for a bumpy ride to a cashless economy, if at all.
Hyped up Expectations
So his image managers have been able to create another image from this event. Supporters seem to be believing that this is the start of the end of black economy. Or that it is a big slap in the face of terrorism or that it is the dawn of the cashless society in India. Once again a Utopian image has been built up in the media to present this step as a huge step solving all the country's problems.
I went to bank for converting a 4000 cash only once till 15th No. 2016 and there I could break conversation with 5-10 people from different walks of life - my sense is that common people out there are confused, a little anxious, a bit irritated but still largely with the PM. They have this feeling that something good is happening. They somehow put a lot of faith in the PM. It would be interesting to see how this faith strengthens/weakens as the impact of these moves plays out in the real economy.
Modiji boldly commit to images when I am sure he understands that there is short term pain involved in this surgery. A large number of unsuspecting public is expected to give in to the nationalist fervour and calls being given to sacrifice in the short term for long term good of the country. They may feel hugely
disappointed when in a 5-10 years they see the black economy thriving back or terrorism again raising its ugly head. In fact the short term pain in the economy itself may lead to many a heart breaks. If and when that happens - it would be interesting to see how Modiji protects his legacy for the posterior. What is possible is that future leaders may become heroes on his tough decisions. (quite like Laloo Yadav was considered the best ever railway minister on the back of huge infrastructure improvements that happened under his predecessors).
If you reached this line - you deserve a heart felt thank you. Because it means you read with an intent to understand. And thats what an author always expects from a reader. So thank you very much.
Do read both the pieces (part-I) and the Part-II again. I Look forward to your comments, suggestions, critique - all. Lets hope for a better world in the future. Lets pray for less pain to those at the bottom of pyramid and lets demand a more sensitive government when dealing with such fundamental change.