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The Great Indian Currency Exchange

vinod reddy 
Updated on 28 December 2016

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At the outset, it is very crucial to understand the objectives of the Demonetisation/Currency-exchange scheme to analyse its future course and its impact. A layman who is politically conscious can easily make out that this is purely a populist step. Because, a part of the black money is not in India and whatever is there, majority of it is non-cash. Therefore, taking an extreme step like this cannot eradicate the black wealth completely or significantly. However, two objectives are being served.

Firstly, the PMO is sending a strong message to all the tax evaders and money launderers out there that this is a government which can take decisions and they are strongly resolved to remove black money from the system.

Secondly, curbing terrorism. We can witness the silence in the Kashmir valley post demonetization. Earlier, the objectives of demonetization were curbing fake currency, black money and fighting terrorism. Now, they are almost replaced with digital economy and less cash economy.

Is the scheme achieving its stated objectives? What are the behavioural aspects of the same?

On 8th of November, when Mr Prime minister announced this scheme, it is for fighting fake currency which was used for acts of terrorism and uprooting the black money in the economy. But on the last week of November during Mann ki Baat, it is for making India a less cash economy. To cultivate some habits, we need to make them mandatory. Demonetization is forcing many to come under the banking system and adopt digital payment practices. Though it is undeclared, it is almost mandatory for everyone to use the bank and online payments now. I appreciate the Prime Minister for the way and the intensity of the awareness he is trying to create on digital payments and less cash economy. This is a crucial point in the economic history of the nation. It is set to redefine the way businesses work, consumer's spending habits and the way transactions happen. I feel the shift in the main objectives is only to cash the opportunity of making the nation cashless. The fact that telecom stocks are the biggest gainers in the previous month signifies that there is a positive sentiment of increase in digital payments and data usage. and I have read somewhere that VCs are targeting digital wallet companies and businesses associated with them expecting high growth. But, I feel the biggest challenge the govt may face is, if at the end of the scheme, significant treasures of black money are not unearthed, the people might lose trust on the govt. The worst is they will not trust and cooperate for such schemes in the future too.

Whether the scheme has brought unused Jan Dhan accounts into life or are they just being misused?

And other issues on governance Being one of the prime minister's ambitious project, Jan Dhan has received wide publicity at its inception. Though the concept of financial inclusion is not new, as it has been more than a decade when Mr YV Reddy coined the phrase in the Indian context, but the scale at which it has taken up now makes it unique. The criticism regarding Jan Dhan is that, though the govt is successful in making everybody has a bank account, but it doesn't solve the problem of financial exclusion as none are using them. Demonetization has certainly changed this. Everyone (I am talking about those who were not using their account before) started using their accounts, money started flowing in and they are getting acquainted with the banking system. The problem here is, these accounts are being misused for converting black money to white. Moreover, the innocent are being used by the tax offenders and are dragging them into this murky waters. Should the authorities or the govt go soft on them? If at all they decided to punish whoever supports the evaders knowingly or unknowingly won't the opposition cry foul saying the govt is harassing the common man once again? This particular point gives the assurance to some who want to circumvent the law and misuse the relaxations without any fear of scrutiny. Influential people who have identities of others in hundreds are using their Jan Dhan accounts for their conversion and exchange of the notes. So, the scheme has brought all the Jan Dhan accounts into life for certain but it is a fact that some of them are being misused. But, the authorities and govt should practice caution in scrutinising these accounts where the deposits are more but closer to the relaxation limit of 2.5L because that could backfire. The universal opinion on the issue/scheme is that the intention of the scheme is good whereas its implementation should have been better. There were many logistical issues, secrecy issues and lack of capacity & infrastructure. The fix here is that if you want to solve one of the above problems, you will end up going light on the other. For instance, if you start calibrating the ATMs for new and smaller notes, we might be compromising the secrecy.

According to some inside sources, the original plan to introduce the scheme is from 18th of November and not 8th. But in order to uphold secrecy which is the essence of the entire scheme, it is preponed. The impact of this has been universal. The honourable supreme court of India, last week has asked the Attorney General, Mr. Mukul Rohtagi, that how is the govt going to remove the difficulties and inconveniences caused by the scheme. They are also asking why some limits prescribed by the govt such as allowing to withdraw 24k per week are not being honoured by the banks. One stakeholder in the entire system which needs much appreciation in the current scenario is the nation's banking system along with their employees. If they were not supportive enough and had they been sticking to their routines of 10 to 4 the situation would have been worse than what it is now. One estimate by NCEUS in 2005 says 86% of the employment in India is unorganised. An economy cannot be developed with such huge percentage of workforce in unorganised sector. It is difficult to bring any welfare measures for them. Those unorganised businesses cannot be supported when data about them is extremely difficult to obtain. This is the reason for failure in implementation of many schemes aimed to provide cheaper credit to MSMEs. This scheme certainly infuses some discipline and make the sector more organised. Trends of conversion of the unaccounted cash in wake of demonetization and its probable repercussions. Based on the cases reported in news, we can say that the conversion is undergoing with reasonable success. Because, till now only 2 or 3 cases of caught while converting have been reported. Even a seven-year-old will tell there is lot more going on. I don't know whether there is a malafide intention or not, but I am unable to find a single good reason, why media is publishing the ways of conversion in the guise of reporting what's going on. And there is a wrong impression in the public minds that CAs are the go-to people for conversion. A police know how the crimes are carried out, that doesn't mean that they commit crimes. In the same way, we CAs know the ways to convert black, but that doesn't mean we do that. Nevertheless, a situation is emerging where we have to prove this. The govt estimated the total cash in circulation of 500s and 1000s as around 15 lakh crores and 5 lakh crores of it will not return to the system (which is black money). But, according to sources already 12.3 lakh crores has been deposited in banks.

This can mean two things. one, the govt's estimates about black money in cash is wrong, or part of black money has been successfully converted. Govt thought of using the windfall gains from the unconverted money (which is black) to provide impetus to the ailing economy by increasing spending. But if the data of 12.3 crores being deposited already is correct, then the govt is seriously under trouble. our economy is in trouble. Impact of the scheme on interest rates, bond yields and growth rates considering the history of such schemes both domestic and internationally. Is it like puncturing the tires of a speeding car or providing a much-needed foundation on which our developing economy can be transformed into developed economy. The RBIs monetary policy committee has kept the interest rates unchanged in the latest monetary policy review earlier this week.

I see this completely as an impact of demonetization. Because prior to the scheme, the expectations are that as the inflation is coming down and the economy is experiencing healthy growth, the central bank will cut the interest rates further, may be below 6%. Here we need to understand why the RBI doesn't cut rates aggressively. It's because the central bank uses this as a tool to curb unhealthy inflation. Any excess liquidity in the system will fuel further inflation. But the government and the industry always lobby for a rate cut because lower interest rates give an impetus to the growth rates.

An allegation on Mr. Rajan was that he is hawk-eyed and keeping the interest high, in turn, damaging the growth. Now this objective of injecting liquidity into the system and lowering the interest rates are being materialised because of demonetization. Currently, the situation is credit has become cheaper without the central bank cutting repo rate. This has resulted in dwindling bond yields. But we need to accept the fact that it is extremely difficult to correlate the exact cause and effects even of whatever happened in the month from Nov 8 because each effect is caused by multiple incidents.

Mr. Trump is nothing less in impacting the markets and even policies of some central banks than Mr Modi. We can only predict them reasonably even with the benefit of hindsight. Impact of the scheme on key sectors like infrastructure, software, auto, retail (consumer goods or otherwise), real estate and technology in short, mid to long term. One thing is certain. The spending has been cut back. The demand has come down. Some thought that RBI might lower the rates to support demand which has slumped due to demonetization.

Keeping that aside, if we analyse the impact of such cutbacks on spending and demand in various sectors of the economy, a trend is clear across sectors except one or two. In short term, i.e. this 3rd quarter or may be the next quarter, the impact is severe and the outlook is bad. But, in mid to long terms the outlook is varying from neutral to positive. But again, it is very difficult to ascertain that positiveness is the result of demonetization or if it is just an extension of the conditions prevailing prior to the announcement of the scheme. Some sectors are more affected than others like real estate, consumer durable goods, automobile and aviation. The impact has been mixed on some others. Apart from few players in Tier-I and Tier-II cities, many in real estate are unorganised. Demonetization affects them badly as they operate majorly on cash. And it is undisputed fact that, some of it black. This has stalled land transaction and launches of some projects. The home-buyers are differing their purchases anticipating lower interest rates and house prices. It is true over a period of 3-6 months.

Consumer durable goods and automobile sectors are also seeing lowered sales. However, many leaders in these sectors believe that this is only a short-term blip may be for a quarter or two. If we see the curious case of banking, there is an upsurge in deposits. So far, people have deposited Rs 11.55 lakh crore worth of 'demonetized' notes. In the short term, this helps the banks to better their margins and increase their balance sheet size.

But, this has become more of a burden on banks than opportunity. Because, due to the lowered demand, the banks are finding it extremely difficult to disburse these deposits, however, interest needs to be paid on deposits. With production estimates falling, the working capital requirements are coming down. Moreover, the asset quality may reduce owing to slowdown in the economy. The second week of November was really bad for software sector. Because, apart from demonetization, trump also added to their problems. Demonetization came at a time when the software firms are expecting their margins trimmed owing to higher employee costs once H1B becomes more stringent.

When the overall economy is getting slowed down, firms across sectors tries to cut their IT expenditure. Incremental revenue for software firms may be very difficult in the next two quarters. The scheme was certainly a break to the economy in general when the corporate houses have reported healthy Q1 and Q2 profits. However, The lower interest rates and speeding up of financial inclusion can compensate that in the next FY. We cannot ignore the politics associated with the scheme because the economics and politics are closely intertwined and inseparable.

Their interaction is likely to shape the future outcomes. Hence, I would also like to discuss the political objectives of the scheme and its ramifications in state elections around 2017, general elections in 2019 and beyond. The nation is going to see assembly elections in many states in early 2017. BJP is going to fight those elections with taking demonetisation into the masses as a real step towards curbing black money and terrorism. Also, they want to prove their credibility by showing this scheme as part fulfillment of their poll promises.

The opposition parties almost all are finding the inconvenience caused by this scheme as a salvo which can render advantage over mighty BJP. 2027 is very crucial for all the parties because the results of this will impact the outcome of 2019. It is a litmus test for 2.5 years if Modi's regime. Many parties of states other than poll-bound states in 2017 are eagerly waiting for this elections because that is a key factor which determines the alliances and equations in 2019. For instance in Andhra Pradesh, a state whose politics I follow closely, both the major parties right now, TDP and YSRCP, are waiting for 2017 elections.

Because the win/loss of BJP determines the continuation of TDP being a part of NDA, because BJP in state will go aggressive. There is already a Rift between BJP and TDP in AP. YSRCP is looking for a partner to fill the gap in coastal Andhra, which became the reason for their loss in 2015. The timing cannot be better for a scheme like this! Because we now have a decisive PM with his party having absolute majority is almost once in a century affair.

We have an economy which is growing healthy and consistently for a decade. If we see the demonetization in other countries, all of them except in Australia were carried out either when there is hyperinflation, negative growth rates or huge unemployment. Or there is a military rule or war. Ex, Nigeria, Ghana, Zimbabwe, USSR, Myanmar etc. Demonetization in Australia happened two decades ago around 1996. It is a success.

There were no payment banks, full-fledged plastic money, online payments at that time in Australia and we can safely assume that today's India is similar to Australia in the 90s. Kenneth Rogoff, a Harvard professor who authored a book on cash titled "The curse of cash", supports demonetization and less cash economy, though he tries to restrict that to advanced economies.

However, he signals long-term gains for India because of demonetization which we all are hoping for. Direct & Indirect Taxes. The impact has been quite opposite on direct & indirect taxes in the short term. Whereas the collection if direct taxes increase, that if indirect taxes has come down due to weaker demand and dull economy. However, analysts predict higher tax collections owing to unorganised businesses going organised and better compliance with law.Another cess may be levied on non-cash receipts. The limit of 20k in 40A(3) may be lowered. The taxpayer base is going to widen, however that might be neutralized if the govt increases the basic exemption limit and shift the slabs further. The 2000 conundrum! Amidst all this brouhaha about demonetisation, one question is eating many brains.

Why 2000 notes? When the scheme itself is about demonetizing the higher denominated currency notes, why to introduce even higher denominated notes?

There can only be two logical reasons. Ones, the cost of printing and logistics to introduce number of notes withdrawn, 5 notes of 100 rupees in place of some notes, will be huge. In order to bring these costs down, a higher denominated note must be brought in. These notes will not cause any notes in the short term. But, that is only in the short term. What happens to them in the long run?

Won't they be used to hoard ill gotten wealth efficiently than before? The answers to above questions give us the second reason. These notes are being used only to bridge the gap between the date of demonetization and the time when sufficient change is brought into the system & the nation reasonably digitized. There is a high chance that they will be withdrawn when the unstated objectives are fulfilled.

Mr. Gurumurthy.S, the latest editor of Thuglaq after the demise of Mr. Cho, has expressed similar views. His views get more weightage as he is a RSS ideologue and said to be close to many in the ruling party.


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