The Global ANALYST: MAINSTREAMING CASH FLOWS

The Global ANALYST, December 2016

Demonetization

Mainstreaming Cash Flows*

M G Warrier

Though I am not one of those who follow the impact of planetary positions on individuals’ and nations’ destinies or consult an astrologer when something goes wrong or when I initiate something auspicious, circumstances lead me to think that the current decade is a lucky period for India as a nation. From somewhere leaders emerge and change the way we look at things, giving deeper insight into what is better for the country. While one can remember several names, those of Arvind Kejriwal, Narendra Modi and Raghuram Rajan remain uppermost in one’s mind. First two for creating an awareness about rampant corruption across sectors and political ideologies and Dr Rajan for exposing the link between erosion of nation’s wealth and management of financial sector.

In India, corruption in high places has been recognized as a roadblock to economic growth and distributive justice, by a strange coincidence, almost concurrently with the emergence of economic reforms, liberalization and globalization, circa 1990’s. I would attribute the transformation of the Indian political scene in Modi’s favour, to the India Against Corruption movement, and Modi’s decisive electoral victory to the confidence he could instill in people, about his ability to take a diversion from the status quo and engage directly with the ‘stakeholders’ of corruption irrespective of their positions and political affiliations. Modi’s election promises on handling black money and corruption got converted into votes in NDA’s favour in 2014 elections.

 The leadership provided by Modi enabled the NDA government to initiate action to bring transparency in transactions and plug the holes in porous financial management practices followed by government.   The Reserve Bank of India and several ministries in GOI were already aware of the need to revamp the institutional system in the financial sector and reorientation of policies to suit the changes that had already taken place in the business environment world over. The several measures initiated by RBI to introduce new players in the financial system and a thorough health check up of the loan portfolios of major banks, the GOI focus on strengthening public sector banks and financial inclusion need to be seen in this perspective. Demonetisation of high denomination currencies is a continuation of the measures to mainstream monetary transactions through legal channels.

Demonetisation of Rs1000 and Rs500 notes

As it is primarily a Government of India decision to demonetize highest value currency notes of Rs500 and Rs1000, we can safely rely on the background explained by the Prime Minister while announcing the strong and decisive step on November 8, 2016. After referring briefly his government’s resolve to fight the challenges posed by terrorism, corruption and black money, PM listed the major initiatives taken since NDA came to power, which included (a) the law passed in 2015 for disclosure of foreign black money; (b) agreements with many countries including the US, to add provisions for sharing banking information; (c) the strict law to curb benami transactions, which are used to deploy black money earned through corruption and (d) the scheme introduced for declaring black money after paying a stiff penalty. PM mentioned that these measures have so far brought into the open nearly Rs 1,25,000 crore rupees of black money belonging to the corrupt.

Prime Minister announced the decision that “the Rs 500 and Rs 1000 currency notes, presently in use, will no longer be legal tender from midnight tonight, that is November 8, 2016”. He qualified this step as a continuation of earlier measures to break the grip of corruption and black money and said that the step will strengthen the hands of the common man in the fight against corruption, black money and fake currency. After explaining the procedural formalities and timeframe for deposit/exchange of  notes which are no more legal tender, PM concluded his speech admitting possibility of temporary hardships to citizens and exhorting all to join the ‘festival of integrity and credibility.

As the measure had an impact on the lives of all, response from the media and analysts has been cautious and ‘measured’. Though most of the people refrained from questioning the necessity of the step, as nobody wanted to be seen themselves as advocates of the corrupt and hoarders of black money, many raised objection to the lack of preparation for implementing such a large scale operation. It has to be said to the credit of bank employees that within the constraints, the implementation of the measure was handled efficiently.

Objectives of demonetization

Motives behind the move which has been variously described as ‘Surgical Strike’ and ‘shock therapy’ has been well articulated in Prime Minister Modi’s speech announcing demonetization. I am not joining the hazardous game of making further guesses which many in the electronic, print and social media are already at, as part of their ‘regular job’. Common man would console himself that all the pain was not in vain, even if the measure partially succeeds in ‘purifying’ the economy and checking growth of corruption. The mainstreaming of idle currency will bring a large amount of ‘hidden’ wealth into books of accounts and that definitely have not only positive tax implications, but will be a deterrent to further accumulation of wealth from ugly sources. Compulsion to do more transactions through banking channels will be a disincentive for further ‘import’ or local printing of counterfeit currency.

Future course

The mainstreaming of ‘idle currency’ will have to be quickly followed up with measures like regulating transactions in gold and property by making mandatory provisions to route them through banks and sooner the political leadership (as different from the government) comes to a consensus on such measures, the better for the country.

A couple of issues, which even analysts of repute avoid mentioning, may be for fear of becoming unpopular, but will have long term beneficial impact for the country’s economic growth and India’s image among developing/developed nations, remain still in the backburner. They are handling the taxation of agricultural income and mapping the assets including gold and jewelry lying unaccounted in various pockets. Government could start with making it mandatory to report periodically the value of assets above a pre-decided threshold level, held by individuals and registered institutions.

Some afterthoughts

In the whole process of implementation of demonetization of Rs500 and Rs 1000 notes, government and banking system (including the regulator) missed a couple of steps they could have taken much earlier to November 8, 2016, the date on which the demonetization was announced, had the system applied its mind. These steps relate to readying at least majority of ATMs for dispensing the new design high denomination notes, print order for which had been given long back and stocking low denomination currency in semi-urban and rural areas where people were still using more hard cash than ATMs or electronic payment systems for their day to day money transactions. In hindsight, this could have been managed without affecting the ‘secrecy’ needed to be maintained while making the announcement.

Till recently, banking did not make its physical presence in India, much beyond ‘walkable’ distance from points where a four-wheeler can reach. It didn’t make much difference when ATMs took over the work of cash dispensation from banks, as ATMs crowded cities and towns and Public Sector Banks which were forced to go  to rural areas and open branches or service rural clientele too, went by and large by the ‘walkable’ distance rule. Those who are responsible for this state of affairs are enjoying the fun of being in the opposition now. The imported concepts of Banking Correspondents is yet to take roots in India. An RBI Governor (Dr Raghuram Rajan) who understood the problems and initiated some revolutionary reforms in the financial sector including the concept of small banks and  as using Post Offices as conduits for banking services to improve outreach was eased out fast.

As the idea of phasing out Rs 500 and Rs 1000 notes were somewhere in the back of the mind of policy makers, even while print order for Rs2000 notes were being given and instructions were being issued for increasing supply of lower value notes for circulation, without affecting the secrecy of demonetization announcement, simultaneous measures should have been taken to:

(a)  Prepare at least fifty per cent of the ATMs ready for dispensing new high denomination notes of different dimensions and

(b) Suck out Rs500 and Rs1000 notes from rural areas which could have been done in the guise of poor people who were really having problems in handling high denomination currency. Many of them were dependent on daily wages which were less than Rs500!

One possible reason for the chaotic position is outsourcing of work by institutions in piece-meal to agencies which have no moral allegiance to the institutions which hire them. We need to invent new strategies to build up reliable relationships between masters and servants, in the modern era of hiring and firing at higher levels and contract/bonded labour at lower levels.

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*Submitted version of the article published at pages 16-18, The Global ANALYST, December 2016

Blog Post No: 2464/06122016