The Global ANALYST: Post-Demonetization India

Post-Demonetization India
A God-sent Opportunity to Cleanse the System
M G Warrier
Former General Manager,
Reserve Bank of India,
and the author of the 2014 book
“Banking, Reforms & Corruption:
Development Issues in 21st Century India”
Slowly the entire world is moving towards a cashless society (different from world without money!) and though India, with the present level of literacy and banking infrastructure, may not be able to keep pace with the developed world, cannot stand still, either

Opportunity to govern a country, like life, comes sans ‘rewind’ and ‘fast forward’ buttons.  Prime Minister Narendra Modi’s case is no exception. Without going astray in a philosophical mood, let me straight come to the point. Right or wrong, Modi has no option to go back on the announcement of November 8, 2016 withdrawing the ‘legal tender’ status of high value notes (Rs500 and Rs1000). The only option now before government and the nation is to implement what is now called in general parlor as ‘demonetization’ with least pain to the people and ensure that the country is benefited by achieving the purpose clearly mentioned while announcing the decision namely, “ighting black money and terrorism and minimizing presence of fake currency in the system.”
Unintended consequences
Former Prime Minister Manmohan Singh concluding his article “Making of a mammoth tragedy” in The Hindu on December 9, 2016  observed asunder:
“Black money is a menace to our society that we need to eliminate. In doing so, we have to be mindful of the potential impact on hundreds of millions of other honest citizens. It may be tempting and self-fulfilling to believe that one has all the solutions and previous governments were merely lackadaisical in their attempts to curb black money. It is not so. Leaders and governments have to care for their weak and at no point can they abdicate their responsibility. Most policy decisions carry risks of unintended consequences. It is important to deftly balance these risks with the potential benefits of such decisions. Waging a war on black money may sound enticing. But it cannot entail even a single loss of life of an honest Indian.”
Conceding his right to be concerned, let us also remember, all martyrs were honest citizens. The arguments put forth only explains the rationale behind his reluctance to take decisions during the ten year period when Manmohan Singh was Prime Minister.  Manmohan Singh’s brief, but forthright indictment of demonetization in Parliament was more explicit. Though the harsh language seemed having been smuggled into the speech by his sponsors, by and large the outburst represented his resentment with the management of economy and financial sector in India for decades now, simmering in his mind.
The managers of the Indian Economy and the Indian Financial Sector, who opted to procrastinate action against the looting of the common man in India post-liberalisation should pro rata share the entire blame contained in the Manmohan Singh’s 6 minutes speech and his laments quoted above. Generations to come will remember MMS for this speech, as it is not a political speech, but one backed by long years of experience as economist of international repute, central banker, finance minister and Prime Minister.
Dr Manmohan Singh’s advice to ‘reflect’ on the content of his speech needs to be taken seriously by all including the victims(common man) and factored in, in their future action plans. Instead of throwing the ball back, alleging that MMS did not act or speak at appropriate times or in appropriate forums, policy makers should opt to commission the former PM’s experience and wisdom  to make midway corrections in the crusade against corruption, fake currency and terrorism. Once he cools down, definitely he will help and never leave you in the lurch. After all, having managed an unwieldy coalition for a long time, more than anyone else, Dr Manmohan Singh is aware of the constraints with which governments work.
Manmohan Singh is not alone. Bloomberg published a story filed by Vrishti Beniwal & Anirban Nag captioned “Central banker missing in action as India escalates war on cash” referring to the low key participation of RBI in managing the post-demonetization problems in banks. Following closely on the heels of a BBC lament about how India will handle 20 billion pieces of useless currency notes, Bloomberg story was interesting reading, indeed. Let us not underplay the anxieties of external agencies, though they have only pedestrian interest in India’s real problems. Let us have a look:
First, RBI Governor has spoken just only once, since November 8 announcement of demonetization. Earlier, someone had researched and found out that during the entire 2 years plus tenure as Deputy Governor, Urjit Patel had made only one public speech against the tally of fifty-plus, posted by one of his colleagues and two dozen posted by his immediate predecessor Dr Raghuram Rajan.
 To put records straight RBI Governor did speak to media more than a couple of occasions and clarified the central bank’s position on currency management and problems faced by banking sector. Of course, the leadership team in RBI met the press formally after the monetary policy announcement on December 7.
Two, the observation “a senior bureaucrat was tasked with firefighting”  is based on a senior Secretary in the Finance Ministry explaining the measures taken by GOI to ameliorate the inconvenience caused by withdrawal of the legal tender character of Rs500 and Rs1000 notes announced by PM on November 8. In the given context the official was doing his assigned duty, while RBI was busy with ‘follow up’ measures. Robert  Hocket, who talks in ‘general’ terms, appears to be totally out of touch with the Indian context.
Three, K C Chakrabarty, another person whom the writers have contacted, has already gone on record saying that when he was RBI Deputy Governor, the demonetization proposal received in RBI (he said it was immaterial whether the proposal was made over the phone or in writing) to which, in his words, “We said, no”. So the ‘benefit of doubt’ offered by him to Urjit Patel must be genuine.
Four, though repeated references are being made to 1978 demonetization in the media by analysts, the context, content and magnitude of the 2016 measure make any such comparison ridiculous.
Did anything go wrong?
It is always easy to be wiser after the event. Let us not brush aside the criticism against inadequate preparations made before demonetization of Rs1000 and Rs500 notes announced by Prime Minister Narendra Modi on November 8, 2016 or for that matter the gravity of the sufferings the measure inflicted upon unsuspecting innocent elders and poor people in remote villages of India. It is, in a way, comforting to see that, media and vigilant social activists are making work easier for those who do post mortem, audit, post-project analyses of project implementation, inspections, various judicial processes and enquiries/investigations by recording evidence on an ongoing basis.
The November 8, 2016 announcement
What one understands from Prime Minister Narendra Modi’s November 8 speech announcing that high denomination currency note of value Rs500 and Rs 1000 will not be legal tender from the midnight of Tuesday, November 2016 is that the action is in exercise of GOI’s power to alter the legal tender character of currency notes.
The GOI announcement does not impact the RBI’s promise to pay ‘value’ or the sovereign guarantee printed on the currency note. Therefore, legally, it would be wrong to make any adjustment in Reserve bank of India’s balance sheet with reference to the quantum of notes surrendered within any stipulated time limit. Such adhocism in accounting practices can lead to erosion of trust in institutions like Reserve bank of India.
The misconception which got circulated through media, though in a small circle, that it would be perfectly legal to accept old Rs500 and Rs1000 notes  in the normal course of transactions till December 30, 2016 or March 31, 2017(As RBI will be exchanging these notes till that date) has since been removed. Extended time limits allowed for certain essential services like Railways, petrol outlets, hospitals etc relate to accountable transactions and these entities will be able to show source of further accumulation of high value notes after the midnight of November 8, 2016. 
The measure has been accepted, by and large
By and large, national and international media and monetary institutions have accepted the rationale behind the demonetization. While some were cautious in their appreciation,  New York Times quoted an expert saying it was a wise move and went on to observe in an article: “The plan, top secret until Mr. Modi’s announcement, was hailed by financial analysts as bold and potentially transformational for India. It is also a high-stakes experiment.”
RBI restoring trust
Dr. Raghuram G. Rajan, then Governor RBI, on September 3rd  2016, at St. Stephen’s College, New Delhi commenced his speech with the following observations:
“Over the last few weeks, I have outlined the RBI’s approach to inflation, distressed debt, financial inclusion, banking sector reform, and market reform. Today, I’d like to first discuss why central banking is not as easy as
it appears  (just  raise  or cut interest  rates!) and why it  needs decisions,  sometimes  unpopular or hard -to-explain  ones,  to be made under conditions of extreme  uncertainty. This will then lead in to my arguments about why we need an independent central bank.”
Rajan’s efforts to preserve India’s central bank in one piece did yield dividends. Reserve Bank of India managed the multi-dimensional threats to the financial system posed by the side-effects of demonetization within the constraints RBI and GOI are working today. The quick absorption of excess liquidity in the system by using the instrument of CRR, fast responses to changing needs in the supply of currency and above all the assurance that the interests of genuine depositors and borrowers are safe need to be seen in this context.
As always, RBI through its monetary policy announcement on December 7, 2016 has once again proved that its decisions are based on its own perceptions and not influenced by media lobbying or other external influences. India could sail through several tough economic crises in the past, only because monetary policy interventions and other measures by the central bank unreservedly supported government policy.
On August 29, 2013, Dr Duvvuri Subbarao concluded his Swan Song on the eve of completion of a tumultuous five year term as RBI Governor with the following observation:
 “There has been a lot of media coverage on policy differences between the government and the Reserve Bank. Gerard Schroeder, the former German Chancellor, once said, "I am often frustrated by the the Bundesbank. But thank God, it exists." I do hope Finance Minister Chidambaram will one day say, "I am often frustrated by the Reserve Bank, so frustrated that I want to go for a walk, even if I have to walk alone. But thank God, the Reserve Bank exists."
Subbarao’s successor Dr Raghuram Rajan  brought  more transparency in the working of RBI and sorted out some relationship issues between GOI and RBI during the 3 year period 2013-16. The transition of Technical Advisory Committee which advised Governor on monetary policy into the present ‘independent’ Monetary Policy Committee, besides unburdening Governor from individual responsibility for all monetary policy decisions has infused more professionalism in RBI’s decision making.
When there is lot of confusion in the air even about the motives of the November 8 announcement withdrawing the legal tender status of high value notes, RBI’s coming  out with the central bank’s perceptions about currency management and related matters will go a long way in restoring people’s trust in the banking system. The clarification given by Governor Urjit Patel that the measure by itself will not have an immediate impact on RBI Balance Sheet should set at rest the speculations about GOI having an eye on a windfall gain from ‘demonetization’. In the business of banking, trust is of paramount significance.
The currency note of Rs 2 and above carries a promise (“I promise to pay the bearer the sum of  …rupees”) signed by Reserve Bank of India governor and a sovereign guarantee (“Guaranteed by the Central Government”). The promise and guarantee are not governed by any date line. Prime Minister Modi’s November 8, 2016 announcement has talked only about the ‘legal tender’ character of Rs500 and Rs 1000 notes and has not withdrawn the promise by RBI to pay value or the sovereign guarantee that accompanies the promise.
Deadlines for exchange/deposit of the affected notes can at best be construed as ones fixed for administrative convenience of implementation of the scheme. Making notional entries in RBI’s books to create income by extinguishing liabilities against notes ‘withdrawn from circulation’ and not reaching back RBI, within a stipulated deadline can have perilous long term implications.
Though so far the gossiping is only in the media, and no proposals have come from the GOI/RBI side, a couple of points need to go on record. There are outer contours up to which governments can play such games taking judiciary and people for granted. Thand economy can be a multiple of the notional temporary gains. If one needs an example, such measures will have immediate repercussions on public debt.
Ajay Shah in an article “A monetary economics view of the demonetization” in Business Standard (November 14), observed that “Money is the lubricant of the economy”  which reminds one of a ‘Times View/Counter View’ column about corruption, some years back, where one side argued that ‘corruption is the lubricant of the wheel of economic growth’. The article, by a deft theoretical approach, almost confused the reader to think that money is cash and reduced amount of money in circulation is, by itself, something bad for the economy.
The decision to demonetize presumes hoarding of high value currency for purposes other than normal genuine transactions, existence of fake currency in the system and evasion of tax by off-the-book high value transactions as in purchase of gold and property. Though there have been initial flip-flops, by and large, it appears, Reserve Bank of India has taken care to ensure availability of currency notes in exchange and for withdrawal from banks. Looks, there was a slip in making ATMs ready to dispense new Rs2000 and Rs500 notes.
Slowly the entire world is moving towards a cashless society (different from world without money!) and though India, with the present level of literacy and banking infrastructure, may not be able to keep pace with the developed world, cannot stand still, either.
As regards the success of demonetization now under way, 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.
Go ahead signal from C Rangarajan
Former RBI Governor C Rangarajan’s article “Making the most of demonetization” in The Hindu Business Line (November 16) must give a lot of comfort to those who initiated action for ‘Demonetization’ and the thousands who are working 24X7 for implementing it as efficiently as possible with minimum pain for the common man, as the ‘Go ahead’ signal comes from an informed and unbiased veteran who has the backing of an entire life’s experience in practical central banking with post-retirement association with policy making at the highest level in government.
Former RBI Governor has endorsed the three objectives of targeting black money in the form of currency, funding of terrorism through cash and making fake currency which found mention in PM’s November 8, 2016 speech announcing demonetization, suggesting positive measures to achieve these objectives.
Taking the advice seriously, policy makers need to quicken the measures to prevent further accumulation of black money and to flush out the huge quantities of unaccounted wealth concealed in sectors like gold and jewelry, real estate and accounts abroad, leaving the burden of minimizing the pains caused mainly by planning and logistic problems to executives down the line with guidance from Reserve Bank of India.
The two steps suggested by Rangarajan in this context relating to keeping the tax rates at moderate levels and Electoral Reforms (though not specifically mentioned, government funding of electoral expenses based on need-the rich who fight election should not get this facility- is an immediate priority area) are significant and can go to the drawing board simultaneously with the preparation of Budget 2017-18.
Hardships are real
The hardships experienced by the people of a country which is dependent on cash for several day-to-day transactions are real, though the long term benefits outweigh the temporary inconveniences. The link between corruption and black money and abuse of accumulated cash by miscreants had become unbreakable without some drastic measure of this magnitude.
There is need to simultaneously go vigorously on financial inclusion by activating and use Jan Dhan Yojana(JDY) accounts, timely prevention of use of channels like Railway ticket booking to bypass legal routes for exchange of old high value notes and disincentivize use of currency as a ‘store of value’ brought out in the article should draw the attention of the authorities for immediate follow-up action.
Tasks ahead
When ‘normal’ banking business resumes, and it will, much faster than many of us think, there will be an attitudinal change not only on the side of the clientele, but for those responsible for formulation and implementation of banking policy and the human beings (we have found how far technology can serve you without the men behind the machines during these days!) converting the policy into action plans and the reaching out to the individual depositor/borrower. For a short period, banks need not have to worry about deposit mobilization and big borrowers are, hopefully, aware of the need to keep their assets ‘performing’, so that banks are not forced to categorise their credit as NPAs. Banks should use this temporary respite provided through measures taken by GOI and RBI to put their houses in order. Banks can broad-base lending, improve their outreach to semi-urban and rural areas, increase their direct involvement in lending and supervision of MFIs with which they are associated and improve their image before the public.
If banks start providing credit liberally to small businesses especially in informal sector and GOI/RBI quickly sort out grass-root level issues arising from the sudden sterilization of the functioning of cooperatives (as in Kerala) and MFIs and NBFCs HFCs in most of the states by allowing them to handle old notes already accepted in repayment of loans and other genuine transactions below a reasonable cut off limit, the problems that have surfaced so far may not be insurmountable. It will be another matter, if the dissent is allowed to simmer and issues that need to be resolved by quick policy interventions are left to hairsplitting judicial scrutiny or to be allowed to be sorted out on the streets by masses who are aggrieved.


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