By Jerri-Lynn Scofield and cross-posted from Naked Capitalism
December 30 has now come and gone– the last day for people to exchange old INR 500 (worth USD 7.36) and INR 1000 (USD 14.72) notes– that were no longer legal tender after Indian Prime Minister Narendra Modi launched his demonetization policy on November 8. At a stroke, the policy withdrew 86% of Indian currency from circulation. Holders of old currency notes could exchange them for new currency, but only up to a limit of 4000 INR per person. Sums above that threshold had first to be routed through a bank account– in a country where only about half the population has a bank account– and then withdrawn later, subject to weekly caps on such withdrawals.
I have written about the policy in three previous posts, India Moves to Severely Restrict Use of Cash, Forcing Much of Economy Into Barter (November 10), India’s Cash Crackdown: Chaos Continues (November 16), and India’s Cash Crisis May Take Months, Not Weeks To Resolve (November 18). I include the links for interested readers but it’s not necessary to read these three previous posts to follow the discussion here.
How has the Indian policy been a debacle? Let me count just some of the ways. It has failed to crack down on “black money”– its announced goal, as discussed further below. Demonetization has been poorly implemented: the Reserve Bank of India– India’s central bank– has failed to supply sufficient currency, in usable denominations, to support ordinary economic activity, and has further confused matters by issuing frequent, ad hoc, contradictory circulars on policy detail. The inability to secure cash has affected just about everyone– whether a national or visitor– who has been in India since demonetization was announced. Consequences have ranged from mere inconvenience, to failure to be able to conduct ordinary business or economic activity, to in the most extreme cases, suffering and on one estimate, as many as 112 deaths.
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The basic problem stems from a failure to distinguish between “black money”– money on which tax due has not been paid– and the legitimate informal sector– the cash-based economy. Estimates of the size of that sector range from about 50% to around 90% (depending on how it’s measured, e.g., as a percentage of GDP, or in terms of the percentage of wages paid in cash and not paid into a bank account). Many people working in the informal sector don’t pay any income tax– not because they’re corrupt or tax evaders, but because their income falls below the threshold upon which tax is due.
No one denies that India has a serious corruption problem. But most experts agree that demonetization– especially as implemented since November 8— is not an effective way of addressing this problem. Far more difficult to achieve but considerably more effective would have been measures directed at illicit real estate transactions, tightened tax enforcement, or political and administrative corruption.
Nonetheless, there was overwhelming, widespread support for the Modi policy when it was first announced– as I witnessed first hand as I was visiting India at the time. This support came from some unexpected quarters: a group of cosmopolitan Bengalis I dined with the night after Modi launched his policy, as I wrote in this November 16 post:
To place this in a US context, I would have been more likely to find a public supporter of Donald Trump at a New Republic cocktail party than to find a public Modi supporter among the Bengalis gathered that evening…. Given the huge inconvenience the new policy had caused– some guests I was looking forward to seeing didn’t show because they couldn’t cobble together enough cash to pay for cross-town transport– I was surprised that to a person, everyone present at that party mounted robust defenses of the objectives of demonetization.
Little did we know at that time that that “huge inconvenience” would soon be dwarfed by considerably more inconvenience, due to the spectacularly inept way demonetization was implemented…