“Demonetisation in a booming economy is like shooting at the tyres of a racing car,” says development economist Jean Drèze . A leading advocate of welfare policies, Drèze who was a member of the National Advisory Council during the UPA regime, tells ET that the sudden move to demonetize high-value currency notes has created a scary situation for people who live on the margin of subsistence, and that opposition parties may well be the real targets of the move. Edited excerpts:
“Demonetisation in a booming economy is like shooting at the tyres of a racing car”
How do you view this sudden demonetisation measure?
The debate on monetisation is vitiated by delusional hopes of the impact it might have on the black economy. Tall claims are being made about the ability of demonetisation to “flush out black money”, “crush the shadow economy”, or achieve “an all-out assault on the parallel economy”, to quote just a few expressions used by the government and its admirers. These claims are based on what might be called the hoard theory of black money. In this view, black money is a gigantic hoard of illegal income that keeps growing and needs to be flushed out. This is wrong. Crooks know better than to keep their illegal income in suitcases of cash. Instead, they spend, invest, launder or convert it in one way or another. They use it to buy property, fund lavish weddings, shop in Dubai or oblige politicians. Of course, at any point of time some black money is likely to be lying in jars or pillow-cases. But going after that residual liquidity is like mopping the floor under the shower. Thinking of it as a decisive strike on the black economy is a severe delusion. This point has already been made by many eminent economists, but the government seems to prefer its own echo chamber.
The main cash hoarders are likely to be political parties. For them, it makes sense to accumulate cash over time, in anticipation of election campaigns. Opposition parties may well be the real targets of the demonetisation move. Being in power, the ruling party is less vulnerable. I am all for preventing fraud among political parties, but this is not the best way to go about it.
How has it affected rural India?
Some of the short-term costs are already clear – the time people waste in long queues, the liquidity crisis in the informal economy, the worker layoffs, and of course many tragic deaths. Wider economic costs are likely to be felt soon. Some reports already suggest that economic activity in rural markets has slowed down. For instance, a study by Nidhi Aggrawal and Sudha Narayanan at the Indira Gandhi Institute of Development Research shows that mandi arrivals of non-perishable agricultural commodities crashed across the board within a week of demonetisation. The declines range from 30 per cent for cotton to 87 per cent for soyabean, and did not occur last year at this time. When farmers are short of cash, agricultural labourers and local artisans are bound to suffer too. NREGA workers are also likely to be badly hit. As it is, they are affected by chronic delays in wage payments. With bank staff out of action for weeks, it is bound to become even harder for them to collect their meagre wages. The same applies to social security pensions, a lifeline for millions of poor widows and elderly persons. For people who live on the margin of subsistence, this is a scary situation.
The present government is pursuing the vision of a cashless economy. Your comments on this and what could be done to improve financial inclusion?
Real financial inclusion means providing effective banking services to everyone. Today, many people have bank accounts but they are still deprived of banking services because the banks are distant, understaffed, overcrowded and often unfriendly towards poor people. One reason why demonetisation is causing so much havoc is that banks are out of their depths in the first place, especially in rural areas. For instance, they are finding it difficult to keep up with wage payments, pensions and scholarships. Now, bank staff are going to be diverted full-time for weeks to renew bank notes. You can imagine the chaos this is going to create, well beyond the demonetisation deadline.
The answer does not lie in magic bullets such as a cashless economy. We are decades away from that. Meanwhile, simple measures such as extra bank counters, functional ATMs and better queuing systems could go a long way in improving banking services in rural areas. This is not rocket science.
The opposition has criticised the introduction of the new 2000-rupee note and argued that this undermines the demonetisation drive. Your comments?
I don’t see any serious inconsistency here. The release of 2000-rupee notes does not make it easier for those who hold black money to launder their cash. So, demonetisation can serve its limited purpose even with 2000-rupee notes being printed. Withholding them would perhaps make it more difficult to hoard black money, or rather black currency, in the future. But the complete absence of high-denomination notes would cause much inconvenience to the public, and I doubt that it would have a major impact on the black economy. Remember, black money in the sense of illegal income may or may not be earned in cash, and even if it is earned in cash, it can easily be converted into other stores of value.
The Centre’s argument is that the money that would come into the system with demonetisation will compensate the negatives. There is also a view that the demonetisation could improve liquidity in banks and thereby help boost the economy. Your comments.
Demonetisation on this scale is a huge gamble with the economy. The full consequences are difficult to predict. The best-case scenario is that the economy will stay the course, after the initial disruption, and that significant sums of black money will be neutralised. The worst-case scenario is a prolonged economic slowdown, with very little result in terms of preventing illegal activity. The initial economic shock, already visible, can easily have ripple effects over the next few months. For instance, delayed sowing of rabi crops today could affect the harvest months from now. With employers short of cash, labourers are likely to lose jobs. It is also important to remember that macroeconomic trends depend a lot on expectations. If the initial shock creates adverse expectations, the economy’s growth trajectory could be derailed. In a booming economy, blanket demonetisation is a little bit like shooting at the tyres of a racing car.