The last month has been one of the
most exciting months in the history of the Indian economy. With the rattling
news of currency bans as a mammoth campaign of curbing black money, I was
fortunate to have taken a course on Banking and Financial markets which made
the proceedings very exciting. With my newly acquired knowledge of banking and
financial instruments, I decided to explore the essence and impact of “Demonetization”
on the lives of the common man. Needless to say, knowledge acquired as part of
my B-school courses helped me a great deal in staying unbiased and my analysis
of the issue, was without emotions and was only based on fact and logic.
On November 8th 2016,
the prime minister of India, announced an earth shattering and bold decision to ban
the use of the 500 & 1000 Rupee notes as a legal tender (An estimate from the RBI mentions that the value of these notes in circulation, stands at about Rs 14.18 trillion). What followed was
a never before seen flood of emotions, not just on social networks, but also on
the streets of the world's largest democracy. People were frantically discussing if and how they could save
their money. A new term was added to the vocabulary of the common man called ‘Demonetization’.
While people began praising the prime minister for his bold move (while criticizing
ever other government in the past), a large fraction of people began wondering
if this indeed was a good move. The government had announced the release of new
2000 Rupee notes along with fresh 500 Rupee notes. People began to queue up at
banks in order to exchange their old notes or deposit whatever hard cash they
had in the form of the banned notes. While people were standing in long serpentine
lines across the country, social media and the media themselves began experiencing
a war of words. On the one hand, people were praising the PM, elevating him to
the status of a demi god, while on the other, there were people cursing the
move as it was evident that the banking infrastructure wasn’t ready to deal
with the sudden move. The war of words manifested itself into an ugly conflict plucking nerves across the nation. People in buses, local trains, near coffee machines and of course, B-schools, began having chaotic
conversations and debates. People who were once friends, began fighting over what they felt about the Prime minister and his 'surgical strike'. The patriotism
of people who had reservations against the move was questioned. Jokes about the move were created and circulated on Whatsapp. Leaders
who were once admired were mocked upon. Daily wage workers suffered the brunt as they had no clue about their hard earned money they thought was safe under their mattress. Emotions
that ran high on social networks began to squeeze through into daily face to face conversations. “The run on the bank”
saw an all new meaning. Even the US elections took a backseat with all the commotion. And amidst all
this, people lost their sense actually decoding the reasons and effects of the
move (or at least I think so). In this blog, I attempt exploring the nuances of
demonetization and its effect on the economy and the psychology of people.
So, what were the reasons for the demonetization?
According to the Prime Minister, the main reasons for demonetization were
- · Increase in black money being circulated around the country
- Increase in counterfeit currency being circulated (An estimated 9.6 crores worth of fake currency was recovered in Nov alone)
- · Fake currency being used to fund terrorist activities in the country
- Large amount of unaccounted wealth being stashed in the form or hard currency
So what does our dynamic prime
minister do (or was it the great minds at the RBI)? He bans old 500 and 1000
rupee notes. The immediate effect – leaders of various monetary institutions
and “proud Indians” go gaga over the move. The RBI comes out with a press
releases stating that they would be releasing a new Rs 2000 note and it would
follow with new 500 rupee notes. And people were advised to go deposit their
old notes with the banks within 50 days. People on social networks praised the
Prime minister (now a demi god) for such a bold move. People who had stashed ‘black’
money in their closets started shitting bricks. Shops stopped accepting notes
of those denominations. Liberals began wondering if the move was actually a
good one and started hunting for loop holes. The coming days brought out bigger
problems. Serpentine queues, ATMs going dry (even one month down, we still are
facing cash crunch), continued war on Facebook and twitter, Manmohan Singh being mocked,
the was democracy being compared to autocracy……. Never ending story. I had half a
mind to delete my Facebook page. Anyway, lets decode the demons of demonetization
now.
Can this move bust the fake currency menace?
Definitely. Imagine all the notes (fake or original) getting back in to the banks. It is almost logical that all fake notes could be flushed
out of the system. An estimated 9.6 crores worth of fake currency was flushed out in November alone.
Can this curb black money?
Now this is a philosophical
question. Black money has been generated over several years in a very unsystematic fashion and declaring that this move could bring an end is an exaggeration. Money stashed as
hard cash can easily escape the taxman’s talons resulting in hordes of money
being painted ‘black’ and loss of revenue to the exchequer. A typical example is
the practice of land/property registrations. It is common knowledge that people tend to
pay a certain percentage of a land sale value as white (accounted and taxed) money
and the rest is in black, typically as cash. Another example is the practice
cash transactions at garment shops and busy merchant transactions in order to
prevent the 2% tax on plastic money (fake bills are produced or not given at all). Can these practices stop with
demonetization? I don’t think so. Even after the new notes come into the
market, there is a high chance that black money generation can see a revival as
there aren’t any stringent mechanisms to put an end to these practices. The
only effect demonetization could have is psychological. People would be scared and may think
twice before filling their pockets with 'cursed' money. But unless these
practices are nipped at the bud, we cannot expect eradication of black money.
How does this move affect the
banks and the government? Does it really benefit the economy?
This is where it gets a little
interesting and the devil is in the details. Since it could get a little
technical, bear with me. Now that everyone is going to deposit their wealth in
the banks, it can be expected that there could be surplus liquidity in the
banking system. With the vast amount of money that would be deposited in the
customer accounts, banks will have to find ways to pay them their interest in
due course. How does the bank earn revenue? That’s obvious right? By giving out
loans and earning high interest on them. With the large amount of cash, they can now give out loans at their will.
Seems simple right. In actuality, it isn’t that simple. Banks cannot just go on
a loan rampage (else they could end up with 2008 like financial crisis). A
considerable percentage of the cash needs to be maintained with the reserve
bank or in government back assets with often result on Non-performing assets. NPAs).
Also, the number and quantum of loans they can give out is based on amount of
capital the bank can raise. Capital not as customer deposits, but as reserve
cash and equity. A bank needs to maintain a minimum capital adequacy ratio (CAR)
which is the ratio of capital employed to the risk weighted assets (defined by
the quality and quantity of loads). So if the bank has a lot of liquidity raised
from deposits, they cannot just give out loans without raising sufficient
capital to maintain the CAR. Not to forget, consumer sentiments which is right
now being clouded with uncertainty, is only making tings worse, thus making the loanable funds market
rather dull. How else can they pay the interest on all the deposits. And as a
cascading effect, publicly listed banks will face the heat as dividends can
be paid out only after paying of interests. This makes banking stocks look
unattractive in the financial markets. How then, can banks and the RBI for that
matter, deal with this situation? People think that banks and the government can
get rich after this move but the truth is, it isn’t that simple.
One thought is
that banks can lend to the government. While it seems to be the most
economically beneficial approach, the government needs to
issues bonds which the RBI and other banks can buy, thereby releasing funds. But
the truth is, with the vast amount of liquidity, lending to the government may
not be feasible as there aren’t enough bonds available. With restrictions on
withdrawals liquidity had churned into a bigger problem. This whole sudden move has put the RBI in a tizzy.
Also, remember, the government will eventually have to pay back and old bonds
will be reaching their maturity sooner or later. This means that the RBI would
have to come up with innovative ways of dealing with the issue. And moreover,
its ironical right, with the vast amount of liquidity, the common man is still
facing a cash crunch with ATMs running dry. The larger problem of the
economy has now become the problem of a few (at the RBI). Boy would it be fun
to work at the RBI now.
The Government’s move is also
interesting. They start off by putting curbs on withdrawals and say that they
would increase the limit slowly. They expect every citizen to have a bank account
totally oblivious to the fact that the unorganized sector doesn’t believe in
banking. With taxes being the main source of revenue to the government, they
decide to go the demonetization way, especially when there is a big push for GST.
And above all this, in an attempt to get some serious revenue (thanks to the
banking norms that prevent banks from lending blindly to the government) the government
decides that legitimize black money. They come up with a policy, wherein, if someone
has loads of black money, they can pay 50% of it to the government as tax (I call
this protection money), deposit 25% of it in an interest-less bank account for
a period of 4 years and enjoy the rest 25% as pure white money. Wow!
So, if I have Rs 10 crores which
I have earned by exploiting the common man or laborers or blood money of
sorts, I become a perfectly clean law abiding citizen by paying the government Rs
5 Crores?
Interesting right. And in the process, the government earns their much
needed revenue which is good for the economy right?
And what about the common man?
Well! The honest taxpayer seems
to have found himself stuck in the middle of all the hustles. He has to stand
in long queues to deposit his useless 500/1000 rupee notes. He is unable to withdraw
his own money with all the limitations imposed. With a total operational
failure in terms of providing sufficient new notes, the ATMs are still running
dry. One month after the move was imposed, people still have to rush to the
ATMs at early hrs in the mornings and stand in queues outside banks to withdraw
their own money (which has daily and weekly limits). Daily wage laborers are being duped by the corrupt by asking
them to deposit their (the corrupt’s) money in their accounts. Those who don’t
have bank accounts are frantically running about trying to understand what a
bank is.
As a human and a citizen, don’t I
have the right to decide if I want to keep my money in the bank on with me at
home?
But people on social networks come out and say that people must do their duty and stand in lines. I honestly
wonder how many of these people have actually stood in the long queues,
especially when most of these social network ‘activists’ live in the calm of a
different country. They go on to compare the common man with army jawans who
protect our borders. When they can stand in harsh weathers to defend the
country, why not the common man? People should do it for the nation and the future. This is
true patriotism. And anyone who raised concerns was deemed anti-national. As I
read these comments I couldn’t help but recall a message a friend of mine once
sent.
“Nationalism teaches you to take
pride in shit you have not done, and hate people you have not met”
Honestly, and I shall write about this some other day, I believe that the future hold bigger surprises for us in store in the form of climate change, food security, population explosion etc, and we will be busy understanding the after effects of demonetization instead of dealing with real issues that threaten or very existence.
But all this is for the greater
good!!
Well I sincerely hope it is for the greater good. People have voted the government in with that hope that they could make life better. But standing in lines for hours to get their own hard earned money, and facing cash crunches when they need it the most, isn’t proof of a better life.
The biggest benefit of the move
according to me is the push for digitization and e-money.
But it really needs a monumental
effort to take it to the phase where it could be truly beneficial. I totally appreciate
and echo the thoughts of the prime minister in his “Mann ki bath” speech, where
he motivated the youth to help him achieve his dream of digitization of money.
So what is going to happen with
all the old 500/100 rupee notes
In the past, notes would first be shredded and then incinerated. However, it was noted that burning such notes, especially because of the metallic alloys that are added to it, could release harmful gasses. And even the reserve bank has realized this and has come up with an innovative way of dealing with it. I urge you to read this article to know more.
I hope this piece of writing has
helped you understand a bit about the economics of demonetization. Sometimes it
is really useful to do your research and get to the depth rather than listen to
random people and create systematic errors (also known as biases). Any
questions, critiques, suggestions or debates are welcome. However, please
refrain from being abusive and illogical.
Think without emotions, but act
with compassion.
