Demonetisation Read from TOI Blog

Something all should read...

At a time when populist nationalism is confusing ideological battle lines across the world, no nation is more confused than India. Politics here divides into camps for and against Prime Minister Narendra Modi and this is once again evident in the reaction to the demonetisation plan. Ironically, Modi’s enemies on the left find no merit in this scheme to apparently soak the rich, and his supporters on the right see no reason to question this clumsy exercise of state power.
The Prime Minister has presented the demonetisation plan as his version of draining the swamp and has called on Indians to join this “decisive war” on corruption. Early on, many responded with patriotic fervor but now the dialectic seems more fractured than ever.

While Modi’s allies concede that removing nearly 90% of the cash in circulation is indeed leading to some chaos, they insist it will eventually promote larger goals: increasing tax collections, boosting bank deposits, thus fixing many of the institutional shortfalls that keep India poor.
The impassioned debate obscures a basic problem with the demonetisation scheme, which is that it presumes to know what comes first, development or growth. In general, institutions grow stronger as a nation grows richer. India cannot expect to leapfrog up the development ladder simply by purging black money from its system. Certainly no other nation has done it that way.

Drastic action might have still been appropriate if Indian institutions were especially dysfunctional, but as heretical as this may sound they are not for a country with such a low per capita income. Though commentators often compare India unfavourably to global averages the relevant comparison should be nations with similar average incomes, around $2,000. On most measures that matter in this debate, India mostly ranks better than its peers.
Like other low income countries India is cash dependent, but not outrageously so. Cash in circulation amounts to 12% of GDP, somewhat higher than the emerging world norm but not out of line with even countries like China and Thailand where the number is around 10% of GDP. The black economy is about a quarter the size of the formal economy. That is similar to low income peers like Indonesia, and in fact smaller than in higher per capita income nations like Mexico and Russia.
Indian banking and tax institutions are flawed, but not so flawed as to justify this kind of therapy. Tax collections amount to 16% of GDP, slightly higher than the norm for India’s peers. Bank deposits amount to 60% of GDP, strong for a poor country and about the same as in emerging countries known for institutional competence, such as Poland and the Czech Republic.

Modi also chose an odd moment to attack corruption, which appeared to be in retreat. On Transparency International’s ranking of the most and least corrupt nations, India was getting worse until 2011, when it bottomed out at 95th, and lately it has rebounded to 76th. India currently ranks as less corrupt than average in its income group, ahead of peers like Pakistan and Vietnam. The least corrupt countries tend to be richest countries from Norway to Singapore.
In the past, the Soviet Union, North Korea and Zimbabwe and other nations also took draconian steps to retire large bills, but most were responding to crises marked by hyperinflation, and were ruled by dictators. India may be the first democracy to attempt this kind of purge in stable economic times.

If India wanted to do something radical it should have taken on privatisation of a banking system in which government ownership is higher than in any other democratic nation. On that metric, India is truly out of line with its peers. Instead, the wide-ranging crackdown on the cash economy has further expanded the powers of India’s leviathan with government officials now emboldened to question any wealth or transaction deemed inappropriate.

There is also a better way to downsize the black economy, which Modi’s government tried but with underwhelming results. Earlier this year, it offered a tax amnesty and imposed a punitive tax of 45%. The result: Indians came forward to declare assets worth less than $10 billion. Contrast that to Indonesia’s recent amnesty, which imposed a tax of just 4%, and drew out $300 billion in hidden wealth – reportedly including $30 billion declared by a son of former dictator Suharto. Of course, such a move in India would not deliver an instant populist punch and would entail the hard work of marketing the benefits to the masses.

It might be more satisfying to punish shady fortunes, but revenge is not a development strategy. Scrapping large bills may destroy some hidden wealth today, but the black economy will start regenerating itself tomorrow in the absence of deeper changes in the culture and institutions that foster it, which in turn is a function of a country’s per capita income. Only as a nation gets less poor do corruption, black money and the role of cash decline. There is no shortcut.

India will have to climb the development ladder one rung at a time. But for now, as economic growth slumps here, the message to other populists in the world is: be careful when draining the swamp. more  

View all 6 comments Below 6 comments
Implementation of demonetisation in a ham handed manner without any planning has resulted in severe hardship to ordinary mortals and has derailed economic activity at least for 6 months. All rich, corrupt & powerful people have easy access to new crrency notes whereas ordinary mortals have to stand in long & unending queues. more  
Mr. Amit Mishra. I have read your article with interest. Frankly speaking I do not want to comment on how the comparison of India you have drawn with some other countries. How valid it is? Anyway, I definitely want to comment on your last but one para. There is no denial that black money would continue to generate/regenerate. But it does not mean that the Government should not destroy the accumulated black money in India. It took 70 years to come to this level of the black money. Now it would take at least one decade to accumulate, assuming the Government does not make strategic moves to stop/minimise the generation of the black money. Further, you seem to have failed or ignored one other objective behind this demonetisation- fake money coming from Pakistan, and the terrorist groups using this money to buy arms and ammunitions to spread terror in India. This demonetisation has given a big jolt to the terror groups who have, as reported in Media, big store of black money, which is now like waste paper in their hands. It is a real win win situation for India, at least for a few years to come. Why India should wait for any other country to first implement any scheme, which Mr. Modi thinks good for India. There can be no two opinions that Mr. Modi is a Nationalist. He has not used the popular and like fire fighting schemes to remain in power. He has staked his whole political career for the sake of the good of the Nation. Think it over, friend. more  
Growth comes with development and no second thoughts about it.Comparing GDP and savings of India Czech republic and the likes and still commenting de-demonetization is not favorable is a confused comment from the beginning. Show us a better way out other than helping black money hoarders,maybe comments are posted because of favoritism in many ways by the beneficiaries whose regular income will stop because of this action are now taking precedence in more ways than one. Only odd moments are choosen for such nation building actions and not fabricated and suitable actions as have been done since the independence of India to Promote corruption and corrupt by the previous government more  
My views on eradication of black money are covered in following points: 1] Any transactions up to Rs.100 should only happen in cash. All higher transactions must be done by one and all either credit card, debit card, personal cheques or bank cheques (as a last option). 2] Largest denomination note should be restricted to Rs.100/- only or exceptionally we could introduce Rs.200/- denomination. 3] Currently all banks carry a maximum of Rs.100,000/- liability to a customer holding a bank account irrespective of his total deposits by a customer. This limit should be dynamic corresponding to the relationship a customer is maintaining with a bank. A customer can lose is whole savings if any thing goes wrong with the bank. This Banking Rule must be changed at the earliest extending relief to the bank account holders. 4] The demonetisation of Rs.500 and 1000 notes could have been managed without disturbing day to day banking operations and life of the citizens if the Government ever realised the facts of Indian citizens. Rs.100/- note circulation should have been increased in advance holding large denomination notes by all Banks. ATM should have been dispensing Rs.100 notes only. 5] The scheme of demonetisation and eradication of black money should have started in 2014 if the present government really wanted the best results. more  
Delhi will be always better place without / with him. He along with Mamta Banerajee set dead line which expired today. Nothing seen from these two. Actions in right direction speak more than your words more  
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