Chances are you have already chosen which side of the fence you are on when it comes to the demonetisation debate. Demonetising 86% of the currency is an unprecedented step and India is flying by the seat of its pants in these tumultuous times. To be fair, demonetisation is an exercise many countries have carried out ­– but never has the scale matched India’s current onslaught.

The Indian economy has been shaken to its roots. Experts forecast the GDP growth rate tanking by 1-3 percentage points, and many of them estimate that the economy is in for a rough quarter or two. The  most pessimistic among them hold that India is in for a bad year with sales and consumption taking a grave hit. Even those closer to the government are not questioning the trend of these forecasts – only the scale.

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Now, the crux of the demonetisation narrative has shifted from whether it will succeed in tackling the rise of black money to how bad the situation will be before it gets any better. What hasn’t helped is the slipshod execution. More than a fortnight into the announcement, banks and ATMs across the country are thronged by people waiting to withdraw money that is legally theirs but which they are prohibited from withdrawing beyond strict limits.

The need of the hour is remonetising the rural and urban economy at a blistering pace to arrest the damage –  which is more than what think tanks and rating agencies estimated.

While there is much that can be faulted with the Modi government’s decision to adopt demonetisation as the modus operandi to flush out black money (a mere 6% of which is held in cash as per income tax data), the move could have yielded marginal economic benefits and massive political mileage, had the government executed the initiative with superior planning.

Finance minister Arun Jaitley’s initial assessment that the measure will cause inconvenience for two-three days widened to become two-three weeks and has now become the woe of millions of rural farmers and urban wage-labourers till the end of December. Naturally, the better-off – with access to digital money or even credit – are still holding fast, secure in their belief that the policy is but a small price to be paid for the massive dividends the country will accrue in the immediate future.

Those at the bottom of the ladder, though, are facing the brunt, with the Supreme Court even warning of the possibility of riots breaking out for want of cash. The SC is not wrong in its assessment.

Sample this: About 45% of the India’s GDP comes from the informal sector, which also accounts for 80% employment. Sucking out 86% cash in value terms is a paralytic jolt to the system when over 40% citizens have no access to a bank. India’s existing banking network is dismal. The ratio of banks for rural and urban areas is more than doubly tilted in favour of the latter. As per RBI reports, in 2015, there were 7.8 branches for one lakh citizens in rural India, while the same number of people in urban areas has access to 18.7 branches.

Undeniably, a policy measure with the breadth and vision of arresting the rise of unaccounted funds in India should have been supported by a healthy, vibrant and far-reaching banking infrastructure, instead of being an ill-equipped matrix that now finds itself taxed beyond its resources to deal with the banking blitzkrieg.

Making matters worse is an RBI circular restricting district central cooperative banks (DCCBs) and primary agricultural credit societies (PACS) from accepting demonetised currencies from its customers as deposits and exchanging them for the newly minted notes. This action puts additional pressure on the already overburdened public sector banks, while operations at 370 DCCBs and over 93,000 PACS have been almost taken out of the banking ecosystem as their customers are only allowed to withdraw money.

The policy is also fast-tracking a digital transition – great news for the formal economy, but painful to many people in the absence of infrastructure. However, it was incumbent on RBI and government officials to understand Indians’ spending patterns before bulldozing such an ill-conceived policy.

As per the July 2016 data from the RBI website, there are a total of 69.72 crore debit cards in the country. Since many urban residents usually have multiple cards, close to half the population do not have plastic money. A total of 88 crore debit card transactions were completed in July. An overwhelming 85% of the transactions were withdrawal of cash, while the remaining transactions were at points of sale (PoS). Thus, the value of transactions at ATMs vis-à-vis PoS was almost 13 times higher. This clearly establishes that people in India are more inclined to buy and sell in cash rather than swiping – something that policymakers should have considered before getting the show on the road.

As for PoS, a JM Financial report notes that for over 14 million merchants in India, the number of PoS devices is only about 1.2 million. This means that over 90% of the businesses are operating without any means to collect payments electronically.

Also, an embarrassing guffaw in the execution of the plan has been the failure to recalibrate ATMs to dispense the new Rs 500 and Rs 2,000 notes. With the new notes being smaller in size, trays (technically called cassettes) holding cash have to be realigned to suit the dimensions of the new notes. The government’s stand has been that informing ATM companies about the move would have undermined the secrecy needed to successfully implement the plan. But the logic is difficult to understand.

If the government was indeed keen on maintaining secrecy, it was – logically – also aware of the crushing rush that would descend on the ATMs. This means that the government prioritised secrecy over the unprecedented inconvenience along with the accompanying dent in the economy, not to mention the electoral cost of losing out on the core BJP vote community of small traders, retailers and businessmen.

In fact, bureaucrats have been coming forward and washing their hands of the entire fiasco. Unnamed key officials in the finance ministry told Business Standard that the demonetisation was “put in place” even before they came on the scene and they were only subsequently apprised of it. Many of the babus now fear that they will be squarely blamed for the botched execution when they were not involved in the decision-making.

On the sidelines, it seems that the government is not legally equipped to extract penalties of the size it has been issuing threats of. Immediately after the cash ban announcement, a senior ministry official said that deposits crossing the Rs 2.5 lakh limit will face a blanket penalty of 200% if found to be disproportionate to income. This is easier said than done as tax officials are clueless on how to levy such a massive fine without having any statutory backing. Tax officials have reportedly said that income tax laws would have to be retrospectively amended to impose such an extortive penalty.

Apart from this, the number of taxmen is also falling short. In 2015, the position of assistant tax commissioners had a vacancy of over 900 officers. The department is afflicted with a host of cadre promotion issues and unions representing the grievances of taxmen have been raising their concerns for long now without much redress from the finance ministry. Burdening an overworked, promotion-deprived staff with a phenomenally higher number of assessees will only serve to break rather than boost morale.

“More and more miracles are expected from bankers like mobile vans to disburse cash to needy patients at hospitals, increasing the cash holding limits of business correspondents and so on [sic], when we are working at the worst weird situation without support from anybody,” Harvinder Singh, general secretary of the All-India State Bank Officers’ Federation, said in a statement. He also called for government departments to chip in, since “the exchange of notes, which does not involve any banking operations, can be handled by these authorities as well”. 

That there was little homework done to execute this initiative is evident from the recurring flip-flops of the government’s fiats. Five days into demonetisation and all that Jaitley had to say on whether one was allowed to withdraw Rs 4,000 only once or many times was that no decision had been taken on the matter. Five days is enough time for industrialists or cash hoarders to get their workers in line to exchange, if not all, at least a good chunk of their cash reserves. While Jaitley took a “no decision yet” stand, the RBI was preaching that the Rs 4,000 option could be exercised just once. Belatedly, the government then came up with the indelible ink solution.

On November 13, the exchange limit was increased from Rs 4,000 to Rs 4,500 and within a week it was slashed to Rs 2,000. The initial intention of the government was to review the exchange limit after 15 days, but these flip-flops exposed how ill-prepared it was in its assessment of the ensuing cash crunch. The weekly withdrawal limit of Rs 10,000 per day set on November 8 was scrapped in just five days and a new limit of Rs 24,000 per week was put in place. Within a few days, the use of Jan Dhan accounts to deposit unaccounted wealth became obvious to the finance ministry and it reacted by putting a bar on deposits in such accounts. A thorough, well-researched and well-executed policy would have considered the possibility of abuse of Jan-Dhan accounts for laundering money and would have put a mechanism in place for it. However, the current regime seems to be a hearty follower of the wing-it-as-we-go policy, which puts bank managers and employees smack in the crossfire of public angst.

Further, the RBI and the finance ministry haven’t had much of a smooth run working together. Reports suggest that the currency press run by the government in Nashik is lagging behind in issuing the new Rs 500 notes. RBI officials have washed their hands of the Rs 500 mess by saying that it is the government’s press which is responsible for minting the Rs 500 notes and that the central bank-run presses are handling production of the Rs 2,000 notes. Between the RBI and the finance ministry, it is the common man’s everyday economy that has come to a grinding halt.

The sowing of the rabi crop has suffered throughout the country. A majority of farmers in Kerala, Maharashtra, Gujarat and Punjab, who rely on cooperative banks for financing inputs, have been left with little or no avenues for ready cash – a consequence of the RBI decision to bar cooperative banks from the exchange-and-deposit cycle.

Bank deposits have gone up and over Rs 5.11 crore has been deposited in PSBs and private banks. However, how long these deposits will be maintained once the market is flush with cash is anybody’s guess. On the other hand, experts have been indicating that the resulting cash crunch can render a number of loans to SMEs into NPAs. This accompanied with a depressing plunge in sales will mean that a lot of entrepreneurs will refrain from risking a loan in such adverse situations, which hits the banks where it hurts most: in its interest earnings.

Other cash-intensive markets, like real estate and jewellery, have prepared themselves for a tough year ahead. Real-estate moguls and bullion behemoths could very easily weather the coming storm but a majority of the work force of these sectors – labourers and skilled craftsmen – will become jobless as sales slide southwards. The volume of the transport business has declined considerably, whereas the prices of other asset classes are riding sky-high. Gold, for instance, is selling for Rs 50,000 per 10 grams in the grey market while its legal market rate is running at a slight discount to the earlier prices at around Rs 28,040. The dollar in the grey market has scaled to unseen heights of Rs 128 per dollar, the pound has touched Rs 130 and the dirham Rs 30, their actual exchange rates being Rs 85.76 and Rs 18.71.

But there is a silver lining to this debacle, though not for Indians. Economists abroad are keenly observing the effects of demonetisation and drawing lessons from an experiment whose prime guinea-pigs are millions of voiceless Indians.

For instance, in their blog, former US treasury secretary and Harvard economist Lawrence H. Summers and PhD candidate Natasha Sarin say, “Without new measures to combat corruption, we doubt that this currency reform will have lasting benefits. Corruption will continue albeit with slightly different arrangements.” They take note of “the ongoing chaos in India and the resulting loss of trust in government”, while also remarking that “Most free societies would rather let several criminals go free than convict an innocent man. In the same way, for the government to expropriate from even a few innocent victims who, for one reason or another, do not manage to convert their money is highly problematic.”

Remember that old adage about the road to hell being paved with good intentions?

kaushal@governancenow.com

(The story appears in the December 1-15, 2016 issue)