CHAPTER 14

The Ongoing Debate and Political Economy

Demonetization was a decision with few parallels in India’s economic history. It was both an economic and a political necessity. The government’s aspirations for India are important. It can be seen as more than an economic policy, rather as a political tool. Modi has staked his position as a leader capable of making bold decisions. The unprecedented boldness of the decision itself seems, at least in urban and semi-urban India, to have played in his favor. It seems the government has successfully portrayed support for demonetization as a civic and patriotic duty, using paternalistic messaging and repeated assurances that the end justifies the means (Beyes and Bhattacharya 2017). It has reinvigorated the Indian public debate about black money and corruption. The impact of demonetization is felt by every Indian citizen. The economic history is a harsh and unforgiving judge. What counts in the end is success measured in terms of the stated goals of the policy.

Right from the moment demonetization was announced, the prime minister acknowledged that peoples’ lives would be disrupted. He invoked civic duty and patriotism: Citizens should accept the challenges of demonetization as a “sacrifice” and “face difficulties for the benefit of the nation.” This appeal to the greater common good permeates the prime minister’s speeches on demonetization, culminating in his New Year address, in which he compared the “patience, discipline, and resolve” that the past seven and a half weeks had required to wars that India had fought in previous decades. Like soldiers fighting external threats, citizens should “unite to fight a war against [the] internal evils” of corruption, black money, and counterfeit notes. The flipside of this argument, of course, is that critics and opponents of demonetization lack patriotism (Beyes and Bhattacharya 2017).

Political Economy in the Era of Post-Truth

“Post-truth” is defined as “relating to or denoting circumstances in which objective facts are less influential in shaping public opinion than appeals to emotion and personal belief.”¹ In this context, truth, meaning a description of the world as it really is, has ceased to be important. Once corruption has evolved in the imagination of the people as big scams, and once people are made to believe corrupt accumulations of black money are hidden in piles of currency, the truth of describing that spurt in corruption scams was sparked by the reforms and that much of what is accumulated as black money is hardly kept in cash does not seem to matter much to the people at large. It is on this post-truth “reality” that the government built up its political strategy of destroying corruption and black money with demonetization. Demonetization is a political gamble, but one that a country like India had to take. Critics were overly obsessed with the financial and economic impact of demonetization and neglected to pay adequate attention to the political design underlying it. It has been pointed out that there are three significant aspects one can observe in the government’s political narrative:

Whether one likes it or not, the vulnerability lies in the possible parallel that the “demonetization story” holds to the ongoing “nationality story” of the government. It is interesting to note that the government believed in making decisions that were good for people, not those that people would like. There is no greater political danger than constructing an image, making the people believe in it, and riding on those beliefs (Reddy 2017b).

Problems of Tracking the Black Money

There are organizations and people in India who have access to money-laundering networks and creative schemes for getting around rules and regulations. Almost 99 percent of demonetized currency had been returned to the banking system. In countries where the writ of law is not binding on the rich and influential, there is a tendency to defy the obligation to document financial transactions and pay taxes. As such, demonetization seems to be a case of major strategic fault because instead of collecting the tax in advance, the government is now chasing the black money to collect taxes.

The most interesting point in discussion is “black money and politics.” The reason why the political opposition’s criticism against demonetization carried no weight is its reluctance to talk about black money and politics. Also, over the years, the greater use of black money in politics has been linked with wealthier candidates contesting elections as they have a greater chance of winning. The biggest demand for cash is from electioneering politicians. The practice of political parties mopping up a large amount of election funds through unaccounted contributions pushes businesses to generate black money. Civil servants allegedly get involved too, making them corrupt. Reddy (2017b) makes a perceptive point of the winning candidates’ exponential growth in assets while in office. Coalition Partners insistence for more “lucrative portfolios” as the money “invested” fighting the elections has to be recouped while in office. Electoral politics has also been shaped by these hoards of money. The government had claimed the mantle of anti-corruption. Demonetization has come as a shock and awe for the political parties and politicians for whom black money is a lifeline and will help make the election process clean and transparent. But it has brought tough times for the political parties and politicians who believe in the idea of purchasing votes in exchange for notes.

Some positive impact is visible on the political front. The government announced an electoral funding reform, including a reduction in the permissible amounts of anonymous political donations by a factor of 10, from 20,000 to 2,000. Such measures to institutionalize political funding have been long-standing recommendations of the Election Commission of India (EC) to address corruption in the electoral process. The announcement sent a positive message vis-a-vis the integrity of the demonetization exercise and the government’s commitment to address the primary roots of corruption more broadly (Beyes and Bhattacharya 2017). Predicting the future is difficult; it is yet to be seen how this reform impacts the nexus between elections and corruption in the long run. As per Moody’s, demonetization will strengthen India’s institutional framework by reducing tax avoidance and corruption. It would result in efficiency gains through greater formalization of economic and financial activity, which would help broaden the tax base and expand usage of the financial system.²

While digital transactions did spike post-demonetization (when consumers had few alternatives), one must rely on an understanding of factors that drive digital adoption as digital uptake has the prospect to deliver over the longer term. The economy would also be serviced by both cash and highly digitized transactions. In spite of challenges, public reactions to demonetization were initially broadly positive. The policy’s perceived decisiveness struck a chord with the electorate. Political analysts feel that people of the country had supported the union government’s intent to act against black money, and the electoral success in Uttar Pradesh was an example of the support for the decision. It appeared there was a consensus that innovative, perhaps radical anti-corruption, policies were needed and that this consensus was so strong it outweighed even personal inconvenience and potential economic losses (Beyes and Bhattacharya 2017). Overall, the biggest hope of long-term payoffs for the economy lies in forcing a behavioral change on tax evaders. It not only changed the agenda and made corruption difficult, but because it was a “morally and ethically correct” step, it was also “politically correct” (Mathew 2017).

Uncertainty of Long-Term Impact

The targeted benefits of demonetization would be in the long run. How long is not very clear. Only time will tell. Rakshit (2018) is of the view that the long-run impact of a one-off demonetization is unlikely to be significant or unambiguous. The net results of the cost–benefit calculus are not so clear-cut. A worthwhile research program is expected to shed new light not only on the consequences of demonetization but also on the working of the Indian economy in response to other important policies and events. The short-term pains to demonetization are acknowledged. The failure of the government lies not only in the demonetization exercise but also in the failure to grapple seriously with the inefficiencies that inhere in the Indian economy. Farmers’ distress has gone national, as has the demand for waiving loans given to farmers. The resulting fiscal burden on states is a cost of the note ban exercise.

The policy of demonetization was a bold political and economic experiment. The Economic Survey (2016 to 2017) seeks to discuss “complexities of the analytics, empirics and potential impacts of demonetization.” It is difficult to resist the conclusion that the Economic Survey has been used to justify the decision on demonetization and related issues. Counterfeit notes are the result of deficiencies in the currency management architecture of the RBI. It is important for the RBI to improve the currency management architecture. From a longer-term perspective, it is important to strengthen the currency management architecture and tax administration without harassment. Government spokespersons may have been more effective in media debates, but on the economic plane, there has been a glaring lack of trust in the narrative.

Demonetization decision was taken with good intent. But the government is not adequately focused on ensuring growth, job creation, and investment. It put the economy into a spin. Critics of demonetization cite the deceleration of growth. The government is on the defensive because of the slowdown in the economy, and the opposition parties see this as an opening to target the government. But some measure of deceleration was predicted. Unfortunately, there are reasons to believe that other factors, possibly arising due to structural causes and with long-term effects, have also played an important role in slowing down the economy. Stopping and reversing the slowdown call for a multi-sectoral, multi-pronged, multi-government level approach. There won’t be one single silver bullet (Ranade 2017).

Mehta (2017) has opined that “demonetization was a populist measure, done in the name of the poor. It hurt them by extracting the highest price from them. It is doubtful that the measure dented the complex webs through which plutocracies shield their money. Indeed, new laundering mechanisms came into being as a result. Demonetization created fantasies of a cashless economy, but cash is back with a vengeance. Formalization was a desirable objective of demonetization. But it underestimated the fact that informality was also a form of low-cost participation. Formalization without preparation leads to exclusion.”

Demonetization hit the poor, but they forgave because they believed the government was on their side and the move was aimed against “filthy rich people.” It was, however, yet to be known whether the rich got hurt. People were upset with the establishment—the rich people and the government, that is, the crony capitalism. Other people suffering took it as a triumph. The government has obviously used it as a potent political tool and has demonstrated that the measure did not hurt at the political hustings. It is important for the government to now invest its political capital on rebooting the economy. Some of that has been on show recently. However, the political effect on the opposition of their protests has been less than salutary. The demonetization decision could be the first step in rewriting the social contract in India. If the vast majority of people feel their representatives are not delivering, basic rules of social order fall apart as local law enforcement agencies are viewed as corrupt and venal. To reinforce this social contract with the people, the government must take steps that will hurt the fat cats. Only then will it be possible to talk about a new social contract, where citizens feel that paying taxes in return for social services is a good deal (Hyder and Khan 2016).

Policy actions have real consequences, and tracing the path toward their wider impact is difficult and complex. There may be short-term political benefits, but the negative impact on the economy can create longer-term risks and eventually bite back. Such policy ought to be founded on both theory and evidence. India’s demonetization should serve as a cautionary tale (Chakravorti 2017). For many Indians, Modi is a beacon of nationalism—a man who binds the country together through his iconic speeches. But for the opposition, he is an authoritarian figure who has made the honest Indian suffer through his sudden decision to remove cash from the economy (Mukhopadhyay 2017). One can view demonetization as removal of distortions that may increase total factor productivity (TFP) and resource allocation in the long run. It would drain the swamp because hoarders have come up with ingenious methods of laundering their money. One may have to pay more attention to the nature of transformation in the public imagination about the notions of black money and corruption. Somehow, adequate attention needs to contextualize the images constructed around black money and corruption and the effective way in which these images were put to political use by the government (Reddy 2017b). A few voices against demonetization remain as loud as ever. The criticism that has the strongest force relates to the badly handled remonetization of the economy. However, the disruption caused by demonetization was needed for the country to move toward a “new normal.”

Endnotes