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Admirers of Prime Minister Narendra Modi have long extolled his political acumen, in particular his sense of timing, his firm grasp over administrative matters, and his ability to take and stand by tough, even unpopular, decisions, essential in his view to achieving needed national transformation. It, however, appears that the unexpected, and unprecedented, decision to demonetize, and thus declare illegal Rs 500 and Rs 1000 notes, together constituting 86 per cent of all currency in circulation, has left many of them bewildered, likely dismayed and angry. As we near the end of the first phase of the exercise to remake the Indian economy and society, it is clear that the achey din expected following a ‘temporary’ period of inconvenience, pain and adjustment, are nowhere in sight.

The 8 November decision was initially justified as a decisive blow to the ‘black’ economy, a rooting out of the menace of counterfeit currency reportedly fuelling both terrorism and left wing extremism, and a first step towards moving the country to a less cash dependant economy, critical for both ‘cleaning up’ the economy and widening the tax base. It turns out that the initial estimates of fake currency were vastly overstated, accounting for less than a quarter of the currency in circulation, eliminating which would hardly make a substantial difference to the activities of the terrorists.

Similarly, unreported cash holdings, whether part of criminal enterprise or otherwise, constitute less than ten per cent of the estimated black money in the system, the larger proportion being held as gold, in foreign bank accounts, or in real estate. Since demonetization would make illegal not just the black money but also legitimate cash holdings with the public, it was necessary to give some time to honest citizens to exchange/deposit the now illegal currency. The expectation was that a substantial part of the currency would be forced out of the system, not only eliminating some stock of black money but also yielding a dividend to the government. Unfortunately, the government vastly underestimated the ingenuity of the public, as almost all the Rs 15.4 lakh crore currency has got deposited in the banks. This has not just dried out any ‘potential dividend’ to the government but made the task of identifying black money, now all in legitimate bank accounts, that much more difficult.

Take now the third objective, of forcing cash based transactions into a more formal mode through the banking system. Few disagree that the existence of a large shadow economy is unhealthy for the economy and that moving far more of our economic transactions into the formal/regularized domain would not only enlarge the tax base but also give an upward boost to GDP. Encouraging digital transactions is a step in this direction. Yet, the degree to which this move would be successful depends not only on the scale and reliability of the infrastructure, the costs associated with digital transactions and, most important, an allaying of fears about security. Equally, one needs to be confident that the banking infrastructure, number and spread of branches and ATMs, trained personnel and reliable and secure back end systems are in place so that a move such as the one attempted does not overwhelm the system.

Far from fulfilling these ‘laudable’ objectives, the ‘scorched earth’ demonetization exercise has created severe distress, dislocation and uncertainty, with a disproportionate burden falling on the poor. With all cash-intensive activities more or less ground to a halt, the resulting contraction in demand has worsened an already precarious unemployment situation. Even the formal, organized sector expects a 30-40 per cent decline in turnover for the foreseeable future.

All this raises serious concern – about the decision itself, the timing, and the ability of the state apparatus to manage such a massive exercise. One hopes there were some compelling reasons as to why demonetization had to be introduced in the peak agricultural season, with the kharif crop coming into the mandis and preparations in full swing for sowing – all of which, in the absence of liquidity, face disruption, as does the wedding season, another cash intensive activity. Surely, some more time might have enabled much better preparation – sufficient stock of new currency of the right denomination, ATMs recalibrated, and back end systems in place. No wonder the growing feeling is that far from the stated objectives, the decision was driven more by political considerations given the elections scheduled for early 2017.

The growing disquiet amongst all sections of society has clearly pushed the government on the back foot. Little surprise that the government has not only revised banking rules repeatedly as also stepped up its propaganda, castigating all critics as ‘supporters of corruption’ and worse, ‘anti-national’ – a sure sign of panic. Whether or not this is the ‘beginning of the end’ of the Modi mystique, there is little doubt that he stands substantially diminished.

Harsh Sethi