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A 'completely silly' move

November 24, 2016

The Indian government's recent surprise decision to ban all high-value currency notes in circulation has affected almost everyone in the country. Economist Rajiv Biswas talks to DW about the effectiveness of the move.

Indien Straßenverkäufer mit Geldscheine Archiv 2013
Image: picture-alliance/AP Photo/B. Rout

Weeks after Prime Minister Narendra Modi announced a drastic move to withdraw all 500- and 1,000-rupee notes from circulation, the monetary situation in Asia's third-largest economy has yet to normalize and most people across the country continue to face problems accessing cash for their daily needs.

The government has said the move will bring billions of unaccounted money into the formal banking system and clean India's economy of "black money," a term used in the country to refer to unaccounted, untaxed wealth.

But since the announcement, serpentine queues have lined up outside banks and ATMs of people replacing their rupee notes or making small withdrawals. And Modi's administration has faced sharp criticism over the slow pace of introducing the new notes, with banks running out of cash and ATMs having to be recalibrated to cope with the different sized bills - a process that is still incomplete.

The Indian economy's high reliance on cash only adds to the crisis. Furthermore, many in the South Asian nation lack proper access to banks and financial services.

The uncertainty caused by the shock decision has also led foreign investors to withdraw huge amounts of capital from the country and put it elsewhere. The resulting slide in the rupee has sparked speculation that the country's central bank may intervene to shore up the currency.

Rajiv Biswas
Biswas: 'There seems to be a vast disconnect between the ivory tower of Modi's government in Delhi run by urban middle class bureaucrats and the reality of life for the rural poor in India'Image: IHS

In a DW interview, economist Rajiv Biswas says the Modi government seems to be living in a parallel universe to India's rural poor, and therefore is unable to grasp the problems that its demonetization edict has created for much of the country's population.

DW: How is the demonetization impacting India's economic growth prospects?

Rajiv Biswas: The overnight cancellation of 86 percent of India's banknotes in value terms has created a huge shock to Indian consumers since 50 percent of adults do not have bank accounts or digital money and a high share of ordinary transactions rely on cash, particularly for everyday food purchases such as vegetables, fruits, meat and fish.

Much of this cash-based economy involving the poorest 50 percent of Indian consumers has slowed down sharply, and this will hit the fourth quarter (October-December) GDP figure assuming the statistics are properly calculated in the first place.

There are reports suggesting that many people, particularly the working classes employed in the informal economy, have been hit hard by the move. What problems are they facing?

India is still essentially a very poor nation by international standards, with annual per capita GDP of only around $1,600 (1,500 euros) in 2015. An estimated 50 percent of the adult population does not have bank accounts or digital money, particularly in rural India where villagers have little access to bank branch networks or ATMs.

India is a nation divided between the urban middle class and the rural and urban poor, and the poorest often are not part of the digital economy or banking system. Therefore the poorest segments of society have been hit hard by the demonetization, because they are most likely to have their savings kept in banknotes since many don't have bank accounts, and also this means they cannot buy daily necessities anymore since their banknotes are not valid.

What can be done to mitigate their difficulties?

There seems to be a vast disconnect between the ivory tower of Modi's government in Delhi run by urban middle class bureaucrats and the reality of life for the rural poor in India.

According to the World Bank, an estimated 270 million Indians live in extreme poverty, so they hardly have any access to bank accounts or fancy credit cards. Which bank will give a credit card to a homeless Indian living in a slum on $1 per day? While much could be done to mitigate the burden of the poor, it seems that the Modi government is living in a parallel universe to the rural poor, and therefore is unable to grasp the problems that its demonetization edict has created for much of India's population.

How do you assess the demonetization move overall? Is it really worth it considering the costs that it has imposed on millions of underprivileged sections of society?

While there is nothing wrong with issuing new denomination banknotes to replace old bills and to combat the use of counterfeit bank notes, almost every other country allows a transition period for people to exchange their old banknotes for the newly issued notes. This procedure still effectively removes the old counterfeit notes from the system since banks will detect counterfeit notes at the point of exchange. However, to just abolish 86 percent of banknotes overnight in a poverty-stricken nation where the poorest half of society depend on cash transactions seems completely silly.

Many in India view the government's decision as a "masterstroke" that will resolve the problem of untaxed, unaccounted wealth in the country. What is your take on this?

India has been plunged into chaos by this Indian government brainwave of abolishing 86 percent of banknotes overnight. Huge queues have lined up outside banks every day since the decision was announced, with ordinary people queuing in desperation as people fight to exchange their daily allowance of banknotes. It is like a scene from Leninist Russia after the Bolshevik Revolution when the economy collapsed.

It is hard to believe Modi's demonetization snake oil cure-all magic potion will resolve the issue of black money as those who are involved in illegal transactions can turn to alternative forms of money, such as foreign currency or gold. Other developing countries such as Myanmar or Cambodia, where there has been a lack of trust in their own domestic currency, sometimes become dollarized, with the local population using US dollars as their preferred currency.

What more needs to be done to resolve the issue of black money in the country?

Many countries worldwide have high levels of corruption and it is a very complex process to reduce corruption and black money in an economy. For India, the process of reducing corruption will need to start with the various layers of government bureaucracy, gradually eliminating corruption throughout national, state and local governments. Large organized crime groups would also need to be tackled, since they are important conduits for black money and counterfeit notes.

Even if the political will is there, the process of reducing black money and corruption would take many years, and simplistic solutions like abolishing almost all the bank notes overnight will not address the fundamental root causes of the problem.

Rajiv Biswas is Asia-Pacific Chief Economist at HIS Global Insight, a global information and analytics firm. He is the author of Asian Megatrends (Palgrave, 2016).

The interview was conducted by Srinivas Mazumdaru.