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KAMAL MITRA CHENOY | 18 DECEMBER, 2016

Demonetisation CountDown: Rs 2000 And Recession


NEW DELHI: Minister of State for Finance, Arjun Ram Meghwal has said that the government would introduce new design bank notes in other denominations. This is interesting because the new ₹2000 note has a sketch of Gandhi's spectacles on the back of the note and within the two rims of his spectacles "Swachh Bharat" is printed. Below is the slogan " Ek Kadam Swachhatha Ki Aur".

Under the Reserve Bank of India Act,Section 25, "the design, form, and material of bank notes shall be such as may be approved by the Central Government after consideration of recommendations made by the Central Board (of RBI)".

It is not clear whether this procedure was followed fully. In any case a party political slogan of a central government that has existed for only two and a half years is a clear misuse of power. Is it even known whether this political design was considered by the entire Central Board of the RBI?

A major question to be examined by the Constitution Bench of the Supreme Court in January 2017 is whether district cooperative banks have been discriminated against by excluding them from accepting deposits and exchanging demonetised notes.

Under Section 9(1) of RBI Act, the Local Boards of the RBI, appointed "by the Central Government to represent, as far as possible, territorial and economic interests and the interests of co-operative banks." So the co-operative banks empowered by the relevant laws, are ignored in the demonetisation legal set up.

Minister Arjun Meghwal's assertion amounts to stating that all currency will be changed e.g. an even higher demonetisation? Continuing changes of notes leads to even less confidence in the economy. A basic necessity for a stable economy is that currency is not repeatedly changed. Once again there will be problems about the time for retention of old notes and their eventual removal as legal tender.

It is often said that the planning for demonetisation was fine, but implementation was poor. But in such critical matters the two are almost invariably dovetailed. As is well known, as even the former RBI Governor Bimal Jalan whose term largely coincided with the Atal Bihari Vajpayee government (1997-2003) pointed out there was no need for demonetisation since neither hyperinflation, national security and war which can be the usual causes for such a move, did not exist. The economy was growing at 7.6% of GDP which was clearly on the high side.

In any case, this extent was unprecedented as contrasted to the Great Depression in the United States in the late 1920s and 1930s where the demonetisation was only 30%.

The argument that the high notes would lead to black money is poor, since most studies assessed the cash component in the black economy to be around 5%.

Money rarely stays black. In the circulation of money and capital, black money turns into white, and this cycle continues.

Also a very large amount of black money is in tax havens abroad, like the Cayman Islands, Virgin Islands, Singapore, Dubai, Panama etc. Virtually no one who has unaccounted assets will keep them in the form of money in their homes or offices as the value of money would depreciate due to inflation. The idea is to make monopoly profits by evading taxes.

In any case the GoI has made no estimates. Finance Minister Arun Jaitley stated "There is no official estimation of the amount of black money either before or after the government's decision of November 8..." He did not cite the World Bank estimate that the "shadow" (black) economy in India was 22.2%. To just quote money found in tax raids without a factual estimate is poor economics.

The ₹2000 note was printed two months earlier to November 8. The ₹500 and ₹1000 notes were printed barely two weeks earlier, and as the former Deputy Governor of the RBI pointed out there were managerial issues in one of the four printing presses.

Further, currency paper was in short supply. This year the GoI imported 8,000 tonnes of currency paper. Yet some days ago the GoI asked for 20,000 tonnes of currency paper. This by a government that demonetised an unheard of 86% of the value of the currency.

The value of currency prior to the notebandhi was ₹ 15.5 Lakh Crore according to the RBI. On December 10, 2016, the value of new currency infused was ₹ 5 Lakh crore, less than one third of the demonetised currency prior to November 8. It is not rocket science to understand that this will lead to a massive currency shock, as even now.

In any event, the claim that ₹500 and ₹1,000 notes fuelled terrorism if true, should have negated the printing of a ₹2,000 note. The continued substantial existence of the parallel (black) economy, gives the lie to GoI claims. Post November 8, money poured into the Jan Dhan accounts amounting to ₹21,000 crores in just two weeks. This later rose to ₹64,250 crores by November 2016.

After this what can Indian economy expect? By the time this is done, if what is stated above is any guide, there will be financial chaos, loss of faith in the currency, thus underconsumption leading to a sharp fall in aggregate demand which even now is low.

Consumer and business confidence will be low, foreign investment, $5 billion of which has already left, will think twice before returning. As The Economist pointed out everyone will suffer, especially the poor.

In statistical terms it is clear that Dr. Manmohan Singh, who spoke in the Rajya Sabha was right when while stating that the growth in GDP would fall by 2%, he also stressed that this was an under estimate. If he is right as many believe, India is heading for recession.

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