Demonetization: The Stumbling Block in Modi’s India?

Photo Credit: Quartz

By: Trisha Ray, Columnist

On November 8, 2016, Indian Prime Minister Narendra Modi unexpectedly announced that all high-value currency notes would no longer be legal tender, effective midnight.[i] This declaration made valueless 86% of the currency in circulation at the time.[ii] The lack of transparency, forethought and planning that accompanied this policy is in many ways symptomatic of the Modi administration’s modus operandi and while it may be considered a master stroke by some, it does not erase the problems of terror financing and undeclared wealth that it seeks to fix. 

The Policy

The rationale behind demonetization is simple: by withdrawing the legal tender on high denomination (Rs. 500 and Rs. 1,000) notes, fake currency is put out of circulation and billions in “black money” is brought into the formal banking system.[iii] The Rs. 1,000 per day limit set on the exchange of notes makes it impossible for those with this illegal wealth to deposit their money by the year-end deadline without raising red flags.[iv]

This policy has security implications as well. India is eighth in the Global Terrorism Index’s list of countries most affected by terrorism and it has long struggled with the nexus of terror and black money.[v] Modi has said that cross-border terrorists often fund their operations using fake currency, therefore demonetization would negatively impact their illicit activities.[vi]

The Problem

There has been no dearth of criticism levelled against the Modi government in the aftermath of demonetization. India is a primarily cash-based economy. The average Indian doesn’t have a credit card or Paypal and thus no access to digital money.[vii] Additionally, more than half the population does not have a bank account, making the transition phase particularly difficult for the poorer sections and those in the informal sector whose small savings became worthless overnight. Even for those with the means to convert their money legally, the banks simply do not have enough of the new notes to meet the influx.[viii]

Meanwhile, the intended targets of this policy have plenty of loopholes to exploit. In the 24 hours following the initial announcement, gold prices in India shot up as people rushed to convert their undeclared money.[ix] Others are depositing their money in Jan Dhan accounts, a type of no-minimum-balance account introduced by the Prime Minister in August 2014 to increase financial inclusion among people with low-income.[x] While the government has belatedly announced that it is considering a curb on domestic holdings of gold, this reactionary move further demonstrates the lack of forethought undergirding Modi’s policy.

Critically, the claim that demonetization will curb terrorism is an empty one. Though black money funds persistent terrorism, India’s lackluster counterterrorism effort is also to blame. The National Investigation Agency (NIA) that was created in response 2008 Mumbai attacks has an annual budget of just $16 million, and suffers from personnel and equipment shortage.[xi] If the Modi government is serious about terrorism, it needs to do more than temporarily disrupt their funding.

Many of the planning failures that have manifested over the last two weeks of demonetization are emblematic of the opacity with which the Modi government functions. Opposition Leader Ghulam Nabi Azad, addressing the Rajya Sabha, pointed out the lack of dialogue with Parliament prior to the unilateral declaration of the new policy.[xii] Also notable is the fact that the offices of Chief Vigilance Commissioner and Chief Information Commission, two key independent bodies that monitor the central government, were left vacant for nearly two years after Modi took office.[xiii] This lack of transparency is reinforced by the rabid nationalism that has arisen under Modi’s administration, creating a climate where journalists face mounting threats in response to reportage that criticizes the government.[xiv]

The people’s faith in the currency and in the banking system is suffering. If demonetization does not deliver on the promises made by the Modi government, black money will simply return within the next five years and the credibility of the seemingly infallible man himself may suffer.

[i] Mr Baniya, “PM Modi Notes Banned 500, 1000 Narendra Modi Speech. 8.nov.2016”, YouTube, posted November 8. 2016. https://www.youtube.com/watch?v=Hkt6uxjbzJg.

[ii] Harish Damodaran, “Are banks equipped to replace Rs 2,300 crore pieces of Rs 500 and Rs 1,000 notes?”, The Indian Express, November 9, 2016. http://indianexpress.com/article/opinion/web-edits/rs-500-rs-1000-notes-are-banks-equipped-to-replace-1874-crore-pieces-of-notes-4364746/.

[iii] Black Money refers to undeclared, unaccounted and often illegally acquired money.

“Frequently Asked Questions: Withdrawal of Legal Tender Character of the existing Bank Notes in the denominations of ₹500/- and ₹1000/-”, Reserve Bank of India, updated November 25, 2016. https://www.rbi.org.in/Scripts/FAQView.aspx?Id=119.

[iv] Harish Damodaran, “Are banks equipped to replace Rs 2,300 crore pieces of Rs 500 and Rs 1,000 notes?”, The Indian Express, November 9, 2016. http://indianexpress.com/article/opinion/web-edits/rs-500-rs-1000-notes-are-banks-equipped-to-replace-1874-crore-pieces-of-notes-4364746/.

[v] National Consortium for the Study of Terrorism and Responses to Terrorism (START), “Global Terrorism Index 2016”, Institute for Economics & Peace: p. 10. http://economicsandpeace.org/wp-content/uploads/2016/11/Global-Terrorism-Index-2016.2.pdf.

[vi] Seema Mody and Ted Kemp, “India abolished larger notes in fight against graft, ‘black money’”, CNBC, November 8, 2016. http://www.cnbc.com/2016/11/08/india-abolishes-larger-banknotes-in-fight-against-graft-black-money.html

[vii] Asli Demirguc-Kunt, Leora Klapper et al, “The Global Findex Database 2014: Measuring Financial Inclusion around the World”, World Bank, 2015. http://documents.worldbank.org/curated/en/187761468179367706/pdf/WPS7255.pdf#page=3.

[viii] Saloni Shukla, “Delhi, Mumbai run out of cash as focus turns to rural areas”, Economic Times¸ November 25, 2016http://economictimes.indiatimes.com/industry/banking/finance/banking/demonetisation-bank-branches-in-delhi-mumbai-run-out-of-cash-as-focus-turns-to-rural-areas/articleshow/55608981.cms.

[ix] The volatility in the gold market was further exacerbated by news of the American president-elect.

Madhura Karnik, “One week of demonetization in India: the good, the bad and the ugly”, Quartz, November 14, 2016. http://qz.com/836378/t/492437

[x] Correspondent, “Demonetization effect: Jan Dhan account deposits spike to Rs 21,000 crore”, DNA India, November 23, 2016. http://www.dnaindia.com/money/report-demonetization-effect-jan-dhan-account-deposits-spike-to-rs-21000-crore-2276303

[xi] Sumit Ganguly, “India’s Achilles Heel”, Foreign Affairs, August 18, 2015. https://www.foreignaffairs.com/articles/india/2015-08-18/indias-achilles-heel.

[xii] The Rajya Sabha is the upper house of parliament.

Livingindianews, “LIVE: DISCUSSION ON DEMONETIZATION IN RAJYA SABHA – PM MODI IN THE HOUSE (COURTEST RS TV”, Youtube, November 23, 2016. https://www.youtube.com/watch?v=o2PFQuJkJYo

[xiii] Rajat Kain, “Sonia Gandhi attacks Modi govt; demands transparency”, Rajya Sabha TV, May 6, 2015. http://rstv.nic.in/sonia-gandhi-attacks-modi-govt-issue-transparency.html

[xiv] “India: Government indifference to threats against journalists”¸ Reporters Without Borders, accessed November 24, 2016. https://rsf.org/en/india

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