NOVEMBER 8, 2017, marks the first anniversary of demonetisation, an exercise that shocked, numbed and grievously wounded livelihoods on a scale unprecedented since Independence. A year later, the effects of the monumental blunder, undertaken in the name of fighting the “black money” menace, still linger. Livelihoods in huge swathes of the economy that were uprooted in the wake of demonetisation have still not recovered. To make matters worse, the imposition of an ill-designed Goods and Services Tax (GST), whose impact fell disproportionately on small manufacturing units and traders, has compounded the crisis.

As the Bharatiya Janata Party (BJP) geared to celebrate the day as “Anti-Black Money Day” ( kala dhan virodh diwas), the opposition parties observed it as “black” day ( kala diwas). But one thing is clear: a deeply scarred nation and its economy, still stumbling under the impact of demonetisation, may never fully recover from the severe trauma. Institutions whose reputations were battered by the manner in which the entire exercise unfolded—chiefly, the Reserve Bank of India (RBI)—may have compromised their integrity, possibly fatally. Clearly, Prime Minister Narendra Modi personally staked much on demonetisation. The fact that he, and not the RBI Governor or the Finance Minister, announced on national television the decision to demonetise 86.4 per cent of the entire value of the currency in circulation made that very clear. In the immediate aftermath of the announcement, nobody had an inkling of the scale of the tragedy that was in store for Indians. It was assumed that adequate preparation, especially regarding the logistics of the distribution of currency notes across the country, would have been taken. In fact, initial discussions within the Frontline team veered around to taking stock of the situation after a few days, in the expectation that some semblance of normalcy would return. But within a week, it became clear that what Modi had initiated was nothing short of a monumental blunder, which is how Frontline’s cover story in the issue dated December 9, 2016 described it.

Bungling troika



It quickly became evident that unprecedented bungling at the very highest levels was responsible for the crisis. It was clear that the troika of Modi, the Finance Ministry and the RBI was responsible for the crisis. Modi himself chose to stay away from the country as people, especially those in informal occupations and in agriculture, bore the immediate and savage brunt of the sudden evisceration of the overwhelming proportion of the currency in circulation.

Huge queues at banks, compounded by the fact that automated teller machines (ATMs) had not been “recalibrated” to handle the new currency notes, reflected the grim reality of a massive shortage of adequate currency available at banks. While this was on, both the RBI and Modi acted irresponsibly. The RBI maintained that “adequate” currency had been made available to commercial banks, which only resulted in people abusing or even acting violently against hapless bank employees. Modi, who had returned home, was on the verge of tears and sought 50 days’ time for things to settle down.

Clearly, he was misleading millions who had lost their livelihoods, lost access to whatever little savings they had in banks, and stared at a hopeless future. The simple fact of the matter, which was highlighted by Frontline in its first cover story on demonetisation, was that the RBI’s capacity to replace the value of the withdrawn currency did not make this a realistic probability.

In hindsight, two aspects of the government’s response to the unfolding crisis are particularly noteworthy. The first pertains to the manner in which the government shifted goalposts as it realised the enormity of its folly. The second was the utterly opaque nature of the entire operation.

As the tragedy unfolded, the reasons for undertaking demonetisation shifted. It moved from fighting “black money”, which objective was already being discredited by the growing realisation that cash hoards are only a fraction of ill-gotten wealth, to fighting terrorism and counterfeiting and finally to reducing the proportion of cash relative to the national income. But, by early 2017, as the crisis gathered momentum and it became clear that cash-starved Indians were in for the long haul, the justification for demonetisation was placed on the need to evolve into a cashless economy.

Meanwhile, the central bank, which has always enjoyed a formidable reputation in the world of global finance, turned into a laughing stock. The newly appointed RBI Governor, Urjit Patel, was missing in action despite the fact that demonetisation was unleashed in his institution’s name. It soon became evident at press conferences and elsewhere that the Finance Ministry was calling the shots even as the central bank appeared to act as a bystander. But things were made far worse by the utterly opaque functioning of the RBI.

Anecdotal evidence soon after demonetisation—anecdotal because of the simple fact that neither the government nor the RBI has provided any information—clearly indicated a widespread shortage of currency. More significantly, the evidence also pointed to severe imbalances in spatial terms as well as in terms of how currency was more easily available to the rich compared with the poor. The thriving market for fresh currency, available to those who could afford a commission for exchanging old notes for new, reflected this shortage.

As the former Deputy Governor of the RBI, K.C. Chakraborty, had pointed out then, the RBI’s failure to ensure transparency in its currency distribution operations significantly aggravated the situation. Bank customers had no way of knowing where they could access their money. Indeed, as representatives of bank unions have claimed, the information asymmetry that followed meant that some banks, mostly private ones, were favoured over public sector banks in the matter of supply of adequate currency. The severe shortage of fresh currency was aggravated by the fact that the RBI failed to ensure a more equitable and fair distribution of notes.

Faced with this unprecedented crisis, the RBI, upon the obvious prodding of the Finance Ministry, issued modifications and clarifications almost on a daily basis on the terms on which Indians could access their own money. Indeed, it was only in August 2017, when the RBI published its annual report, that Indians learnt that more than 99 per cent of the old 500- and 1,000-rupee notes had been surrendered to banks ( Frontline, September 29, 2017). Meanwhile, a year after the gigantic fiasco, the RBI claims it is still “scrutinising” the old notes.

Shifting goalposts



As the official discourse shifted to moving India towards a cashless nirvana, institutions such as the NITI Aayog were pressed into service. The NITI Aayog, a pale shadow of its predecessor, the Planning Commission, was reduced to functioning as a training institute for advocating and promoting digital payment systems. At the height of the crisis, it was reduced to running a lottery for those using digital payment systems. Indeed, speaking at Moradabad during the worst phase of the crisis, Modi made the preposterous claim, based on a staged WhatsApp video, that even beggars were using swipe machines these days. As the accompanying piece by James Wilson demonstrates, the value of digital payments, although growing, still accounts for only a minuscule proportion of the value of all electronic transactions (inclusive of electronic clearing, which has significantly replaced physical cheques).

The simple point was that the gradual evolution of digital payment systems was happening anyway and that any further push towards digital payments would have required two specific interventions of the government. The first would have been a government-driven subsidy system to promote digital payments, especially because digital payment systems are not scale-neutral: the smaller value transactions are actually, on a proportionate basis, costlier in terms of the charges paid on transactions. If the intention was to replace cash by digital modes of payment, the latter would have to assure the same level of certainty, predictability and acceptance.

The second intervention would have entailed the most basic of requirements for such a system to work effectively: accessibility of a countrywide always-available mobile network, followed by fail-proof assurances by fintech companies as well as financial institutions. In fact, belatedly, almost as an afterthought, the Modi government instituted a committee (the Watal Committee) to suggest a regulatory framework for digital transactions (see Frontline, March 3, 2017).

Clearly, the most significant section of the population hit by demonetisation was the peasantry. The dramatic collapse of agricultural commodity prices since demonetisation was truly breathtaking. Although it is not uncommon for agricultural product prices to fall during a year, what happened after demonetisation was stunning both in its geographical spread and in terms of the kind of produce. There is not a single agricultural commodity whose price did not collapse immediately after demonetisation. Indeed, prices have still not recovered, as an accompanying story documents.

It does not take a genius to understand why the Indian peasant is as restive as he has been this year. Farmers across the country have been protesting against the all-round collapse in prices. The Modi government’s utter failure to actually procure agricultural commodities at their minimum support prices (MSP) has been callous, especially because it offered an opportunity to make amends for the folly of unleashing demonetisation on a hapless peasantry.

Demonetisation was much more than a folly as far as the peasantry was concerned. The all-round collapse in prices offered an opportunity for the elite, rural and urban, to convert their hoards of old cash into commodities bought at throwaway prices ( Frontline, December 23, 2016). Indeed, there is evidence to show that Modi’s claim—made in the initial days after demonetisation—that the rich and poor suffered equally as a result of demonetisation is false, misleading and mischievous.

The collapse not just of agricultural commodity prices but also of products manufactured by small producers paved the way for a massive transfer of wealth from the poor to the rich. As reports from across the country have shown, from Tirupur to Kanpur to Murshidabad to Mumbai, livelihoods remain in peril a year after demonetisation. These people have been hit by two body blows, demonetisation and GST, and this makes for a tragedy that is still unfolding.

Demonetisation-GST continuum



The key prerequisite for comprehending why the effects of demonetisation continue to linger is to understand that they are, in effect, a continuum. In order to appreciate this, one has to understand the nature of livelihoods of people working in marginal and small occupations. While the immediate effects of demonetisation on consumption, via access to savings, have been better appreciated, the savage impact the move had on access to working capital has been ignored by most observers. In an economy where cash served as the basis for a small business, its sudden evaporation immediately led to the collapse of these businesses. Add to this the costs associated with digital modes, plus the steep learning curve to deal with these modes, and we begin to appreciate why and how these businesses just folded up.

It is interesting to note the uncanny parallels between demonetisation and the manner in which GST was implemented. Note the current discussion within the government: that GST is a great idea and only its implementation has been flawed, which, with some fine-tuning, can be set right. This was exactly the same refrain once it became clear that the effects of demonetisation were going to last long: that it was a great idea which was implemented badly.

However, GST is hitting exactly those who were hammered by demonetisation and is having exactly the same impact. While most critics have focussed attention on the tax rate—for instance, weavers and makers of handmade textiles face a 5 per cent tax rate compared with zero earlier—less attention has been paid to the crushing burden that GST imposes by squeezing the working capital of these small producers.

In effect, what this implies is that unlike in the earlier tax regime, such producers have to make arrangements for higher levels of working capital to tide over deferred payments due to them from their customers; meanwhile, they have to pay the GST that is levied on them. The fact that GST was unleashed barely six months after they were hit by the cash shortage caused by demonetisation explains why the crisis was aggravated for this section of producers.

But this sorry state of affairs of the suffering small producer or farmer tells only half the story. Just as demonetisation unleashed a massive and unprecedented transfer of wealth from the poor to the rich, GST offers more of the same but in a different name. The squeeze on the working capital of the smaller units is also accompanied by higher costs that arise from complying with the new tax regime. This is apart from the higher costs of working capital that they need to pay when compared with big corporates that manage to access institutional credit.

In short, while demonetisation simply removed their very modus operandi (cash), GST makes them uncompetitive and unviable. This is illustrated by reports by Frontline correspondents from several States that accompany this story.

Logic of demonetisation



All this brings us to the fundamental question of why demonetisation was undertaken at all, a subject that Prof. D. Narasimha Reddy dwells at length in an accompanying piece. What were the motives for undertaking such a risky adventure? The most charitable one would describe it as being undertaken by a government that had to do “something big” (Modi is fond of saying bada socho, as for instance, in justifying the Bullet Train project) to counter mounting criticism that it had failed in its promise to deliver acche din.

However, as events since demonetisation have shown, especially the manner in which the government aggressively pursued GST despite the devastation caused by demonetisation, the motives were elsewhere. Both demonetisation and GST (the first clearly demonstrating and the second tending in that direction) provide a pathway towards consolidation and concentration of economic power in the hands of larger businesses. Seen from this standpoint, nothing about demonetisation was unforeseen: the great hardships, the 100-plus deaths at ATMs across the country, the collapse of businesses and livelihoods and the loss of employment.

What appeared as bungling, in this version of why demonetisation was undertaken, was expected but considered a desirable objective clothed in the garb of “formalising” business processes or of taking India on a digital highway. The fact that GST was undertaken regardless of the mindless assault on livelihoods that demonetisation has already wreaked renders this a plausible explanation, but one which places the Modi regime in a much poorer light: as a callous regime recklessly pursuing a path that is deeply divisive in terms of its social and economic impact.

The lack of sustained public anger against demonetisation was not an indication that the people were completely sold on Modi’s commitment to fight “black money”. “Spontaneous” bursts of protest have only so much energy in them: they require political vehicles to carry them forward, and this did not happen after last November.

Whatever may have been the motives for demonetisation, one thing is certain: demonetisation, and now GST, has badly scratched the sheen of invincibility that Modi acquired after his historic victory in the 2014 elections.