By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends most of her time in Asia researching a book about textile artisans. She also writes regularly about legal, political economy, and regulatory topics for various consulting clients and publications, as well as writes occasional travel pieces for The National.

December 30 has now come and gone– the last day for people to exchange old INR 500 (worth USD 7.36) and INR 1000 (USD 14.72) notes– that were no longer legal tender after Indian Prime Minister Narendra Modi launched his demonetization policy on November 8. At a stroke, the policy withdrew 86% of Indian currency from circulation. Holders of old currency notes could exchange them for new currency, but only up to a limit of 4000 INR per person. Sums above that threshold had first to be routed through a bank account– in a country where only about half the population has a bank account– and then withdrawn later, subject to weekly caps on such withdrawals.

I have written about the policy in three previous posts, India Moves to Severely Restrict Use of Cash, Forcing Much of Economy Into Barter (November 10), India’s Cash Crackdown: Chaos Continues (November 16), and India’s Cash Crisis May Take Months, Not Weeks To Resolve (November 18). I include the links for interested readers but it’s not necessary to read these three previous posts to follow the discussion here.

How has the Indian policy been a debacle? Let me count just some of the ways. It has failed to crack down on “black money”– its announced goal, as discussed further below. Demonetization has been poorly implemented: the Reserve Bank of India– India’s central bank– has failed to supply sufficient currency, in usable denominations, to support ordinary economic activity, and has further confused matters by issuing frequent, ad hoc, contradictory circulars on policy detail. The inability to secure cash has affected just about everyone– whether a national or visitor– who has been in India since demonetization was announced. Consequences have ranged from mere inconvenience, to failure to be able to conduct ordinary business or economic activity, to in the most extreme cases, suffering and on one estimate, as many as 112 deaths.

The Patient Has Diabetes, So Let’s Treat Him With Chemo And See How That Works Out

The basic problem stems from a failure to distinguish between “black money”– money on which tax due has not been paid– and the legitimate informal sector– the cash-based economy. Estimates of the size of that sector range from about 50% to around 90% (depending on how it’s measured, e.g., as a percentage of GDP, or in terms of the percentage of wages paid in cash and not paid into a bank account). Many people working in the informal sector don’t pay any income tax– not because they’re corrupt or tax evaders, but because their income falls below the threshold upon which tax is due.

No one denies that India has a serious corruption problem. But most experts agree that demonetization– especially as implemented since November 8— is not an effective way of addressing this problem. Far more difficult to achieve but considerably more effective would have been measures directed at illicit real estate transactions, tightened tax enforcement, or political and administrative corruption.

Nonetheless, there was overwhelming, widespread support for the Modi policy when it was first announced– as I witnessed first hand as I was visiting India at the time. This support came from some unexpected quarters: a group of cosmopolitan Bengalis I dined with the night after Modi launched his policy, as I wrote in this November 16 post:

To place this in a US context, I would have been more likely to find a public supporter of Donald Trump at a New Republic cocktail party than to find a public Modi supporter among the Bengalis gathered that evening…. Given the huge inconvenience the new policy had caused– some guests I was looking forward to seeing didn’t show because they couldn’t cobble together enough cash to pay for cross-town transport– I was surprised that to a person, everyone present at that party mounted robust defenses of the objectives of demonetization.

Little did we know at that time that that “huge inconvenience” would soon be dwarfed by considerably more inconvenience, due to the spectacularly inept way demonetization was implemented.

The Result: What had been the world’s fastest growing economy is no longer. Third quarter growth has slowed, and this slowdown will certainly continue into fourth quarter as acute cash shortage continues, and likely beyond (India’s financial year runs from 1 April through 31 March for government financial statements and for corporate tax; for the self-employed and those who pay personal income tax, the year runs from 6th April through 5th April. I’m referring to the government financial year here.)

Day 50 after the November 8 launch of the policy was a seminal day, being both the deadline for exchanging old currency for new and the deadline Modi had previously asked for public forbearance for the policy to show its impact.

As the Economic Times reported yesterday, in 50 days of demonetisation: How Indian economy went off the rails, and what the future looks like :

“There’s a problem at the moment, but it may not remain so for long… people will start consuming once they have more money at their disposal. Demand is only deferred, not denied…,” said Shyam Srinivasan, MD and CEO, Federal Bank. “Parts of demand will come back quite aggressively. We may see 2/3 quarters of pain, but the pent up demand will blow out eventually,” the banker added. Though experts prefer to play down the negative effects of demonetisation, the impact of it – which involved the removal of 86% of total currency value – has been widespread. Acute cash crunch has impacted almost all sectors and sections of the population as currency dominates significant proportion of transactions. Consumer spending, trade, industrial and farming activity have been adversely affected. Ratings major Care Ratings has revised its GDP growth estimates for FY17 to 7%, from 7.8% set at the beginning of the year. [Jerri-Lynn here: Other estimates have been far more pessimistic.] “In overall terms, third quarter GDP growth may be affected badly… things may not look up for fourth quarter too. Growth recovery may start only in the first quarter of next fiscal,” predicted Sabnavis of Care Ratings.

Reality Does Not Resemble a Bollywood Movie

It’s a staple scene in many Bollywood films to see stacks of illicit cash secreted somewhere in the villain’s lair. Demonetization was designed to flush out just such cash. Yet, unfortunately, mundane reality doesn’t conform to these Bollywood cliches. As I first pointed out in this November 16 post: black assets are typically not held in the form of Indian bank notes– but are either held off-shore, or if kept in India, are invested in real estate, gold, jewellery, art, antiques, or securities.

The latest figures show that much of the outstanding currency has been redeposited into bank accounts. The possibility that there would be a big demonetization windfall– and an increase in income tax collected– has not materialized. As reported this week by the Economic Times in 90 per cent of scrapped notes back in system, big dividend unlikely:

Of the Rs 15.4 lakh crore worth of Rs 500 and Rs 1,000 notes that were scrapped as a resulted of PM Narendra Modi’s November 8 declaration, as much as Rs 14 lakh crore has been deposited in banks. [Jerri-Lynn here: Under the Indian numeric system, a lakh is 100,000, a crore is 10,000,000, and a lakh crore is 1,000,000,000,000.] The value of scrapped currency exceeded the government’s expectation that as much as Rs 3 lakh crore will not be returned as this would be part of black money hoards. This also means that expectation that RBI will be able to give a substantial dividend to the government will be belied. While the value of deposits indicates that ways were found to deposit unaccounted money, the government expects to gain tax revenues from large deposits above the prescribed Rs 2.5 lakh per individual limit.

I should emphasize that a higher value of cash has been returned to the system, deposited into bank accounts, than the government anticipated, as reported in the Financial Times in Indians rush to exchange cash ahead of deadline. But the lack of sufficient quantities of new currency means that people cannot access that cash– which is subject to strict withdrawal limits (24,000 INR per week– but many banks lack sufficient currency to allow customers to withdraw up to the limit to which they are in theory entitled). The Financial Times also reported that “banks had replaced just 38 per cent of the Rs15.3tn in demonetised notes that was sucked out of the system by November’s announcement, according to RBI data”, in Indian banks warn against lifting cash withdrawal limits.

Interested readers might look at this more extensive account arguing that the government’s aim of extinguishing black money has failed in The Wire, While the RBI Is Silent, Its Numbers Tell Us Demonetisation Has Failed.

Inept Implementation: Printing Logistics

The board of the RBI approved the demonetization decision a mere three hours before Modi’s November 8 speech, as reported by the Economic Times in RBI approved cash ban just hours before Modi’s November 8 speech:

It remains unclear what kind of preparations the RBI made for the currency ban that caused chaos across India: it did not respond to queries on how many new 2,000 and 500 rupee notes were being printed each day in its mints or the number of hours each day the printing presses were working in the month leading up to the Nov. 8 announcement. Nearly 50 days after the decision, there is still a shortage of cash in circulation, with ATMs regularly running out of money and a 2,500 rupee per day cap on ATM withdrawals [Jerri-Lynn here: Increased to 4500 INR from January 1].

The biggest mistake the RBI made was in not making sufficient quantities of currency available, in usable denominations, to replace the cancelled 500 INR and 1000 INR notes. A new, 2000 INR note was introduced. And as I wrote in my November 18 post:

Printing policy was apparently set to produce the highest replacement value of currency, rather than based on any detailed understanding of how currency typically circulates, and in what denominations, in the Indian economy. [According to LiveMint:] “We planned to first bring the 2,000 rupee notes as the focus was to create high-value notes to ensure the smooth replacement of the old 500 and 1,000 rupee notes. We would have to print four 500 rupee notes for every one 2,000 rupee note. If we would have focused on printing the 500 rupee notes, the entire printing exercise would have taken much longer,” said an official who didn’t want to be named.

To place these values in context, “[A] week’s worth of vegetables for one person costs no more than Rs 150, a takeaway order of a full tandoori chicken costs Rs 280 (with a further Rs 80 for two orders of naan bread), most taxi rides around central Kolkata don’t even top Rs 100, and ten tablets of aspirin cost Rs 3,” as I wrote in my November 16 post.

And, I should also add, that in this November 18 post, I quoted former Finance Minister for the Union government P. Chidambaram– who is a controversial figure in Indian politics. Yet at this point, it’s clear that the comments I quoted were on the money:

“They have blundered,” says Chidambaram. “They have blundered hopelessly. They are trying to race against time.” 2,100 crore in currency notes must be replaced … The capacity of existing printing presses is 300 crore notes per month. If the government wants to replace (and print) 2,100 crore notes, by equivalent denomination notes to those made non-legal tender by demonetization, it would take them seven months simply to print the notes, which is why Rs 2000 notes are instead being printed. There is no economic justification for the higher value notes. If the government is demonetizing Rs 500 and Rs 1000 notes, why is it introducing Rs 2000 notes? His answer: only to reduce the number of notes that must be printed. It will still take 5 to 6 months to print the necessary currency notes to replace the value of the notes withdrawn. To print sufficient Rs 100 notes [Jerri-Lynn here: a far more usable denomination for ordinary Indian cash transactions] would take five times as long.

As the Los Angeles Times has summarized in People are dying because of an audacious cash policy that India says will modernize its economy

Modi’s government has struggled to explain why the policy, crafted in near-total secrecy, has been implemented in such a disorganized way. The central bank — the Reserve Bank of India, whose well-regarded Gov. Raghuram Rajan resigned amid disagreements with Modi’s government in June — has found itself becoming a national punchline as it issues rule upon rule on deposits and withdrawal limits, some conflicting with one another.

Frequent, conflicting RBI circulars, convey the impression of a disjointed, reactive, ad hoc policy, a well-conceived, carefully-thought-through plan.

Inept Implementation: Inopportune Timing

The Modi government couldn’t have chosen a more inopportune time to impose the demonetisation policy, as I explored further in this November 16 post and merely recap here.

First, agriculture is the biggest single source of employment in India, and many farmers are especially cash dependent. They lack bank accounts and in fact, many of the villages they live in have no branches of banks. It often requires a journey of several kilometres– either on foot, or by catching a ride– to visit the nearest bank. Demonetization has coincided with the sowing season, when ample supplies of small bank notes are necessary to pay farmers for their crops. They in turn take the cash they earn and invest it in seed necessary to sow the next round of crops.

Further, as per my November 16 post:

It’s currently wedding season in India. These extravagant celebrations are often financed with cash– some saved outside the banking system for years, in anticipation of the event. The economic activity generated by weddings isn’t limited to bride, groom, dancing and dining alone, but extends to expenditures by guests, many of whom purchase new clothes or gifts for the event. Many of these transactions have stopped, as people just can’t get access to cash at the moment.

The government did provide a one-off exemption for access to cash to finance weddings; the effectiveness of this provision has been hampered by lack of sufficient liquidity to provide sufficient cash to those entitled to claim it. There have been widespread reports of banks simply refusing to honor the announced withdrawal ceilings simply because they lack sufficient currency to meet these obligations.

What I didn’t mention in those earlier posts is that this is also prime tourist season in India. Now I don’t know about you, but when I travel, I generally don’t carry large sums of cash with me, nor do I purchase traveller’s cheques. Instead, I rely on credit and ATM cards.

While in India, I could use my credit cards for things like hotels and some types of restaurants. But it’s still necessary for tourists to have access to cash– taxis require cash, museum and other admissions are cash only, as are many restaurants. Yet all tourists were subject to the same maximum withdrawal restrictions (initially 2000 INR, increased to 4500 as of January 1). Once I found an ATM that had currency, I had to wait in the same long queues and usually couldn’t withdraw anything other than the useless 2000 INR notes.

Now, to be clear, I’m not asking for special treatment. I’m an Indiaphile and a frequent visitor, and I’ve learned to put up with various types of inconvenience in order to visit this marvellous country. But I think I’m a bit of a unique character in that regard– and I wonder how many other visitors– in for a brief visit for a week or two– felt about sacrificing hours out of their holidays in order to score currency.

At least visitors, however, don’t have to maintain a household in India. Consider the unfortunate position many diplomats found themselves in. Allow me to quote from the following Times of India article, Stretched diplomats join rush for cash on December 11 (and note that this was more than a month since demonetization had been launched, and still, no workaround had been developed so that diplomats could secure access to sufficient amounts of currency to allow them to conduct their ordinary household and economic affairs):

Demonetization has not only squeezed out cash from citizens’ accounts but has also left scores of foreign diplomats and consulate officials stumped. Barred by law from holding bank accounts in India, many of them in Kolkata have been finding it difficult to get rid of old currencies. Strapped of cash, they, too, have been forced to stand in ATM queues and curtail their expenses. For Stephane Amalir, director of Alliance Francaise, managing his home has been a struggle since November 8. “I have not been able to pay my local staff and drivers. Going to the market is also tough since most shops don’t accept cards. So, I am only going to malls for vegetables and fish,” he said…. Russian consul-general Irina K Bashkirova has no account in any Indian bank. Nor does she have a credit card. “Our rules do not permit me to hold a foreign bank account or any foreign bank card. So, I draw my salary partly in Indian currency from the consulate. The distribution of new currency should have been better. The situation has not changed in a month. Locals can go to ATMs but what about diplomats?” she asked. She said the consulate can only apply to the bank for withdrawing money. “We have diplomatic accounts with three banks but are treated on a par with the other Indian customers. We are not getting any special treatment as a consulate. Now we can only withdraw Rs 50,000 per week. But that is not enough,” she said. The consulate, Irina added, has not been able to pay its staff. She felt sorry for those who died in the queues for money. “Demonenetisation took place in Russia also, but none died.” Irina narrated how she was stuck with Rs 2000 notes as none wanted to take them. “This should not have happened,” she said. German consul general Olaf Iversen said his office had also been finding it difficult to weather demonetization and had received no special treatment. Most ATMs near the consulate office has remained dry, he pointed out. “I have a Visa card but I unable to withdraw any money. The Visa card allows a minimum withdrawal of 50 Euro. But as per the present law, I can withdraw Rs 2500, which is only 35 Euro. So, I can’t use my card. However, Deutsche Bank is helping me,” he said

Change Chicken and Growth Slowdown

I can’t tell you how much time I, a casual visitor to India, spent in the weeks after demonetization was launched and before I left earlier this month, in discussions about how to cope with the policy. What ATMs had money? Where was it possible to find usable denominations — anything but the dreaded 2000 INR notes?

Elaborate forms of what I call “change chicken” occurred– making the minimal possible expenditure for which one could get the maximum amount of change. Now, at this point you may be saying, these issues seem more a matter of inconvenience than life threatening. After all, if I was finding my visit to India unusually trying, no one was forcing me to stay there, and I could easily have left the country and gone someplace else where the ATMs worked and currency plentiful.

But stay with me for a second. As I’ve mentioned, the acute shortage of currency has imposed a significant cost on the growth of the Indian economy– which had prior to demonetization been the fastest growing economy in the world– and shaved the growth rate, with no end in sight. I lack the space to go into this issue in any greater detail here at the moment.

Also, the failure to secure currency has led to documented deaths– either people collapsing in queues for cash, with others denied necessary medical payment due to an inability to secure sufficient cash to pay a medical bill. As The Los Angeles Times reported in People are dying because of an audacious cash policy that India says will modernize its economy:

Usha Boinavad, a farmworker in western India who underwent a heart operation as a teenager, began suffering from chest pains this month. A doctor advised the 26-year-old to seek heart valve surgery in the nearest major city, 200 miles away. She immediately ran into another problem: cash. The procedure would cost at least $1,500, far more than what she and her husband had in their bank account. But with India in the grip of a severe currency shortage since the government invalidated 86% of the cash in circulation on Nov. 8, the couple couldn’t scrape together even $100 for transportation to the hospital. Banks in their farming region have been slow to receive new bills, dispensing at most $30 to a few customers before closing their doors, leaving masses to walk away empty-handed. Like most rural Indians, the couple did not possess a checkbook or debit card. Boinavad’s father decided to sell his two buffaloes, but the buyer asked him to wait a few days because he couldn’t find cash either. It didn’t come in time. Boinavad’s pain worsened for several days until she died at her parents’ home Dec. 13 in Nanded, 300 miles east of Mumbai. “If not for demonetization” — the name for the government’s policy — “she would still be with us,” said Boinavad’s cousin, Sanjeev Halde.

West Bengal chief minister Mamata Banerjee (of the Trinamool Congress party), a political rival of Modi, has consistently criticised the demonetization policy, as I discussed in my November 16 post. As I mentioned, Modi had asked for the public’s patience for 50 days to implement demonetization. In a report in the Business Standard on day 51, Mamata attacks Modi over cash withdrawal limit, demonetisation deaths, she redoubled her criticisms:

“Modi Babu, public are not beggars of your Government. Why are there still restrictions on cash withdrawal ? 50 days are now over. How can you take away the rights of citizens to withdraw their own hard-earned money,” she tweeted. Modi announced demonetisation of high value currency notes on November 8, and subsequently sought 50 days to put things in order. “Governments may come into power but they just cannot snatch people’s economic rights,” she said. The Trinamool Congress supremo slammed Modi for his “arrogance.” “Modi babu, you are totally arrogant. You are responsible for 112 deaths,” she added.

Inadequate Infrastructure, Lack of Privacy and Other Safeguards

Where does this leave us? Well, as of this week, Finance Minister Arun Jaitley is still talking up India’s future as one of the deliberate use of less cash (because I may point out, Indians are certainly currently forced to eschew cash, but that is due to the liquidity crunch that has arisen from the RBI not making sufficient quantities of currency available in usable denominations). According to The Times of India, in Money has lost its ‘anonymity’ after demonetisation: Arun Jaitley:

Finance minister Arun Jaitley on Sunday expressed hope that demonetisation will help increase government revenue and lower fiscal deficit, leading to higher expenditure on defence and rural infrastructure. With the junking of the old high-value currency, the parallel economy has become part of the formal system, which leads to higher accountability and taxation that boost economic growth and transparency, he said at the launch of Digi Dhan Mela. He illustrated this point by saying that shifting towards less cash economy will help bridge fiscal deficit and bring about improvement in rural India [links omitted]. This is outright fantasy.

I should mention some of the major problems that are preventing India from moving out of cash anytime soon– or at least, once the RBI manages to get sufficient currency in circulation, in appropriate denominations, to support “normal” levels of economic activity.

The first serious obstacle is a lack of bank accounts. Allow me to quote from my November 16 post:

Yet as of 2014, only about 53% (up from 35% in 2011) of Indians have bank accounts. Even those with bank accounts usually receive wages in cash, while only 4% of those aged 15 or older have their wages paid into a bank account. Moreover, poorer Indians also don’t have credit cards, which the more well-off have been able to use to mitigate the policy’s impact. In fact, only 22% of Indians even have debit cards (all figures are from the World Bank, as of 2014 unless otherwise noted).

Although both before and especially after demonetization, the Modi government has made a concerted push to get people to open bank accounts, this is not a straightforward process– whatever incentives the government may provide. As mentioned above, many Indians live in villages where there is no bank branch. At present, economic activity in those villages is conducted in cash (or through various barter arrangements now that currency is in such short supply). So, it’s a bit of a tough sell to get people to accept the logic of opening a bank account.

Second, there are basic infrastructural impediments to any cashless system for transactions. I have experienced many times frequent problems with phone and internet access– especially out in the countryside but also– due to the sheer volume of people using networks– in the metros as well. In the countryside, India suffers from an unstable, irregular electricity supply. Although India has recently become the second largest smartphone market, terms of active unique smartphone users, as I’ve recently written in Apple Chases Indian Smartphone Market By Asking Modi Government for Manufacturing Deal, the current rate of smartphone penetration is only 30%– an impediment to a shift to cashless transactions.

I should mention two other issues, each raised in an article The Wire, There is No Magical On-Off Switch That Will Allow India to Transform Into a Cashless Economy. Privacy issues are currently not a major concern in India, which lacks adequate privacy and data protection laws:

The Attorney General of India has even claimed before the Supreme Court that Indian citizens have no constitutional right to privacy. Given the situation, the spectre of a cashless economy is scary indeed. Most of us do need the comfort of anonymity that cash provides, even while carrying out legitimate and harmless businesses. It will require a fair amount of informed debate before the privacy rights of citizens can be properly worked out, and it will definitely be premature to consider going cashless before that can happen. The government needs to clearly spell out the technical standards and the legal measures required to ensure the protection of privacy of its citizens, even from itself. The possibility of electronic mass surveillance on all monetary transactions does not augur well for civil liberty and democracy.

And a further concern is deficient security standards. Assume one could wave a magic wand and give all Indians bank accounts, and some form of card, app, or device that would allow for cashless transactions. Such a hypothetical system would rely on some form of authentication system. Now, most all Indians have great experience in dealing with cash, and know how to safeguard their small holdings– and what the consequences are of losing cash.

Over to The Wire again:

Clearly, the government has to worry about user education and familiarisation in a big way and needs to work out the public policies and legal frameworks that may have to be invoked to give quick comfort and grievance redressal to its citizens who may lose their hard earned money because of ordinary ignorance. This is obviously not a mean task given the complex demography, and the problem is bound to get compounded as we move further towards cashless. Fiercely protecting our cash is a skill that we learn from our early childhood and is one that suits us naturally, and the skill may have to be completely re-learnt if and when we go cashless – which is not comforting. Besides, the government also has to define security standards for the back end infrastructure and make it as transparent to its citizens as possible. It also has to explain to its citizens why it expects their banks and wallets to be safe. So far it has failed to do so and we remain unaware of the data protection standards followed by the retail banks, Paytm or Airtel money.

Bottom Line

Demonetization in India has been a debacle, and there is no end to the problems that it has created currently in sight. The best that can be said about it is that it might deter political leaders in other countries think long and hard before initiating similarly ill-conceived, premature efforts to try and nudge transactions away from cash and toward cashless payment systems.