Demonetization: Consequences & The Way Forward

The govt. has called the current demonetization move as a “surgical strike” on black money - building up on the military strike on Pak earlier - unleashing yet again the patriotic sentiment of the people. The Supreme Court averred that it is actually “carpet bombing” while hearing a PIL requesting for staying the move; a stay has not been granted though. Kejriwal & Mamata Banerjee, the two leaders with aspirations of leading an anti Modi front, have issued an ultimatum to the govt. to reverse the move in 3 days; perhaps protests shall follow.  As Abhishek Manu Singhvi put it eloquently, we are in a “scrambled egg” situation & recovery of the egg is, therefore, ruled out. It would therefore be prudent to think on way forward to ease the inevitable pain.  

That the demonetization plan was ill planned is a fact. How will once explain the spelling mistakes on the 2000 rupee notes?  Earlier we had news reports on Marathi misspelt & now it is Urdu’s turn. Terror funds have dried up says MOS Home Ministry, Kiran Rijuju & perhaps Naxals are hand tied. Relative peace in Kashmir, as per analysts, though could either be attributed to the shortage of Rs 500/- notes paid daily to the demonstrators or temporarily suspended due school examinations underway; only time will tell. Other details of whether demonetization is good or bad is analysed in the following article.

http://meetrk.blogspot.in/2016/11/demonetization-in-india-good-or-bad.html

As per an India Today report, India has a capacity to print 26.66 billion notes per annum in two shifts across 4 currency printing presses: Nasik (Maharashra) & Dewas (MP), Salboni (WB) & Mysuru (Karnataka).  India has demonetized 15.7 billion 500 rupee notes & 6.8 billion 1000 rupee notes; Arun Jaitley has indicated that there are no plans to re-issue 1000 rupee notes unlike the 500 rupee notes.  Therefore, if the 2000 rupee note replaces the 1000 one, we need to print 3.4 billion notes along with 15.7 billion of 500 notes for replacement. If the printing presses work for 3 shifts they can print 40 billion notes per annum & printing the 19.1 billion (15.7+3.4) would take about 6 months. Clearly currency worries would not end on 30^th Dec as the PM would like us to believe even if we incorporate the news that the 2000 rupee note printing started at Mysuru from Sept.

What are the options then?

Religious Trusts: The govt. has persuaded religious trusts to deposit small change into the banking network to help liquidity which is unlikely to be a successful intervention since only 14% of the overall cash economy is in small denominations & not all of the same lands up into places of religious worship. 

Mobile Payments:  87% of Kenya’s GDP is transferred vide “mobile money” & it would seem an enticing opportunity for replication. However, It is pertinent to note that while India has over 1 billion of its 1.25 billion population, with mobile connections, urban tele-density is about 150% while rural tele-density is only about 50%; clearly, 150% penetration in urban indicates multiple SIMs with the same person which alludes to the actual mobile penetration being less than a billion while rural penetration at 50% indicates that many are yet to be incorporated into the mobile revolution. Incidentally, 68.8% (86 crores) of the Indian population resides in rural which means about 34 crore people have no mobile connections. Perhaps they belong to the BPL (Below Poverty line) segment.

Furthermore, overall tele-density in states like Bihar, Assam etc. is under 60% & hence mobile option in such states is rather limited – rural or urban. Thus mobile payments or wallet options is thus a slow burn.

Use Plastic: As per the RBI, at the end of Aug 2016, India has 71 crores debit cards & 2.6 crore credit cards. India has about 25 crore households & the debit card fig indicates that each family has at least 2 cards; however averages mislead. It would be safe to assume about 30 crore people to be BPL (Below Poverty Line) – despite various figs being bandied about - & in all probability many of those people would not have either a Jan Dhan account of a RuPay card activated.

Even if the above argument is disproved, one cannot wish away the paltry count of ATMs & POS machines in the country.  As per the same RBI data, end Aug’ 16 India has 2.02 lakh ATMs & 14.6 lakh POS machines; 1/3^rd of India’s 2 lakh ATM are based in the top 60 cities & 60% are located in urban.  Clearly the rural economy would go cashless for many more days for their inability to access the bank network - branches or ATMs.

In Aug’16,  71 crore debit cards were used to dispense 2.19 lakh crores from ATMs & 0.18 lakh crores from POS machines vide 7.5 crore transactions & 1.3 crore transactions respectively indicating that less than 10% of the people could be using the cards; clearly, these people need to be educated on how to use cards. 2.6 crore credit cards have a better story but their nos. are small; they were used to dispense 0.03 lakh crores from ATMs & 0.25 lakh crores from POS machines vide 64.63 crores & 83.95 crore transactions respectively.  Thus machines would dispense only 2.65 lakh crores of the 14.5 lakh crores cash notes being demonetized; surely, the current infra would be inadequate to handle the additional rush. Add to that the fact that there are only 2000 engineers to re-calibrate the ATMs to dispense the new 2000 note implies that many of the ATMs are currently forced to dispense only 100 notes leading to the proliferation of serpentine queues; safe to assume that it would take 3-4 weeks for the recalibration work to conclude. 

Activating the 1.2 lakh banking correspondents, inadequate in number though, is a solution but the process would be excruciatingly slow.  Logistics problems abound in supplying cash even to the 1.5 lakh post offices across the country - 89.9% of which are in rural.

Go Online: Govt. has already asked PSUs & central govt. departments to make all payments possible online. Responsible citizens have also started doing the same which needless to say is welcome.

   

Engage additional Printing presses: Since reversal of the demonetization decision is foolhardy, the only option left is to arrange for printing across presses across the world; security however could be compromised.

Conclusion

If 25% ($500 billion) of the $2 trillion Indian economy is “black” & 50% of the $217 billion in value of 500/1000 notes are assumed to be part of the parallel economy, it is unlikely that the entire money would be forfeited. The govt., perhaps, believes that if about $40-50 billion is forfeited & the RBI transfers the same as a dividend, the same could be used for pump priming the economy. While the aim is laudable, lack of cash for 6 months would ensure that the infra projects, even if announced, would fail to take off.

The rural economy which is largely a cash based one would be in shambles.  APMCs (Agricultural Produce Marketing Committees) at many places have started refusing to buy edibles since liquidity squeeze at the destination markets have effected payments. Farmers now have an option to either sell directly to the consumers, perhaps, at huge discounts or allow the vegetables & fruits to rot. The situation would worsen once the Kharif crop is harvested; it is probable that prices would drop or farmers store till liquidity eases. Purchasing power in either case, in rural would be an unfortunate casualty.

The industrial situation in urban is deteriorating rapidly. MSMEs facing a cash crunch have started retrenching labour which could start an unfortunate spiral of migration back to the villages. Production is surely going to drop effecting exports further. The drop in GDP during the next 3 quarters, including the current one (Sept 2016 - June 2017) is therefore a certainty.

While demonetization was a politico- financial move – to break the back of political financiers, largely of the opposition apart from sending across a signal to the electorate that the govt. is serious in tackling black money - the lack of detailed planning to ensure a smooth transition is a worry.  Needless to say, the path to hell is often paved with good intentions.