Demonetisation: Right Wrong Step

There is no way one can find fault with the intent behind the demonetisation announcement. There has been a significant level of undeclared money in the system that has evaded the taxman’s eyes for years. The PM deserves credit for this brave, bold, transformational and historical move.

Now the bigger question, is this step right for India’s economic growth and jobs creation? My answer unfortunately, is not a ‘yes’! Perhaps, the most shocking oxymoron of an issue in India’s economic landscape. A “Right Wrong Step”!

Several governments and political credit taking aside, India’s rise in the last two decades has been largely because of the GDP growth underpinned by the middle class led consumption. The next twenty years also are pivoted around the GDP growth expectations driven by consumption.

Whilst demonetisation is a punishment for the corrupt, who hoarded cash and didn’t pay taxes, that money is suddenly going to go out of the consumption pool. Whether we like it or not, most undeclared money gets circulated and ultimately becomes part of the GDP. Even if we discount what goes into property and gold, there is a significant chunk that goes to unorganised labour and small vendors (be it marriages, elections, small scale construction, daily wagers, tourism, small eateries etc.) and then gets further spent by them for day-to-day needs.

Even if all undeclared money comes back as new currency (which is highly unlikely), the consumption pool will be impacted because of the penalties and the time taken. To make matters worse, legitimate cash also goes out of the consumption pool and will take a long time to come back. The big benefit is tax net widening with a limited positive impact on consumption (that too if income tax rates are lowered which is unlikely). Collateral damage by reduced spending power in the short- to mid-term will cause serious damage to consumption by the unorganised labour force and rural population at the bottom of the pyramid, who are a big part of the GDP.

Corruption is a hot topic and how does demonetisation tackle this age-old cancer? One needs to be careful when talking about corruption, Kashmir and the armed forces in India. So much is the emotion attached with these topics that even a slightly different view (even if rational at times), invites serious attacks and too much hullabaloo. Hence, I will try my best to remain measured.

Let’s classify different kinds of corruption in India. Corruption by cronyism (public sector bank loans, policy favours, largely off shore bribes or non-cash); Political corruption for government works (mid-scale, largely cash); Bureaucratic corruption (mostly cash); Corruption in day-to-day life (small bribes, all cash). Whilst there is widespread emotional hysteria that demonetisation will wipe out all corruption, cronyism will continue as it rarely involves onshore cash ; Political corruption in government works might reduce in the short term, but will stifle day-to-day work/approvals (no policy will make local politicians honest, they will want their pound of flesh or work will suffer till they figure out a way); Last two categories of corruption will very quickly move to the new currency notes.

Over simplification maybe, but the sad truth is that this move is not going to make a big dent in corruption because the root cause isn’t the availability of cash. So, the big and only benefit that comes out of this is tax collection. The tax department is perhaps, one of the most corrupt and inefficient. One of the reasons we are in the situation that we are, is their ineffectiveness of several decades. Instead of solving their inefficiency/corruption, we are planning to give them a one-time windfall, but at what cost? It’s only a matter of time before they get back to the same rut.

I am not even attempting to refute the benefits towards reduced terrorism, fake currency, dollar equating rupee and several others. At best short-lived and not worth the collateral damage. So unfortunately, this leaves us in a mixed-up spot. It’s a noble and right step to punish the culprits who escaped paying taxes. The money those culprits used to spend on goods and services produced by non-culprits is suddenly gone. The non-culprits must clap and cheer for this noble step, but unfortunately won’t have the wages/earnings any more. Catch 22 shall we say?

Instead, should we have fixed the corruption in the tax department; cracked down on tax evaders and offshore undeclared money; gone after public sector banks’ dubious lending to big corporates, continued to digitise government processes and schemes? No, because the emotional euphoria will be less and that’s no fun for the partisan politicians on both sides of our political spectrum.

The PM is a forward-thinking politician, means well for India and wants to build a legacy around progress. I wonder how he misread this cost-benefit equation. The explanation I can think of is that he has been surrounded by sycophants and too many ‘yes men’. It might have been his idea but nobody dared tell him about the pitfalls. Instead, all of them hailed the idea without much analysis or preparation. Now new rules are being made every day and a debate is already being run on rumours and social media propaganda. Such is the need to create popular mood that the penalty is named “Gareeb Kalyan” cess (whatever that means or will do but sounds good and sells well).

It’s too late now to go back (for it’s a noble idea) and the whole country has been thrust onto this emotional partisan dialogue around the policy that has far reaching implications. Opposition parties sound even more hopeless by trying to make political curry out of a serious issue that needs a comprehensive debate.

Borrowing partly from Churchill’s definition of capitalism— corruption perhaps causes unequal distribution of wealth but a draconian clean sweep money supply shutdown (without attacking the roots of corruption) might end up causing equal distribution of poverty. You chose!

For the emotional chest thumpers, I am not a supporter of corruption and have been an honest tax payer for as long as I have been earning. I just feel we need noble causes and good intent if they drive us in the right direction, or else we should wait and prioritise other stuff, there is a lot that needs to be done.

Getting your arm amputated for a severe infection in your finger is a “Right Wrong Step”, no matter how many brownie points one gets for being right! The trick is to treat the finger without losing the arm.