THe Blog

November 25, 2016

Demystifying Demonetisation

Montek S. Ahluwalia, in this Livemint article, explains why demonetisation is only a piece of the puzzle to tackle corruption and black money, and is likely to have an adverse effect on GDP and low-end employment. Moreover, Ahluwalia advises several steps to significantly improve the process and impact of outcomes. 

 

"What effect has demonetisation had so far?

 

It has clearly caused considerable inconvenience as people with perfectly legitimate quantities of old notes of Rs500 and Rs1,000 have to queue up at banks to exchange them into new notes. Tragically, many deaths have also been reported. In addition to inconvenience, the shortage of cash has also disrupted business in the cash-based informal sector, which is where the majority of the population is employed...

 

Does demonetisation affect black wealth held in cash?

 

Much of the public enthusiasm about demonetisation comes from the expectation that those with hoards of cash will not be able to exchange it in the banks for new notes, and will therefore lose their ill-gotten money. This group includes businessmen, or politicians (either on their own behalf or on behalf of political parties), or bribe-taking bureaucrats. The public will certainly applaud their loss. However, much of this may be laundered...

 

How long before we get to normalcy?

 

It has been reported that given the capacity constraints at the two printing presses which can print the high-value notes (assuming three shift operation), it will take until May 2017 to replace all notes...

 

Will GDP growth slow down?

 

The negative impact on the various sectors of the economy is bound to produce lower growth. Estimates for gross domestic product (GDP) growth in FY17 from financial analysts vary from a low of 3.5% to a range of 5.5-6.5%. My best guess is that GDP growth is likely to slow down to around 6% in 2016-17. More importantly, it will also remain subdued next year. Much depends on what happens to the investment climate...

 

Could things have been managed better?

 

Building up a larger stock of new notes in advance would certainly have avoided some of the inconvenience and the associated cash shortage. The belated provisions made for weddings and farmers, could have been anticipated. The ministry of agriculture’s request regarding an exemption for farmers purchasing seeds and other inputs during the sowing season, in order to avoid disruption in sowing, should also have been addressed promptly, rather than after several days...

 

Will demonetisation control generation of black income?

 

This is the key question and demonetisation does not address this problem. There have been announcements that more steps will be taken, but these relate to benami properties and undeclared foreign holdings. What is needed are steps that will discourage fresh black income from being generated in future through continued corruption."

 

Read the full article here

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