Without adequate preparation or thought, the monetary authorities and the government have taken a drastic step declaring as worthless over 86 per cent by value of the currency notes in circulation with the public. A prior large increase of lower denomination notes should have been ensured through banks and ATMs, so that overall money supply did not reduce and a normal level of activity could be maintained. This was not done, so effectively a very severe monetary contraction has been imposed, the purchasing power of the population has been suddenly taken away, reducing the level of economic activity and causing distress to people, which is getting worse as time passes.
The denomination puzzle
The government’s rationale for the extreme measure of demonetisation is not clear. There is talk of targeting black money, but the denomination of notes has nothing to do with the existence of black money, which is not held in hoards of notes but is a circulation of unrecorded and undeclared incomes. Those larger-scale activities where income is declared produce white taxable money, while large incomes generated in legal or illegal activities where these incomes are not declared in order to evade tax constitute black money. There is a constant parallel flow of black money in the economy. Clearly the monetary authorities or the government itself do/does not naively believe that black money somehow is connected to Rs.500 and Rs.1,000 notes which they call ‘high denomination’ — if they did, they would not have chosen to issue a new note of Rs.2,000 which is of even higher denomination. So what is the point of the measure? Investigation of and raids on suspected tax evaders do not require such an extreme step as almost complete demonetisation, which in present conditions of lack of preparedness, amounts to economically disenfranchising the entire population.
The adverse impact on the economy of sharp monetary contraction (to the extent of around Rs.14 lakh crore) is already evident, and the greatest sufferers are the rural population, and the urban poor and middle class. The first impact is on the supply chain of goods and services which is disrupted, and this is then feeding back to impact production. Traders and retailers have been deprived overnight of the funds to carry on their business, and the former can neither source goods after using up their existing stocks, nor can they pay for the transport of the goods to the market. Retailers cannot sell the goods since customers do not have money to buy them, and they can provide goods on credit to customers only up to a point since they need to pay their suppliers and cannot obtain enough new notes to do so. The entire chain of supply and distribution has been thoroughly disrupted.
In villages the kharif harvest is not yet fully marketed in many regions, but producers are unable to sell their crops owing to the shortage of the new money. Many are being offered drastically lower prices for their produce which runs the risk of damage in coming days. Farmers who have already marketed their kharif crop and have existing notes in hand now cannot buy seed and fertilisers for sowing rabi since there is no lower denomination or substitute money available in their nearest banks. Delayed rabi sowing is bound to affect future output. The majority of farmers are net purchasers of food, and rural labourers and artisans are entirely dependent on purchase from the market. They are in the greatest distress since they cannot purchase basic necessities for their families with their existing money, and their attempts to change it for new money is fruitless since the latter is simply not available to the required extent in banks. Even in a relatively organised sector like tea plantations, daily wages in the new money have not been paid to workers who are unable to meet their subsistence needs.
Hitting the most vulnerable
The worsening situation in urban areas is well known — not only the wage-earning poor but the middle class too is adversely affected by the overnight artificial and extreme loss of purchasing power involved in the demonetisation exercise. Millions of hours during working days are being wasted by people in standing in long queues at banks, and many are turned away eventually with the new cash running out. For the physically frail and senior citizens, it is a risky and indeed impossible exercise to obtain the new notes. A number of deaths have taken place already owing to the inability to purchase medicines or obtain timely medical care. The government has admitted that it will take many weeks to fill the gap in money supply.
With the severe loss of purchasing power, the country is being driven into an artificially created recession and the level of economic activity is declining. To prevent further damage to the economy and to relieve distress among the people, the measure of demonetisation should be revoked immediately. The government can replace existing currency notes with new notes, but in a more planned, orderly and phased manner and over a longer period, bearing in mind that the bulk of our population needs humble money to carry on myriad small daily transactions, and Rs.2,000 notes which cannot be changed are of no use to them. Citizens and leaders of all political parties, including the ruling party, should unite to demand immediate revocation of the demonetisation measure before the situation worsens any further. There is nothing to prevent the government from continuing to investigate or raid suspected tax evaders.
Utsa Patnaik is Professor Emeritus, Jawaharlal Nehru University, Delhi