A long view of the note ban

During Richard Nixon’s ground-breaking visit to China in 1972, which set the stage for Sino-US détente, US diplomat Henry Kissinger is on record as asking Chinese Premier Zhou Enlai for his thoughts on the French Revolution. Zhou’s cryptic answer — “It’s too early to tell” — was interpreted by hyperbolic contemporary historians as encapsulating Confucian wisdom characteristic of Chinese statesmen, who were given to taking the ‘long view’ of history. After all, if the Chinese were reserving judgment on a world history-shaping event even 200 years after its time, it must be because they were given to taking an expansive, sagely, ‘civilisational’ view of things, the historians reasoned.

A curious twist to this narrative was, however, provided in 2011 when a US diplomat (who was present at the famed 1972 interaction with Zhou) disclosed that such a reading was the result of an elementary misinterpretation. Zhou, he claimed, was responding to the more proximate student riots and general strike in Paris and elsewhere in the combustible summer of 1968, not to the epochal events of 1789.

The clarification served to illustrate that while Chinese statesmen may or may not be given to taking the ‘long view’ of history, they were just as fallible as anyone else to linguistic misreading of historical contexts.

Much the same dilemma of temporal perspective has enveloped contemporary Indian economic policymakers and commentators looking to make a definitive assessment of the success — or lack thereof — of Prime Minister Narendra Modi’s radical move of November 2016 to demonetise high-value currency notes. Over what time-frame should the merits and demerits of the measure be reconciled to declare it, in the final analysis, a success or a failure? Is history ready to hand down a verdict — or is it “too early to tell”, as was said in another context?

Near-term assessments have tended to conclude, with near-unanimity, that the entire demonetisation plan, from conception through execution to conclusion, was a colossal failure.

All the short-term markers associated with the implementation of the scheme do seem to validate that verdict. After all, even on the index of ‘deliverables’ as initially defined by Modi and his mandarins — netting black money, cutting off terrorist financing, and arresting the counterfeiting of notes — the scheme has, going by the end result, underperformed to an embarrassing extent.

Against the initial official expectation that up to a fifth of the ‘black money’ in demonetised notes would not be returned to the banking system, virtually all the money in circulation has come home, exploiting the corrupt entrenchments and loopholes that the banking system is riddled with it.

It is, of course, true, as officials claim now, that the mere act of depositing money in bank accounts does not render it ‘white’, yet it bears reiteration that these are mere post-facto justifications of an officialdom that was wrong-footed by the return of all the demonetised notes in circulation.

There is, of course, anecdotal evidence of a decline in real estate prices on the margins, which is being interpreted as the effect of a stampeding out of black money from such transactions.

That remains to be verified, but before we celebrate moral victories, it is worth bearing in mind a postscript from 2008-09, wherein, as former Chief Economic Adviser Kaushik Basu reminds us, the pervasive use of black money in real estate actually insulated India from a home-grown subprime mortgage crisis, which many feared then.

That’s because unlike in the US, where banks’ balance-sheets bore the strain when home-owners walked away from their homes (and their debt obligations) when prices fell, in India, banks were insulated from mortgage risk because the ‘declared value’ of homes (against which loans are typically taken) was artificially depressed by the ‘black money’ component in the transactions.

In effect, even when prices fell, home-owners here had an incentive to stay invested because they were still ‘above water’.

All this is, of course, not to commend the continuance of black money in real estate transactions, but to say that even well-intentioned actions can sometimes have malefic consequences: in this case, a greater systemic risk to the banking system when the black money swamp is drained.

Any long-term assessment of the success or otherwise of the demonetisation scheme must perforce factor in these future risks. It doesn’t inspire confidence, however, that for the entire 50-day duration of the demonetisation exercise, policymakers were hopelessly behind the curve in their firefighting efforts.

Having lost the near-term narrative over demonetisation, owing largely to flawed conceptualisation and implementation, Modi and his mandarins can yet retrieve lost ground if their policy responses going forward are more thought-through and sure-footed than they have been so far. That process must begin by acknowledging that demonetisation with the aim of going after black money was never intended as a one-time ‘gotcha’ moment in the way Modi made of it — and that too, without adequately plugging the loopholes.

The Indian economy, with its excessive reliance on cash, is akin to a supertanker that is not geared to change course abruptly. Gradualism will yield surer results and, more important, give policymakers the chance to test policy measures without the ignominy of public exposure of their ineptitude, as was manifest through November and December with their frequent roll-backs. And although the incentivising of a transition to a digital economy is worthy of commendation, the e-evangelism from on high grates, particularly when the architecture of financial inclusion is far from perfect.

Lastly, for all the moral overtones that envelope any debate on black money, in the end policymaking to combat black money isn’t a morality play. Practical, pragmatic policies that plug loopholes are worth rather more than thunderous speeches and the unleashing of ‘tax terrorism’. Ponderous though the progress may seem in the short term, history will judge such a course of action more favourably — over the long term.