CIRCUIT BREAKER. Short-term pain for long-term gain?

On the morning after Prime Minister Modi’s bolt-from-the-blue decision to demonetise large-denomination currency notes, the reactions of the man on the street were in stark contrast to those flooding the social media.

Folks on Twitter, in particular, seemed wildly excited. While labelling it a “masterstroke” and a “surgical strike” against corruption, black money, terror funding, et al , the Twitteratti seemed quite unconcerned about its impact on daily life. That’s not really surprising. It is quite likely that the folks on Twitter with their smartphones and high-speed internet connections have little use for hard cash in.

Modi’s demonetisation move delivers a nasty jolt to users of cash, but it doesn’t impact credit or debit cards, online money transfers through NEFT or mobile wallet applications. The affluent will, therefore, hardly feel the pinch unless they also happen to hold suitcases full of black money.

But if you talked to ordinary folk, you sensed bewilderment, resentment and even mild panic at the turn of events. The cook who helps out home has a bank account, but no credit/ATM or debit card (“I never have extra cash to withdraw, ma” was her explanation). She has about ₹6,000 in hard cash from her pay cheque in ₹500 notes. She is worried about how she will tide over the next few days. She’s quite sure she can’t while away an entire morning at the bank to exchange her old notes. That’s her peak working period. The istriwala is concerned that most of his daily customers will skip paying their bills today. All of them readily offer ₹500 notes, but where will he change them? He wonders how long the queues will be, when counters will open tomorrow. Will the bank staff even attend to a low-ticket customer like him when they have privileged customers to attend to?

An 80-year-old pensioner who stays in my apartment has several bank accounts and isn’t at all hard up for cash. But he has no plastic which he can immediately swipe for his grocery, vegetable or medical expenses over the next day or two. He has never felt the need for a credit, debit or ATM card — preferring the good old withdrawal slip and a visit to the bank branch to replenish his cash.

Anyone would appreciate that my cook, istriwala or a pensioner aren’t likely protagonists in India’s counterfeit, terror or black economies which are the main targets of Modi’s demonetisation drive. Yet, it is these segments of the citizenry who stand to take much of the short-term pain from the move.

That there will be near-term pain from this mammoth exercise is crystal clear, if you take stock of the numbers involved. Despite ubiquitous plastic, 98 per cent of all consumer transactions in India still happen in hard cash. Think of your neighbourhood kirana store, providers of household services like plumbers and electricians, tradespeople or small businesses — they are staring at either a freeze or a substantial curtailment of daily income over the next few weeks.

Then, there is the logistical nightmare involved in banks recalling all those ₹500 and ₹1,000 currency notes. These notes make up the lion’s share of all the cash in circulation in India. According to RBI data, nearly 86 per cent of all the currency with the public is held in the form of ₹500 and ₹1,000 denomination notes. As the total value of currency with public was roughly ₹17 lakh crore as of end-October, that amounts to over ₹14 lakh crore that banks will now have to replace in this demonetisation drive.

Even assuming that 30 per cent of that cash never makes it to the banking system (being black money), it could mean nearly ₹10 lakh crore of hard cash transactions that banks will have to handle within a matter of weeks. To put this in perspective, the total cash in hand with banks as of end-October amounted to a mere ₹76,000 crore. The cumulative deposits with banks are about ₹9 lakh crore.

There is also the challenge of the RBI shipping enough currency notes to ensure that bank branches are able to meet the tidal wave of demand. The logjam may be particularly acute in rural areas where both bank branches and ATMs are in short supply. While rural India reportedly has 6 lakh villages and, at last count, had 44 crore savings account holders, they were home to just 48,000 bank branches. The 12 lakh ATMs that are in operation across the country will also need to be reconfigured to dispense the new denominations. Add on the necessity of ID-proofing all the walk-in depositors and one can visualise the chaos at banks over the next couple of weeks.

But all this short-term pain will be worth it if the move deals a body blow to counterfeit notes, throttles terror funding, and brings all the black money out of hiding. Won’t the resulting benefits be enormous for the economy? Yes, they will, but these gains are extremely hard to quantify at this juncture. The crackdown will definitely put a hold on counterfeit notes for some time. Anti-national activities that thrive on fake notes may take a blow too.

But what is the quantum of black money likely to be unearthed? World Bank estimates put the size of the black economy in India at about 24 per cent of GDP in 2007. However, it would be reasonable to assume that not all that is held in hard currency. We do know that a good proportion of it is stashed away in the form of gold and property, with the big fish owning offshore accounts and dollars as well.

What this demonetisation drive may do is force the smaller-ticket black money hoarders out into the open. Ballpark estimates suggest that some 40 per cent of black money is stowed away in hard currency. These hoarders will now have no option but to declare illicit cash (with ID proof) or destroy it.

India’s GDP (at current prices) in 2015-16 was ₹135.7 lakh crore. Assuming the black economy is a fourth of this (₹34 lakh crore) and the demonetisation drive unearths all of the cash component of 40 per cent, one can expect ₹14 lakh crore of black money to be unearthed. Now, for all these hoarders to turn into law-abiding taxpayers, the banks will have to be diligent about capturing the IDs of the depositors. The Income Tax department will also have to fulfil its mammoth task of matching these deposits with official IT returns, to identify possible evaders.

Overall, the biggest hope of long-term pay-offs for the economy lies in this crackdown forcing a behavioural change on tax evaders. The economy can benefit if this move forces real estate transactions to go completely white, deters gold jewellers from cash sales, and prompts all tax evaders to join the mainstream economy.

Still, while the short-term pain will be felt mainly by the low-income aam aadmi , the benefits may flow mainly to the exchequer and middle-class taxpayers. To ensure that the aam aadmi and aurat too get their fair share of the pay-offs, the Centre must quantify and disclose the exact gains from this drastic measure. Reducing all indirect taxes on goods and services out will not hurt either!