Demonetisation: was it worth the pain?

The demonetisation of ₹500 and ₹1,000 rupee notes has the makings of a game changer.

At one stroke, tax evaders and others who were not keeping their wealth in gold, land or dollars were dealt a lethal blow. Some would distribute currency to their relatives or servants but for the larger operator, this has limited scope.

This was also done in 1978, of which I had a ringside view by virtue of being in the Planning Commission. Prime Minister Morarji Desai decided to demonetise high value notes. In those days he took up a really high value one, the ₹1,000 note.

I vividly remember a conversation then which now has contemporary relevance. IG Patel, then Governor Reserve Bank of India, told Prime Minister Morarji Desai in chaste Gujarati, “Sahib, this will not work, black money is held in land, gold and dollars because they appreciate in value and not in currency”. The late HM Patel, then Finance Minister, was present and was smiling away at this exchange. Morarjibhai would have none of this and went ahead.

When we now talk about that demonetisation episode as comparable to today, we are making a great mistake. In those days, the price of gold was around ₹600 for ten grams. It is now around ₹30,000 per ten grams and since gold is a good measure of the value of the money in classical monetary theory, a ₹1,000 note then would be worth roughly fifty thousand rupees now and so the coverage of demonetisation in the present exercise is much greater. In those days a middle class housewife would not have ₹1,000 notes to tuck way from her savings from kitchen money. Look at it otherwise: A ₹1,000 note then equals a ₹20 note now.

Today, she does save ₹500 or ₹1,000 notes. As a friend’s wife told me if he has a heart attack at night and I have to take him to a hospital they would want ₹1 lakh in cash as a deposit before they admit him to the ICU. The remonetisation of the economy has to be deep now. Eighty percent of our economy, it is estimated, works with cash. Financial intermediation is for the remaining 20 per cent. This ratio is much lower than the rich countries where cash accounts for 10 per cent of the value of transactions. So the economic pain of demonetisation is much higher now.

To aim in the short run at the monetisation of economy according to the standards of a developed economy, when the infrastructure for financial intermediation has to be created, is not very practical. There is no point in blaming the hapless Governor of the central bank. The demand for currency is high and you can’t deliver it instantaneously.

It is necessary to make a distinction between the stock of black money which was destroyed last week and the flow. We need to plug the flow. Otherwise, black money would start being generated with the new notes once they are available in plenty. If everything else remains the same we will have plenty of new currency and the same actors and markets will start functioning again. The only outcome would be the pain the housewife and others went through.

But hopefully this will not be so. The Prime Minister has reportedly said that unaccounted money used in real estate and land deals will be targeted. We need similar plans for gold and foreign exchange in hawala.

The sooner the Government shares the details of their pre-emptive plans for these possible illegal activities, the more the ordinary people will feel comforted that their pain is not in vain.

If we selectively hit at black marketers, a general demonetisation may not have been needed, but that is another story.

The writer is a former union minister