"Demonetisation in a booming economy is like shooting at the tyres of a racing car," says development economist Jean Drèze . A leading advocate of welfare policies, Drèze who was a member of the National Advisory Council during the UPA regime, tells ET that the sudden move to demonetize high-value currency notes has created a scary situation for people who live on the margin of subsistence, and that opposition parties may well be the real targets of the move. Edited excerpts:?
Youtube
The debate is vitiated by delusional hopes of the impact it might have on the black economy. Tall claims are being made about the ability of demonetisation to `flush out black money', `crush the shadow economy', or achieve `an all-out assault on the parallel economy', to quote just a few expressions used by the government and its admirers. These claims are based on what might be called the hoard theory of black money. In this view, black money is a gigantic hoard of illegal income that keeps growing and needs to be flushed out. This is wrong.Crooks know better than to keep their illegal income in suitcases of cash. Instead, they spend, invest, launder or convert it in one way or another. They use it to buy property, fund lavish weddings, shop in Dubai or oblige politicians. Of course, at any point of time some black money is likely to be lying in jars or pillow-cases. But going after that residual liquidity is like mopping the floor under the shower. Thinking of it as a decisive strike on the black economy is a severe delusion. This point has already been made by many eminent economists, but the government seems to prefer its own echo chamber. The main cash hoarders are likely to be political parties.For them, it makes sense to accumulate cash over time, in anticipation of election campaigns.Opposition parties may well be the real target of the demonetisation move. Being in power, the ruling party is less vulnerable.
Reuters
Some of the short-term costs are already clear -the time people waste in long queues, the liquidity crisis in the informal economy, the layoffs and, of course, many tragic deaths. Wider economic costs are likely to be felt soon. Some reports already suggest that economic activity in rural markets has slowed down. For instance, a study by Nidhi Aggrawal and Sudha Narayanan of the Indira Gandhi Institute of Development Research shows that mandi arrivals of non-perishable agricultural commodities crashed across the board within a week of demonetisation. The declines range from 30% for cotton to 87% for soya bean. When farmers are short of cash, agricultural labourers and local artisans are bound to suffer too. MNNREGA workers are likely to be hit. As it is, they are affected by chronic delays in wage payments. With bank staff out of action for weeks, it is bound to become harder for them to collect their meagre wages. The same applies to social security pensions, a lifeline for millions of poor widows and elderly. For people who live on the margin of subsistence, this is scary.
Youtube
The release of `2,000 notes does not make it easier for those who hold black money to launder their cash. So, demonetisation can serve its limited purpose even with`2,000 notes being printed. Withholding them would perhaps make it more difficult to hoard black money, or rather black currency. But the complete absence of high-denomination notes would cause much inconvenience to the public, and I doubt that it would have a major impact on the black economy. Remember, black money in the sense of illegal income may or may not be earned in cash, and even if it is earned in cash, it can easily be converted into other stores of value.
Reuters
Demonetisation on this scale is a huge gamble with the economy. The full consequences are difficult to predict. The best-case scenario is that the economy will stay the course, after the initial disruption, and that significant sums of black money will be neutralised. The worst-case scenario is a prolonged economic slowdown, with very little result in terms of preventing illegal activity. The initial economic shock, already visible, can easily have ripple effects over the next few months. For instance, delayed sowing of rabi crops today could affect the harvest months from now. With employers short of cash, labourers are likely to lose jobs. It is also important to remember that macroeconomic trends depend a lot on expectations. If the initial shock creates adverse expectations, the economy's growth trajectory could be derailed. In a booming economy, blanket demonetisation is a little bit like shooting at the tyres of a racing car.