The announcement on demonetisation of Rs500 and Rs1,000 notes did not just catch the average citizens off guard; it also surprised economic and political pundits. Seen as a masterstroke by the Prime Minister in the government’s war against black money, the implementation of the decision has been anything but smooth. The inconvenience of standing in long queues has, however, not deterred the average citizen from appreciating the novelty of the “surgical strike” on unaccounted-for wealth, although there are now murmurs of protest at the inefficiency of the entire exercise.
Nobody had a quarrel with the objective of such an exercise, including the opposition parties. Suggestions to demonetise Rs500 and Rs1,000 banknotes have been floating around for some time and it was even considered by the previous government, which developed cold feet after a report by the Central Board of Direct Taxes (CBDT) in 2012.
While the impact of such a move on the economy is still an open question, it has certainly earned the government some brownie points as an attempt to reduce the stock of black money. While most people may not understand the intricacies of the economic and political system which generates black money, they support the move because the vulgar display of wealth by the rich and wealthy has been seen as largely the result of the black economy.
On his part, Prime Minister Modi has used this general perception that those who held a stock of Rs500 and Rs1,000 notes were rich and had made their money through illegal means.
The general perception is not too far off the mark and therefore the level of support is along expected lines. That’s why people are willing to suffer temporary inconvenience in the hope that the move will finally bring down the generation of black money. But the impact of this move may not be limited to only those who hold large stocks of ill-gotten wealth, with the larger economy at risk too.
It is not the demonetisation part of the move but its ill-prepared implementation which may create a negative impact on the growth rate of the economy. Many consulting firms and think tanks have already lowered their growth projections for the economy for this fiscal year with some predicting the after-affects to last 2-3 years.
There is some expectation that the businesses, which largely thrived on black money such as luxury goods, real estate and jewellery will be hit by this move. But what is less understood is the impact of this move on the rural economy. Most, if not all, of the rural economy runs on cash and with wages hitting the Rs300-400 mark in many rural areas, Rs500 and Rs1,000 notes were an integral part of the rural economy. If it was just a matter of exchanging old notes for new notes, there would not have been so much inconvenience and the economy would not have been affected. But the culprit in the demonetisation exercise has been its timing—just after the harvesting season—and also the limit on the amount that citizens can withdraw. It has seen a lot of flip-flops since the announcement, but the end result of the move has been a sudden withdrawal of liquidity from the system.
The rural economy, which was the driver of the consumption boom during 2007-12, has been suffering from distress because of various reasons. This got accentuated during the last two years due to falling commodity prices and the back-to-back droughts. This year witnessed a normal monsoon, and for the first time after three years, farmers had money in their hands. But this will not be the case even this year with the money locked up in bank accounts rather than being available for consumption. Those not fortunate to have sold their harvest are struggling to sell their produce. While it may not impact those who are engaged in farming of field crops and can hold on to their harvests till liquidity eases, it will affect those growing horticultural crops, particularly perishable fruits and vegetables. There are already stories of distress sales from many states.
It was private spending due to good agricultural fortunes in the years after the financial crisis which sustained rural demand for construction and other non-farm sector goods and services. This not only helped workers take home higher wages but also kept the economy going. The effect of the distress is already visible with rural incomes at an all-time low and rural wages declining in real terms since November 2013. Most farmers had postponed their investment plans waiting for this year’s income. Now with their money locked up in bank vaults, it will not only delay their spending plans. The inability to sell their produce may also hurt their incomes. Those who are celebrating a fall in inflation should also remember that while it may help the urban consumers, it hurts the poor farmers if prices of agricultural commodities fall. They are already struggling with low international prices and this will further hit profitability in the farming sector.
The final impact of demonetisation will be evaluated by not just on its impact on black money and the rich who have hoarded wealth in currency. It will also be evaluated on how the economy is doing. At a time when rural demand was already at its lowest, the demonetisation drive may have helped score a political victory against corruption but will delay and possibly negatively impact plans to revive demand in the rural economy.
The impact of these may spill over to other sectors in an economy already struggling to create employment with job creation at its lowest level in the past three years. The demonetisation exercise may turn out to be the biggest gamble by the Prime Minister, the result of which will only be known in 2019.
Himanshu is an associate professor at Jawaharlal Nehru University and visiting fellow at Centre de Sciences Humaines, New Delhi.