Home >Opinion >Costs and benefits of the currency swap

It is little over a month since the Prime Minister made his announcement on the withdrawal of specified banknotes (SBN). This is the terminology that the Reserve Bank of India adopts on the exercise that has been underway since 9 November. The costs appear disruptively high and are almost impossible to estimate given the size and scale of the cash-dependent (but legal) economy and geographical breadth of the country. So, experts who thought that the disruption would be transient and scant and that the government decision had a significant upside to the economy with little downside are changing their minds. Now, they feel that the wealth effect (loss to the hoarders) could be transient and scant while the costs of disruption are significant and enduring.

As much as the government, the critics too are also struggling to evaluate it intelligently. For example, there is a suggestion that nothing would have been lost if the government had given enough time for people to change their SBNs. The phase-out could have been set for 31 December and simultaneously a voluntary income disclosure scheme announced. Hoarders would have paid the government the discount on the wealth that they offer in unofficial exchange of SBN for other forms of wealth. This overlooks some basic human behavioural traits.

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Once a date is set, the SBNs become hot potatoes. Holders would want to drop it immediately. In practical terms, the date would be effectively the next day or the next week. Further, a friend pointed out that it would have come as huge inflationary shock for the economy as every commodity and asset would have suddenly skyrocketed in value against money that would still have been available to chase them. The urban middle class could be unhappier than it is now and the move would end up being a political disaster too.

There is another problem with that suggestion. To give more time for people to adjust might be putting pragmatism ahead of principle—the principle that the immorally acquired wealth should not be given an official free pass. Further, given all the changes happening—such as information technology advances, Aadhaar, goods and services tax and benami transaction Bills—the government would have felt confident that they would stem the future generation of black money and hence decided not to give a free pass to the current stock of black money.

Regardless of whether one is comfortable viewing this exercise through the morality prism, the withdrawal of SBNs is about creating a disincentive for future black money creation in any form (“if they can come after my cash like this, they might come after my other forms of black wealth"). It intends to send a signal to many middle-income earners and self-employed professionals, used to transacting in cash, to get out of that habit.

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Of course, the criticism is not confined to chaos and currency shortage but extends to potentially serious economic disruption. Jahangir Aziz of JP Morgan made this point in a recent event in Singapore on the withdrawal of SBNs. Some businesses cannot be competitive unless they operate in a cash environment. If they went formal, costs of compliance—official and unofficial—would rise so much that their businesses would no longer be viable.

The share of the informal sector employment in India at 83.6% is the highest in the world. Quite possibly, almost all of the enterprises in the informal sector operate on a cash basis. The disruption to their business model could be both severe and permanent. Their livelihoods threatened, they could fall below the poverty line. Conceptually, it sounds like a serious issue but orders of magnitude would be needed to assess the severity of the situation. Apart from that, a bigger question remains. No other country of India’s size has such a huge informal sector.

Alex Tabarrok, cited by Niranjan Rajadhyaksha in his thoughtful column (The persistent poverty of the Indian state), makes an important point that many other Indian critics have missed out: India taxes its high-productivity sectors while its low-productivity sectors aren’t. India has no micro, small and medium enterprises (MSME) in manufacturing. Only micro. They constituted nearly 95% of registered MSME manufacturing enterprises. There is a near one-to-one mapping between micro and proprietary enterprises. No surprises, therefore, that employment per unit had come down from 12 (first census) to 6.2 in 2006-07 (fourth census). Units that operate without electricity constituted 40% in the third census and 71.2% in the fourth census.

There is considerable comingling of informal enterprises with black money and cash. Manas Chakravarty has underscored this (Narendra Modi’s great leap forward). Can India really contemplate meaningful and sustainable economic progress with such a large proportion of informal enterprises dominating production? India’s economy is stagflation-prone because of the extreme fragmentation of production in factories and farms.

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Crises and the law of unintended consequences combine to produce changes that cause societies to leap ahead to a different era. Otherwise, we would not be living much differently from the hunter-gatherer generations. The question is whether the government was prepared for the costs of its decision and has done its homework on logical next steps such as the above, to help India leapfrog to the next stage of development. That is the subject of the next column.

V. Anantha Nageswaran is an independent financial markets consultant based in Singapore. Read Anantha’s previous Mint columns at

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