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According to some well-informed observers, Prime Minister Narendra Modi is apparently quite frustrated at the pace (or, the lack thereof) of change that he is able to effect in India. That is understandable. First, a combined opposition put paid to the hopes of reforming the land acquisition laws that the previous government had put in place. Then, changes to the appointment of judges passed by both houses of Parliament and approved by states was rejected by the Supreme Court. In recent years, the court has interjected itself in matters ranging from cricket to jallikattu to the use of Aadhaar for direct benefit transfer, to the national anthem. Naively, we used to think that power, its arbitrary application and lack of accountability, were usually associated with the political class. Then, on 8 November he came up with an unprecedented announcement. He felt that he had outsmarted fellow politicians and bureaucrats.

He had failed to reckon with the banking sector of which his government is the shareholder. Banks had preferred to distribute cash through branches rather than through their Automated Teller Machines (ATM). Based on the search and seizure of new bank notes in crores from the homes of bureaucrats and the well-connected, now we know why. He has now announced that the government will present the budget for 2017-18 on 1 February. But the Election Commission has announced the schedule for elections to five states starting within three days of the budget presentation. If the government were to be prevented from presenting a proper budget, then whatever little chance there is of stimulating the economy through public spending to compensate for the impact of the monetary shock on economic growth would be gone.

So, while the frustration is justified, there is only that much one can pin on external forces and factors. The announcement of 8 November had a morality component and an economic component. Many black money holders have evidently decided to ignore the morality aspect, going by the unofficial estimates of cash that has entered the banking system. While it does not amount to a failure of the currency swap initiative, it is a disappointment to the government. In theory, taxes can be collected on the money deposited. In practice, how much the government will collect and how much the taxmen will take is a matter of conjecture. Then, there are egos, power plays and silos. Neelkanth Mishra of Credit Suisse was shocked to note that there was limited information sharing between the Central Board of Direct Taxes and the Central Board of Excise and Customs. They both signed a memorandum of understanding (MoU) to share data. Yes, two departments under the same ministry had to sign an MoU to share data!

As for the economic component of formalizing the informal part of the economy (it is also a part of the black economy and not just corrupt transactions), there is no global precedence to achieve it in this manner. Some portions of the informal economy will be extinguished. Some will be able to make the transition to the formal economy. It depends on financial resources, enterprise and skills. Equally important is the ability of the formal sector to absorb them, to create scale and jobs. The formal sector is in a state of funk. It is still grappling with balance-sheet issues. Banks are not lending. The mere fact that there is money within the banking system would not lead to more loans without resolution of the legacy issues of non-performing loans and recapitalization of banks. With the exit of Raghuram Rajan, the issue of non-performing assets in the banking system has also been quietly buried. Whatever happened to Indradhanush? Did the arrows ever leave the quiver? Fixing the banking system by jettisoning the existing shareholding patterns should have preceded the currency swap for the latter to be effective.

It is quite possible that the manner in which Rajan was ousted has come back to haunt the government. For one, all the allegations thrown at him by leaders belonging to the ruling party have quietly been buried. Two, the exercise sent a clear message to his successor as to what the consequences would be if he were to act independently. Whether this influenced the advice (or, the lack of it) that the government received from the Reserve Bank of India (RBI) on the currency swap exercise is another matter for speculation. Clearly, this government is missing Rajan at the RBI even if they dare not admit it publicly.

The Prime Minister has a few decisions to make in the new year. If he is determined to disrupt and if incrementalism is deemed inadequate for India’s development tasks—he has to disrupt the banking system and the tax system. Goods and services tax introduction and the technology aspects associated with it have to be better managed than the currency swap exercise. A drastic overhaul of direct taxes—rates, thresholds and exemptions—is overdue.

Learning from the lessons of the relationship between the United Progressive Alliance and the National Advisory Council that existed then, the Prime Minister has to strike a better balance between competence and loyalty in terms of advice. Mistrust and personal insecurity result in a higher weight for loyalty over competence. Finally, I shall repeat the point I made at a gathering at 7, Race Course Road, in September 2015: If the Prime Minister governs as though he has only one term in office, he would stand a far better chance of returning to office in 2019.

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

Comments are welcome at baretalk@livemint.com

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