1. Demonetisation: Why Narendra Modi’s note ban move was necessary

Demonetisation: Why Narendra Modi’s note ban move was necessary

Demonetisation was necessary to deal with the country’s ‘conflict trap’

New Delhi | Published: January 14, 2017 6:17 AM


Data from South Asia Terrorism Portal states that over 700 terror-related deaths have occurred in India each year since 2014. Data from South Asia Terrorism Portal states that over 700 terror-related deaths have occurred in India each year since 2014.

Demonetisation is a harsh measure that is expected to work as a double-edged sword, to primarily kill two among the several demons plaguing the Indian economy. On the one hand, demonetisation is an attempt to bring substantial amount of black money into the economy with crackdown on corruption; and on the other, to disrupt the funding of terrorist activities which have been surviving on counterfeit currency.

Since a lot is being written about the first aspect, we consciously begin with the second and address the importance of mitigating conflicts and promoting peace. Data from South Asia Terrorism Portal states that over 700 terror-related deaths (including civilians, security personnel and terrorists) have occurred in India each year since 2014, of which a large component is on account of either left-wing extremism or terrorism in Jammu and Kashmir. Until November 2016, 789 fatalities had taken place due to conflicts, of which 230 were in J&K, and 386 because of Left-wing extremism. Of the 230 deaths in J&K, 11 were civilians, 73 security personnel, and 146 terrorists. Children missing schools, businesses remaining closed, and governments allocating resources to less productive services such as defence, impedes both the present and future growth potential of the region. Rightly, Collier in his 2007 book titled ‘The Bottom Billion’ cited ‘conflict trap’ as one of the four development traps, besides natural resource trap, being landlocked with bad neighbours, and bad governance. Conflicts have large economic costs, and the longer a country stays in a state of conflict, the more these costs are. In 2007, cessation of violence was expected to generate a “peace dividend” approximating 13% of the 2007 gross world product! The dynamic component of the peace dividend comes from the total additional economic output likely to occur due to the liberation of human, social and physical capital, which was suppressed by violence. Static peace dividend, on the other hand, accrues from the economic activity that would be transferred from violence-related industries to peace-related industries.

So, the question that arises is how can demonetisation bring peace? Two motivating factors that in general make youth join anti-state organisations are greed and grievance. With legal tender notes becoming worthless overnight, the power of anti-state elements to lure youth by satisfying their greed is expected to get adversely impacted. Also, to the extent stability and peace promotes employment and growth in erstwhile conflict affected areas, the grievance factor that pushes the youth into terrorism gets impacted. As per World Bank’s Report on Addressing Inequality in South Asia (2015), in India, the probability of a district being affected by Naxalites (Maoist rebels) has been linked with its poverty incidence. Deprivation and higher poverty intensifies the grievances felt by certain groups. It also reduces the opportunity costs of initiating and joining a violent conflict. Further, according to the Financial Action Task Force (FATF), counterfeit notes are the primary source of terrorist financing in India. Terrorist groups such as Lashkar-e-Taiba (LeT), Harkat-ul-Jihad al-Islami (HuJI), etc, pump counterfeit currency in India through various channels and international routes and make decent profit out of it. Terror attacks have a counterfeit trading link as well. The decision of demonetisation will be enough to cripple the terror activities of such groups, which earlier used to thrive on the fake Indian currency. Undoubtedly, this shall be a major win for the nation.
Moving over to the economic aspect of demonetisation, while certain segments have applauded the scheme, the measure has also raised apprehensions and concerns in equal measure.

The shadow economy has flourished for years, negatively affecting government revenues. The government’s white paper on black money highlights various attempts at quantifying the extent of black money prevalent in India. The National Institute of Public Finance and Policy (NIPFP) conducted a study for the period 1975-1983 to estimate black economy. According to the study, the black economy was 15-18% of the GDP for the year 1975, 18-21% of the GDP for 1980-1981 and 19 to 21% of the GDP for 1985. The World Bank’s report on Shadow Economy (2010), estimated the Indian shadow economy at over 25% of the GDP in the year 2006. In 2011, Central Board of Direct Taxes assigned three institutes—NCAER, NIFM and NIPFP—to provide an estimate of black money held by Indians. While the results of the report are not yet disclosed, it is rumoured that NIPFP speculated India’s black money to be up to 75% of the country’s GDP! While estimates vary, nevertheless it is clear that the magnitude is large. In terms of corruption perception index, as well, India ranks low despite an improvement in recent years. For instance, in 2015, it ranked 76 out of 168 countries, while in 2011, it ranked 95 out of 183 countries. Tackling corruption, therefore, becomes imperative and demonetisation is considered as the surgical strike on the same.

Few schemes adopted in the past to unearth black money have been raids and introducing amnesty and Voluntary Income Disclosure Schemes. However, it is to be appreciated that such steps have to be a part of ‘reform package’ that include measures such as improving institutional quality, rationalised government control on economic activities (such as tax structure and duties), easing businesses, digitalisation, political will, effective governance and trustworthy judiciary. While steps have been initiated, a lot more needs to be done.

To the extent that demonetisation will bring back the black money into the system, as also reduce corruption, not to mention introducing a behavioural change towards cashless transactions, it is a laudable scheme. On the fiscal front, the move is expected to raise revenues for the government substantially. Demonetisation, hand in hand, with GST will help in expanding the tax base and increasing efficiency and accountability in the taxation process. It is expected to increase the tax-to-GDP ratio in the long term, which stands abysmally low at 16.6% presently. Further, government will also earn revenues as ‘seigniorage’ by printing money of higher denomination, i.e, R2,000. Seigniorage is calculated as the notes in circulation less the cost of printing and distributing them, multiplied by the market interest rate. Printing higher denomination notes is cheaper than printing notes with lower denominations. While the printing cost of R1,000, R500 and R10 notes is at 0.317%, 0.5% and 9.6%, respectively of its face value, the printing cost of R2,000 notes will be much lower.

On the downside, the costs of liquidity crunch faced by the common man, especially rural households and businesses, small traders and retail outlets, especially without access to bank branches have been enormous. Land/property sales by, in general, law abiding middle class households have also felt the heat. Enormous opportunity costs are associated with public wasting time in long queues at banks. However, that is not to say that corrupt rich are less impacted. In fact, their pain shall continue much beyond the turbulence in the past few days, especially so if their unaccounted wealth is more in the form of cash, and less in property or bullion. Could the government have handled demonetisation alternatively remains debatable.

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However, with demonetisation expected to hit the economy adversely in the next two quarters, the governments must initiate expansionary policies, especially through investment in infrastructure at the earliest. Given the expected revenue windfalls, this should not be difficult. Also, lessons need to be learnt on government’s revised role in a cashless economy.

Smriti Kaur is professor, public policy and Sakshi Malik is research scholar, Faculty of Management Studies, University of Delhi. Views are personal

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  1. S
    Sandeep punia
    Jan 14, 2017 at 5:20 pm
    One of the most detailed out article. All necessary points are covered related to demonetization.
    1. A
      Jan 15, 2017 at 4:51 am
      Agreed , with author So beautifully explained
      1. Chitranjan Kumar
        Jan 14, 2017 at 4:23 pm
        Nice thought .....I good insight on demonetization...
        1. C
          Jan 14, 2017 at 6:30 am
          1. D
            Jan 18, 2017 at 6:19 am
            Demonetization, or rather remonetization, as announced by PM Modi on 08 Nov 16, is an extremely bold move, and quite uncharacteristic of an Indian Government, which is usually shy of shaking up the status quo, and struck in policy paralysis, often due to political compulsions. The non-ried Indian middle cl have umed it to be their right to evade taxes. If we remove the ried cl, who have to pay TDS tax compulsorily, from the total number of Indians who pay taxes, the number remaining would be ashtonishing! It wasn't a surprise then when the Government announced that the total number of luxury cars bought by Indians in last FY was 25 lakhs, whereas, only 24 lakh Indians disclose their annual income more than 10 lakh! Only way we can increase the tax base in India by making Indians used to 'Less Cash'. Once the cash crunch eases, traders would prefer to get back to cash transactions and avoiding tax. For the 'Less Cash' matra to succeed, the Govt needs to incentivise cash-less transactions for some time, such that the consumers get motivated to use digital payments, and the traders/ shop keepers are forced to accept digital payments. It was no surprise when RBI revealed that until mid Dec 16, it had not yet fully released the currency it had already printed by 08 Nov 16. Going slow in pumping the currency back in the system, or rather, keeping it lower than the earlier amount, would be a logical step along with incentivising cash-less transactions. Remonetisation's positive impact on terrorism is self evident. Not only the fake currency, but the genuine currency, in the form of black money also, formed the backbone of terrorist activities in the country. Within days after 08 Nov 16, a slain terrorist in J&K was found to be in possession of a few new 2000 currency. Naysayers were naive enough to cite this as an evidence of the non-utility of the move. Sensible minds, however, would gauge the scourge of this menace, if a terrorist can get hold of the new genuine currency, in such a quick time, either he's conducting business with ease and impunity, or his masters or sympathizers, from local potion, are providing him support in real quick time. How many stone pelting incidents have we witnessed in J&K since 08 Nov 16? This is a clear indication that stone pelting in the valley was through jobless youths, hired on a daily basis, with 500 or 1000 paid through stacks of black/ fake currency. And these incidences did not represent m movement or sentiments, as our learned media sometime read!In addition, with almost entire opposition up in arms against the move, the situation actually provided perfect fodder for organised riots and protests. However, with no black money to pay for the 'hired crowds', such protests and rioting were totally absent. This also throws light on how money power is used in Indian politics to engineer protests and riots.I, however, do not agree with the Seigniorage argument in favour of 2000 notes, as the ease of again stocking up black money with larger denomination notes would offset the gains made through Seigniorage. Although, it could only be speculated, I have a feeling that the Government, in near future, would again phase out the 2000 notes, once sufficient 500/ 1000 are in circulation. Such a move, if undertaken, would not only remove higher denomination that aids in ding with ease, but the second round, of depositing 2000 notes back into bank, would aid in catching up with black money that could hoodwink the system in round 1. Also, such a move will not hamper in normal functioning of the economy, as round 1 did.Tracking deposits since 08 Nov 16 would be vital now, to track and identify black money deposited in banks. Also, transparency in funding of political parties is of utmost significance, as largest des of black money would be the political parties. The Government would be faulting if it stops at 08 Nov 16 initiative. Unless the wheel is completed, with all checks and balances incorporated, the move would eventually backfire. Accordingly, irrespective of the results in the upcoming embly elections in 04 states shortly, the Government must continue with its agenda that it kick started on 08 Nov 16.
            1. M
              Jan 16, 2017 at 12:40 am
              Shadow economy generate growth as 90%of the potion are self emplo.Cashless society could damage small business that hardly take loan from Bank.Most of the developed Countries have black economydia being a growing economy a cashless economy is not a good thing at this stage!A corruption free society is only possible in utopian sciety!
              1. N
                Naveen Navlani
                Jan 17, 2017 at 10:02 am
                The overhead cost of printing money - 'seigniorage' and the logic given for lower cost of printing high denomination notes, is probably not the right way for reasons well known. Hence including that as an advantage to demonetisation, may not be apt.Over all a wonderful perspective.
                1. N
                  Niladri Bose
                  Jan 14, 2017 at 10:30 am
                  The authors of this article seems to be living in a fancy world far removed from reality. Instead of relying on hard data , the authors seem to be expressing opinions based on their imaginations and pro-BJP bias. Fact is that after demonetisation terrorism has increased, instead of decreasing, due to the ongoing financial chaos ( see annexure).Moreover the new series of currency notes are already being counterfeited within India itself as several seizures reported in media recently. There is no new novel technology in the new series notes which will make them counterfeiting-proof. As for the economic aspect the demonetisation debacle is already crippling the economy . The credibility of India's currency/banks and RBI and govt has suffered a serious blow among both the foreign as well as domestic investors, resulting in long term adverse effects on the economy and investments and manufacturing. This view has also been expounded by noted international economists, including nobel laureates Paul Krugman and Amartya Sen, and Pranab Bardhan, and also renowned international economics journals like THE ECONOMIST. This is clear from the fact that the rupees is in free fall from 66 on Nov 8 to 68.38 on Jan 11. The PMI is also falling, signifying shrinking of manufacturing activity. The author writes about NIPFP , but conveniently forgets to mention that NIPFP has reported that the demonetisation will spell doom for the economy both in the short as well as the long term. The economy is also expected to take a hit by 2%, meaning a loss of Rs 2.5 lakh crore, and the consequent tax loss for the exchequer is 40,000 crore ( tax to gdp ratio is 16.6%). Moreover, as estimated by the Center of Monitoring Indian Economy, the cost of only printing the new series of notes is 1.28 lakh crore, leave alone the cost of transportation. And the interest rates have been decreased by the govt after demonetisation resulting in severe pain for senior citizens and savers. And the BJP govt has refused to implement the Lokpal Act as well bringing the political parties funding under RTI Act, connoting that the demonetisation scheme is in reality a political gimmick with a miscalculated aim/hope of BJP of winning the upcoming embly elections, but will ultimately result in drubbing of the BJP due to the seething anger of common people caused by the harment due to demonetisation. For the time being the BJP/Modi govt is on a policy which is a mixture of fascism and communism, and is intent to turn India India into a banana republic, to which even stan will laugh at.ANNEXURE:The list of terrorist attacks that have ocurred after the Nov 8 demonetisation are as follows:1. Bandipora - 22.11.2016 : Encounter with terrorists at Khushi Mohalla.2. Kupwara - 26.11.2016 : Terrorists Attack Security Convoy, Border Security Force Jawan Injured.3. Handwara - 28.11.2016 : Encounter with terrorists in Langate area of Jammu and Kashmir's Handwara4. Nabha jail ( Punjab ) - 27.11.2016 - Five armed terrorists in police uniform on Sunday broke into Nabha prison in Punjab's Patiala district and helped several inmates escape, including dreaded Khalistan ultra and Khalistan Liberation Force (KLF) chief Harminder Mintoo5.Nagrota army camp - 29.11.2016 - Seven armymen killed6. Pampore : Terrorists attack Army convoy on Srinagar-Jammu highway in Pampore, 3 soldiers martyred - 17.12.20167. Shopian school burning - 10.12.20168. Kulgam district of Jammu and Kashmir : 25.11.16 - Two police officers were killed and one injured in a terrorist attack on a police party.9. Hajin town's Naidkhai area in North Kashmir : 25.11.16 : An Army jawan and two unidentified terrorists were killed in an encounter between security forces and terrorists .10. Heavily-armed terrorists on Monday attacked a General Reserve Engineer Force (GREF) camp in Jammu and Kashmir's Akhnoor district killing three personnel. - 09.01.201711. Mallapuram( Kerala ) - Maoist encounter - 24.11.201612. Manipur -eight times :Four policemen killed and four injured in Lokchao and Bongyang( 15.12.16)Triple bomb blasts at Nagaram area in Imphal West district allegedly by Manipur Naga People's Front ( 16.12.16 )Five Special Forces personnel of the Indian army were today injured in an ambush by terrorists in Chandel district of Manipur (27.11.2016 )Blast at Sajik Tampak close to the Myanmar border ( 26.11.16) (Five commandos injured and 1 dead )One person was killed when a powerful Improvised Explosive Device (IED) went off at Chingamathak area in Imphal West district, few metres away from an am Rifles camp ( 20.11.16 )Tadubi section of the Imphal-Dimpur highway in Manipur's Senapati district(22.11.16 ) - United Naga Council (UNC) volunteers set goods-laden trucks on fireMore than a dozen goods laden trucks were 29.11.16 damaged after they were attacked by hundreds of economic blockade supporting militias while proceeding towards Imphal with security escorts along the Imphal-Jiribam section of NH-37.The militias, who came out in large number, launched the attack when 504 goods loaded trucks leaving Jiribam this early morning started crossing Lukhambi village under Noney police station of Tamenglong district this evening, around 4 pm.National Socialist Council of Nagaland (NSCN) militants have attacked security forces in the Noney area of Manipur on 12.01.2017. The militants fired chaotically on the security forces escorting trucks loaded with essentials to Imphal on the Silchar-Imphal NH-57 highway. The ambush has claimed the life of one truck driver and three others are reportedly injured after the militants initiated the attack.
                  1. P
                    puneet bhalla
                    Jan 18, 2017 at 8:06 am
                    The demonetisation was launched by the Govt to bring black money and evade tax payment....linking it with terrorism only reaffirms the thought that the primary objectives were not met. There is no data that has been presented by the Govt on amount of black money un-earthed and the increase in tax collections. Majority of the economists...cluding Amartya Sen have criticised the move. Terrorism funding may have at the maximum PAUSED for a short duration before regaining the pre-demonetisation pace. Terrorism cannot be curbed by choking on funds alone.....more importantly its the battle of hearts and minds. Lets not gloat about the reduction of incidents.....it may purely be due to onset of winters, extra vigil on the borders or the Burhan Wani was fading in the minds.One thing is for sure that Narendra Modi has triumphed by showcasing the image of a DOER and has captured the political space from the opposition successfully. This too will be tested in the upcoming UP elections. Demonetisation at best only sent a message to the public that efforts are being done to change.....success of the either on black money, tax evasion or terrorist financing (the most illogical off shoot) is debatable.But Leadership is all about messaging as shown in US elections.....post-truth will prevail.
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