To aim, in the short-run, at the monetisation of the economy as per the standards of a developed economy—when the problem is to build up the infrastructure to reach there—is not very practical
Demonetisation of 500- and 1,000-rupee notes is one of those big events; obviously, a game-changer. At one stroke, tax evaders and other such people who were not keeping their wealth in gold, land or dollars were dealt a lethal blow. Some would distribute currency to their relatives or servants but, for the larger operator, this had very limited scope. There has been discussion that this was done in 1978, around 40 years ago. Having prepared the first Perspective Plan for an Indian state, Gujarat, at the Sardar Patel Institute in 1972, I was invited by the Planning Commission to head its very powerful Perspective Planning Division (PPD). The Gujarat Plan, in three volumes, had a Technical Forecasting Model for the year 2000. This was, in those days, considered an ‘innovation’, which the Planning Commission decided to replicate for the regional part of the country plan. My predecessor at Delhi had been the iconic Pitamber Pant, a friend of Indira Gandhi who used to mark PPD files, on which I worked, to her as “from Pitamber to Indu”. In 1978, having completed five years, I wanted to come back to my research job at the Sardar Patel Institute at Ahmedabad. But, as fate would have it, my predecessor at Ahmedabad, the senior economist, professor DT Lakdawala—the director of the Bombay School of Economics, who had come on leave as the first director of the Sardar Patel Institute—was appointed as deputy chairman of the Planning Commission and, of course, he insisted that I stay back in Delhi.
Prime minister Morarji Desai decided, as Gujarati prime ministers do, to demonetise high-value notes. He took up a really high-value one, the 1,000-rupee note. I vividly remember a conversation from then which has contemporary relevance. IG Patel, the then Governor of RBI, told prime minister Desai in chaste Gujarati, “Sahib, this (the demonetisation of the thousand rupee notes) will not work, black money is held in land, gold and dollars because they appreciate in value, and not in currency”. The late HM Patel, the then finance minister, was present and was smiling away at this exchange. Morarjibhai would have none of this and went ahead. When we now talk about that demonetisation episode—of a 1,000-rupee note—being, in some sense, comparable to today’s, we make a great mistake. It has to be remembered that the currency cut-off point then was much higher. In those days, the price of gold was around Rs 600 for 10 gm. It is now around Rs 30,000 for 10 gm, and since gold is a good measure of the value of the money in classical monetary theory, a 1,000-rupee note then would be worth roughly Rs 50,000 now. Thus, the coverage of demonetisation in the present exercise is much greater. In those days, a middle-class housewife would not have had 1,000-rupee notes to tuck away as savings from money allocated for household expenses. Look at it otherwise. A 1,000-rupee note today will be as common as a 20-rupee note was then. Today, the housewife is more likely to save in 500- and 1,000-rupee notes. As a friend’s wife told me, what if he has a heart attack at night and she had to take him to a hospital and they wanted Rs 100,000 in cash as a deposit before they could admit him? The remonetisation of the economy has to be deep now. Eighty percent of our economy, it is estimated, works with cash. Financial intermediation is for the remaining 20%. This ratio is higher than in most developing economies, but much lower than rich countries, where cash accounts for 10% of the economy. So, the economic pain is much higher. To aim, in the short-run, at the monetisation of the economy as per the standards of a developed economy—when the problem is to build up the infrastructure, including that of financial intermediation, to reach there—is not very practical. There is no point in blaming the hapless Governor of the central bank who is perhaps one of the best experts on financial intermediation and development, anywhere. The demand for currency is high and you can’t deliver it instantaneously with non-existing infrastructure. Throwing currency notes from a helicopter is a standard tool of teaching monetary economics, but not a very practical solution in the real world.
To the best of my knowledge, I was the first one to make a distinction between the stock of black money which was destroyed last week and the flow, and my argument was that we need to plug the flow. This argument has been highlighted by most experts since. Otherwise, black money would start being generated with the new notes once they are available in plenty which may be so towards the end of the month. If everything else remains the same, we will have plenty of new currency and the same actors and markets will start functioning again. The only outcome would be the pain the housewife went through. But, hopefully, this will not be so. The prime minister has reportedly said that unaccounted money used in real estate and land deals will be targeted. We need similar plans for gold and foreign exchange in hawala. The crispiness and bright colours of the new notes will not deter the operators. The sooner the government shares the details of their pre-emptive plans for these possible illegal activities, the more comforted we will all be that our pain is not in vain. Also, it will be comforting to know that the great political leaders changing sides, like in the states where this has happened in the recent past, are really doing so because of their political conviction and not for a mess of potage, as the Bard said. Of course, if we selectively hit black marketeers, a general demonetisation may not have been needed, but that is another story.
The author served as the Union minister for planning and programme implementation, science and technology, and power between 1996 and 1998