Demonetization:Cutting the Vital Blood Supply to the Economy

By Sreekumar Raghavan

By now you may have read many articles, analysis which were either supportive or against the recent demonetization initiative of Narendra Modi Government in India. This is my first post on demonetization. Without being judgmental, let us try to find out what was done through demonetization.

Let’s take a comparison between blood circulation in our body and currency circulation in the economy. Blood by itself doesn’t have much value in our body but it is important because it carries vital nutrients and life sustaining oxygen to our cells and tissues.
 

For some reason if there is bleeding in our body we use emergency measures to stop it or else we will die. Also we know that blood that comes back to the lungs has less value that that which is pumped into the heart chambers for distribution in the body as it contains oxygenated blood. Also we know that when surgeries are performed, the patient is put on other life support systems to survive.

As blood is to our body so is currency to our economy. The 10, 50, 100, 500,2000 or other currency denominations don’t have any intrinsic value other than as a medium of exchange in the economy. When we curtail the supply of currency economy slows down just as our body turns weak when we have less blood which is medically called Anemia.

Sometimes, patients are diagnosed with blood lacking vital minerals or vitamins—potassium, sodium, magnesium … They are given supplements to make up for what is lacking in blood.  

The currency is exchanged as value of a good or service or an immovable property. Only when people engage in work and business men or government invest in machinery and raw materials, does the economy function. Currency is only a convenient way for people to buy and sell goods or services as otherwise we may have to adopt the cumbersome barter system of ancient age.

What may have gone wrong with demonetization?

The objective of demonetization was to curb black money, money laundering, fight terrorism and bring more transparency in business and personal finance in the country. Ever since I started learning and reading more about Economics after my school years, plenty of analysis has come about black money-politicians, economists, bankers all talk about it. Black money is also legal tender but for which the concerned individual or institution hasn’t paid taxes to the government.

It is true that taxes are what we pay for upkeep of our civilization. We need good roads, hospitals, schools, dams, public utilities, law and order, judiciary. Government can utilize tax payer’s money to fund all these projects. But people are reluctant to pay taxes, most people try to evade taxes rather than avoid it. Tax evasion is a criminal activity while tax avoidance is permitted.

It may be because people dealing in black money have an obligation towards each other. If one party reveals his source of income, it exposes all the stakeholders who were involved in the transaction who in turn have to expose all others involved in the transaction and it will be never ending cycle. 

The voluntary disclosure scheme was laudable but many didn’t utilize it as they may have been anxious about income tax sleuths pestering them with notices and investigations on their wealth.

Now coming back to the blood circulation analogy in our body, if we turn sick no doctor suggests changing your blood however infected it is. Even in case of dengue fever where platelet count drops more platelets are injected into the system or certain herbal medicines are taken to increase the platelet count.

Finding the right cure

Just as the task of any physician is to diagnose the disease and administer the right cure, the government needs to make a proper diagnosis of the functioning of the economy and take corrective steps. It may be rationalization of taxes, bringing more transparency in use of funds for public good, instilling trust in citizens and business community.

The go ‘cashless’ slogan is no doubt laudable. It requires time and more infrastructural investments in backend technologies and proper awareness building. 

I am not being judgmental on the demonetization issue- just because most people are suffering due to lack of currency and restrictions on its withdrawal from banks. Nor I am saying the crisis in agriculture, small and medium industry and trade is going to last forever.


 

                              V C Shukla, India's Revenue Minister's clarification on demonetisation in 1970

The truth is many sectors of the economy are gasping for breath as vital supply of blood (currency) was made as a ‘patriotic’ measure by Narendra Modi government. The Centre for Monitoring of Indian Economy (CMIE) data shows new investment proposals have fallen drastically in October –December 2016 quarter, tourist arrivals have come down, traders report lower sales, farmers have destroyed crops in some places as there are no takers at prevailing prices.

Why the currency was kept in lockers and under bed?

It is astounding the amount of currency that was legal tender but didn’t come to the banking system nor was it invested somewhere. if we had indeed invested so much money in agriculture, industry or in services, we could have easily overcome China , the emerging economy giant, in growth and development. In the post financial crisis period of 2008, it may be recalled that China, India and Brazil were the fastest growing economies in the world.

I think the government, income tax sleuths and policy makers should not be hunting down tax evaders treating them as criminals but think of how to utilize such hidden wealth for the development our nation.

Not yet ready for post-mortem

We are not yet ready for a post-mortem. The government has given indications that currency crisis will continue until April or a bit longer. If the economy, personal finances, money supply and economic activity are not normalized by then, then people would deliver the final judgement.