by Vivek Kaul
A pertinent question is: Why has the rate of currency replacement been so slow? And this is where Big Government comes in. A big decision to demonetise high-denomination notes was taken. But the government did not take into account its capability (or should I say incapability?) to implement the decision.
During the time that the demonetised currency could be returned to the banks, a total of Rs. 2,000 per day could be withdrawn from ATMs. From January 1, 2017, this has been increased to Rs. 4,500. When it comes to bank accounts, withdrawal through withdrawal slip or cheque is subject to a weekly limit of Rs. 24,000. This includes withdrawals from ATMs as well.
Why has this limit been put in place? Why have citizens not been allowed to withdraw their own money? The simple explanation for this lies in the fact that the government hasn’t printed enough new notes to replace the old ones. There is only this much printing capacity that the government mints have. This is a classic example of Big Government living up to its name. At a higher level, a decision is taken. At the lower level, there simply isn’t enough capacity to implement it.
Also, post-January 1, 2017, if the withdrawal limits had been lifted, there would also have been the danger of people withdrawing as much money as they could have from banks and, in the process, causing a bank run.
Getting back to the issue at hand. In total, around 1,716.5 crore Rs. 500 notes had become useless due to the demonetisation. Media reports suggest that the capacity of the government and the RBI is to print a total of around 300 crore notes per month. It is interesting to see how they have arrived at this number. A reading of the RBI Annual Report for 2015-2016 tells us that, in the last three years, the currency note printing presses have supplied around 2,200 crore notes a year, on an average.
The total annual printing capacity of the currency note printing presses owned by the government is 2,400 crore.995 This is achieved by running two shifts. Adding a third shift can increase production, by 50 per cent, to 3,600 crore notes per year. This essentially means a production of 300 crore notes per month.
What if we work with the supply number of 2,200 notes per year? A third shift would lead to a jump to 3,300 crore notes per year. This would mean a production of 275 crore notes per month.
To get back to the point: Around 1,716.5 crore Rs. 500 notes need to be exchanged. At 300 crore notes per month, it will take around 5.7 months to print the new Rs. 500 notes to replace the old ones. At 275 crore per month, it will take around 6.2 months. So, just to replace the Rs. 500 notes can take a period of at least five to six months. Given this, the currency shortage in the Indian economy is likely to continue till at least May 2017.
In this scenario, transactions across markets will continue to remain slow. This includes the textile markets of Ludhiana and Tirupur, the paper mills of Uttaranchal and the shoe market of Agra. Agricultural markets across the country have also been on a slow mode.
Another option that needs to be considered here is that some people will go cashless in the coming months. The more the number of people going cashless, the less the need for new notes. But then one needs to consider the fact that a bulk of consumer transactions in India (as high as 98 per cent, as we shall see) still happens in cash.
Taking all these factors into account, it is safe to say that, given the current state of things and level of information available, it will take around five to six months for enough new notes to find their way into the financial system to replace the existing ones. Hence, it will take at least half a year for the financial system to get back to a similar purchasing power level as it had before November 9, 2016.
This basically tells us that the demonetisation move wasn’t thought through well enough, irrespective of what the establishment tells us now about wanting to maintain secrecy. It also tells us that, time and time again, Big Government just doesn’t seem to realise that it has very limited implementation capabilities.
Furthermore, you don’t pull out more than 86 per cent of the currency from the market overnight without having a significant portion of the new currency ready. It’s time to be prepared for lower sales figures for all kinds of consumer products. And it’s time to be prepared for a lower GDP growth number in the second half of 2016-2017.
Also, it remains to be seen whether this demonetisation turns out to be a game-changer in the long run, as the Modi government has been claiming. But the early evidence isn’t really encouraging. In fact, with the zeal and focus that Modi has shown towards the black money issue, cleaning up the electoral financing system in India should be his next big aim. But before we come to that, we need to look at something else.
****
A major problem because of the lack of cash has been a slowdown in the construction and real estate sectors. This slowdown has been because of two reasons. One is because the sector largely uses cash to pay its workers, and there isn’t enough cash going around to pay them. Furthermore, enquiries in the real estate sector have dropped big time. This has forced construction workers to go back to their villages.
India’s natural comparative advantage is low-skilled labour. Construction and real estate are major employers of this labour. If construction and real estate are not employing people, then clearly there is trouble ahead.
As mentioned earlier, the National Manufacturing Policy of 2011 estimated that the number of Small and Medium Enterprises (SMEs) in India had stood at over 26 million (2.6 crore) units. They employed around 59 million (5.9 crore) people. This means that any SME, on an average, employed 2.27 individuals. The size of an average Indian SME is small. These firms basically employ the owner and one more person, on an average. Interestingly, nearly two-thirds of these firms are own-account enterprises without any hired workers.
A bulk of these small firms operate under the radar and are not a part of India’s formal tax system. Also, they operate largely in cash. Despite their smallness, almost 92 per cent of the workforce is employed in the informal sector.996 Given that these firms operate largely in cash, it has brought their current operations almost to a standstill.
The thinking is that, with demonetisation, these firms will now come under the formal system. And that is a good thing. The trouble is that many of these firms will simply be unviable if they come under the formal economy, with tax being only one of the things that they will have to deal with. As mentioned earlier, the National Manufacturing Policy of 2011 estimates that, on an average, a manufacturing unit needs to comply with nearly 70 laws and regulations. Given this, these firms may simply choose to shut down because it may be totally unviable for them to operate in the formal sector. Furthermore, the lack of cash in the system is likely to hit the smallest of the small entrepreneurs the most.
As mentioned earlier, two-thirds of the small firms are own-account enterprises, without any hired workers. Also, these individuals are not self-employed, by choice, but are self-employed because they have no other option.
Furthermore, these self-employed individuals aren’t exactly making a killing. As the Report on Fifth Annual Employment-Unemployment Survey (2015-16) points out: “At the All-India level, a majority 67.5 per cent of the self-employed workers had average monthly earnings [of] up to Rs. 7,500.” This basically means an income of up to Rs. 90,000 per year. This clearly tells us that the staying power of these very small entrepreneurs, who operate on their own, is not huge. Given that they are not making much money, their ability to survive is limited if they have to shut down even briefly. If they do shut down in the aftermath of demonetisation, they will hit the job market soon to keep making a living. And that can’t be a good thing for India’s already burgeoning demographic dividend.
In fact, income tax needs to be paid only if the taxable income for the year is greater than Rs. 2.5 lakh, which is clearly not the case with those making up to Rs. 7,500 per month. Furthermore, only 4 per cent of the self-employed earn an income of greater than Rs. 20,000 per month. Even at Rs. 20,000 per month, the annual income comes to only Rs. 2.4 lakh, which is still below
the taxable level.
The point being that less than 4 per cent of the self-employed fall in the Income Tax category. Hence, even though they are operating in the informal market, at least they aren’t breaking any income tax laws. I make this point to essentially dispel the argument that everyone in the informal sector is operating in the black economy. That is clearly not the case. They just don’t earn enough to be paying income tax.
Having said that, there are firms which do not pay income tax even though they should. Nevertheless, the pay-outs that they make to their employees do not remain a part of the black economy. When employees of such firms spend money, they pay indirect tax, which lands up in the government kitty. Also, the money they spend is an income for formal businesses, and some of them do pay tax on it.
The point being that even though many businesses which operate under the radar generate black money, those who get paid by these businesses do not have any black money. Also, when they spend their money, they contribute to the formal economy which pays taxes.
****
Demonetisation aims at destroying the stock of black money. It does not do anything about stopping its further generation. For that to happen, the Modi government will have to hit where it will perhaps hurt the most.
An analysis carried out by the National Election Watch and the Association for Democratic Reforms reveals that, during the period 2004-2005 and 2011-2012, the total income of the national political parties was Rs. 4,899.5 crore. (The six national parties are the Congress, BJP, NCP, BSP, CPI and CPM.)
The Congress Party declared the highest income, of Rs. 2,365 crore. This was followed by the Bhartiya Janata Party, which declared an income of Rs. 1,304 crore.
Between 2004-2005 and 2011-2012, there were two Lok Sabha elections (in 2004 and 2009) and multiple state assembly elections. It doesn’t take rocket science to come to the conclusion that the respective incomes declared by the political parties were clearly not enough to fight so many elections.
Within 90 days of completion of the General Elections, political parties are required to submit their election expenditure to the Election Commission of India. The National Election Watch and the Association for Democratic Reforms have analysed this expenditure for the last Lok Sabha election, and their analysis makes for very interesting reading. This expenditure statement contains the “details of the total amount received as funds in the form of cash, cheques and demand drafts, and the total amount spent under various heads”.
The total amount of funds collected by the national political parties for the 2014 Lok Sabha election was Rs. 1,158.6 crore. This was 35.5 per cent higher than the funds collected for the 2009 Lok Sabha elections. The total declared expenditure of the national political parties was Rs. 1,308.8 crore, up by 49.4 per cent from 2009.
Now, compare this to an estimate made by the Centre for Media Studies in March 2014. It estimated that around Rs. 30,000 crore would be spent during the 16th Lok Sabha elections which were to happen in April and May 2014. Of this amount, the central government would spend around Rs. 7,000-8,000 crore to conduct the elections. The remaining amount of around Rs. 22,000-23,000 crore would be spent by the candidates fighting the elections.
Of course, national political parties are not the only parties fighting elections. Nevertheless, the difference between the officially declared expenditure and the ‘real’ expenditure to fight elections is huge. Where does this money come from?
As Sandip Sukhtankar and Milan Vaishnav write in the research paper titled ‘Corruption in India: Bridging Research Evidence and Policy Options’: “On the expenditure side, candidates face strict limits on spending once elections have been announced, but election authorities struggle to properly verify their reported expenditure, since a substantial portion typically occurs ‘in the black’.”997 Hence, black money finances political parties and, in the process, elections in India.
The laws are also structured to help this. As Sukhtankar and Vaishnav point out: “For instance, corporations and parties are only legally required to publicly disclose political contributions in excess of Rs. 20,000. This rule allows contributors to package unlimited political contributions just below this threshold value completely free of disclosure.”998 And this is something that political parties make blatant use of.
Before we dive deep into this, it is important to go back to demonetisation and how the official communication around it evolved after it was first declared on November 8, 2016.
In the November 27, 2016 Mann ki Baat address to the nation, Prime Minister Narendra Modi talked about India moving towards a cashless society. As he said: “The great task that the country wants to accomplish today is the realisation of our dream of a ‘Cashless Society’. It is true that a hundred percent cashless society is not possible. But why should India not make a beginning in creating a ‘less-cash society’? Once we embark on our journey to create a ‘less-cash society’, the goal of ‘cashless society’ will not remain very far.”
A very noble thought indeed, the practical part of implementing it notwithstanding. I say this because smart phone penetration is low, internet connectivity and speeds outside the big cities are patchy and so is the availability of electricity. These are three things required for moving towards digital payments, along with a bank account and the ability to read of course.
The interesting thing is that the mention of this dream of India moving towards a cashless society wasn’t made in Modi’s November 8, 2016 address to the nation.
Neither was it a part of the Ministry of Finance press release that accompanied the decision. The primary goal of demonetisation was to tackle fake currency notes and black money. Of course, it can be said that the dream towards a cashless society goes hand in hand with the dream of eliminating black money. So, to that extent, they are connected. Nevertheless, with the way the entire issue of demonetisation has been handled, it is safe to say that this was not something that the government had thought about originally.
It is worth asking how feasible this dream is. A PwC report titled ‘Disrupting cash: Accelerating electronic payments in India’ points out that 98 per cent by volume of consumer transactions in India are still in cash. The number is 96 per cent in the case of Mexico, 94 per cent in the case of South Africa, 90 per cent in the case of China, and 86 per cent in the case of Japan. While this figure can definitely be brought down, there is no way India is moving towards becoming a cashless society any time soon.
Also, what is Modi’s big reason for India moving towards cashless and digital payments? As he said on the same Mann Ki Baat programme: “You have to voluntarily lend your leadership to this great campaign, this Maha Abhiyan, to create a ‘cashless society’, to eradicate corruption from our country, to abolish the scourge of black money…”
The point Modi was making is that India is a corrupt country because we deal in cash. But is that really true? Take the comparison between India and Japan. Japan has a cash-to-GDP ratio of 19 per cent. India’s is at 12 per cent. When it comes to corruption, Japan is the 18th least corrupt country in the world. India comes in at the 76th position.999
Or let’s take the case of Argentina. The cash-to-GDP ratio of the country is at 2.1 per cent. In comparison, the cash-to-GDP ratio of New Zealand and Denmark are at 2.3 per cent and 3.3 per cent, respectively, both higher than that of Argentina. How do things look when it comes to corruption? As per Transparency International’s rankings, Argentina is the 107th least corrupt nation in the world. In comparison, New Zealand is the fourth least corrupt country in the world, while Denmark is the least corrupt country in the world.
There are many other such examples. Hence, there is no clear link between less corruption and going cashless, as Modi would like us to believe. He is clearly trying to manufacture a face-saver for himself in the aftermath of the demonetisation debacle.1000
But given that the Prime Minister wants India to move towards a cashless society, there is one thing that he should do to convince the nation of jus
t how serious he is about the cashless dream. If the nation is expected to go cashless, why are political parties still allowed to take cash donations? This is something that the Prime Minister and the Bhartiya Janata Party can work towards eliminating.
Given that political parties do not have to publicly disclose donations below Rs. 20,000, large parts of the donations they receive are from unknown sources. As the National Election Watch and the Association for Democratic Reforms point out in a report titled ‘Analysis of Income & Expenditure of National Political Parties for FY 2014-2015’: “Only 49% of the total donations of the parties came from voluntary contributions above Rs. 20,000.” This means that 51 per cent of the donations came from those making donations of Rs. 20,000 or lower. Hence, the donors are virtually unknown.
If Narendra Modi is serious about his fight against black money and moving India towards a cashless society, this needs to stop. If you, I and everybody else are being encouraged to go cashless, why should political parties still be allowed to take donations in cash and not declare their source of funds?
Since the entire demonetisation issue is more about making a political point, the BJP can take a step forward on this front and promote the usage of a Unified Payment Interface for cash donations that are made to a political party. In fact, the BJP should make all donations of less than Rs. 20,000 be made compulsorily through the Unified Payment Interface.
This will work at multiple levels. The BJP will score political points over its rivals and allow Modi to take a high moral ground again. The economy will become more cashless. Furthermore, there will be less infiltration of black money into political parties, given that those making donations of Rs. 20,000 or less can be identified as well.
Also, another important observation that needs to be made here is regarding bringing political parties under the Right to Information (RTI) Act. In an affidavit submitted to the Supreme Court in August 2015, the Modi government said: “If political parties are held to be public authorities under [the] RTI Act, it would hamper their smooth internal working, which is not the objective of the RTI Act and was not envisaged by Parliament. Furthermore, it is apprehended that political rivals might file RTI applications with malicious intentions, adversely affecting their political functioning.”1001