Demonetisation Decision: Sound Judgement on Unsound Policy

TK Arun

A Constitution bench of the Supreme Court has upheld the legality of the government’s decision to demonetise high-value currency notes. The court is spot on. It is not the court’s place to sit in judgment on the soundness of government decisions, it is only entitled to decide if the government had or did not have the right to take a particular decision.

Muhammad bin Tughlaq took some controversial decisions in his time. One was to shift his capital from Delhi to Daulatabad in Maharashtra. Another was to mix copper into the gold used to mint his currency. Each had a justifiable rationale. It made sense to shift the capital of the empire to a more central location than a town in the north-west of the country, to radiate control across the realm. The Mughals built their capital in Agra and only after Shah Jahan built Old Delhi and the Red Fort did their capital move to Delhi. So, moving capitals was not something that could occur only to a deranged ruler.

Debasing the currency is a bit like printing notes today, which could make sense and increase the growth rate in some circumstances but merely foster inflation, in some others. The Song dynasty had introduced paper money in China long before.

Both decisions of Tughlaq had to be reversed, as they were implemented poorly. Daulatabad turned out not to have enough water to support a Capital’s population, and his courtiers were loath to give up Delhi, sulked, complained and made life difficult for Tughlaq. The Sultan had not put in place a mechanism to thwart counterfeiters, and more money entered circulation than he had anticipated, leading to uncontrolled inflation.

But did the Sultan have the authority to take those decisions? He absolutely had. Had he got them right, history would have hailed him as a visionary far ahead of his time, rather than as an eccentric.

Right to take decisions

Do leaders of independent India have the right to take Tughlaqian decisions? They absolutely have. In a democracy, the elected government should have the right to take far-reaching policy decisions in the interest of the people. If the decision goes wrong, it is for the people to hold the government to account and punish those who led the government in the next general elections. If democratic politics fails to work in India, the solution is not to find fault with the process of decision-making.

The decision to delegitimise, at one stroke, all high-value currency notes, accounting for 86 per cent of the value of notes in circulation, was a big step. It gave the economy a financial shock that probably killed thousands of small businesses and destroyed economic value to the tune of at least Rs 1 lakh crore, going by the government’s own Economic Survey’s estimates, which couched the estimate as a range of percentages of GDP, ranging from 0.25 per cent to 1 per cent. It was an ill-informed, disastrous decision in economic terms, but a brilliant move in terms of politics.

It convinced the masses that the new government, on the backfoot after it was accused of being a suit-boot ki sarkar (government of the suited and booted), was actually out to punish the corrupt rich, and going after their black money.

Political advantage

It changed the composition of the ruling party’s support base, which traditionally comprised petty traders and the ultra-conservative among the upper castes. Demonetisation did for the BJP what Garibi Hataohad done for Indira Gandhi. The poor, nursing class antagonism in their hearts, lapped up the rhetoric that the government was destroying the black money of the rich, and happily stood in line to exchange old notes for new ones and voted en masse for the BJP in the Uttar Pradesh assembly elections that took place a few months after demonetisation.

The Left, which seeks to mobilise support on the basis of class solidarity and class antagonism, and has not found much success in North India, was left on the sidelines to watch, in the role of a spectator, as the BJP used class resentment to augment its support, garnered traditionally by fostering insecurity among the majority and hostility towards the Muslim minority.

Subsequent accounting by the RBI showed that almost all of the cash in circulation at the time of demonetisation came back to the banking system. It showed that practically no black money had been extinguished by the move that brought extreme hardship to small businesses.

The rich do not keep their black money as cash. They deploy it in the economy to generate returns. The truly well-off send it abroad and round-trip it back as portfolio investment or direct investment by shell companies in tax havens. A middle layer invests their untaxed money in real estate, gold, silver and dollars. Traders, small businesses and political parties do keep their working capital as cash but have the means to mobilise armies of small savers to deposit these funds in banks in small lots, in the names of workers, landless labourers, etc., and take them out later and return them to their real owners.

Demonetisation’s aim?

Demonetisation did not slay the demon of black money. It led to increased indebtedness, which showed up in the RBI’s Annual Report for 2017-18. In the five years prior to demonetisation, household financial liability averaged 3.06 per cent of Gross National Disposable Income (GNDI). This went up sharply to 4 per cent of GNDI in 2017-18. Liabilities went up by 83 per cent from Rs 3,70,964 crore in 2016-17 to Rs 6,79,349 crore in 2017-18.

The government later claimed that the goal of demonetisation was to create a less-cash economy. The RBI’s 2017-18 Annual Report showed that household savings held as currency grew, in the year after demonetisation, 2.5 times as large as the pre-demonetisation average for five years: from 1.12 per cent of GNDI to 2.8 per cent of GNDI.

The growth of telecom connectivity and innovations such as UPI flowing from the India Stack of Aadhaar-based application programming interfaces (APIs) were already driving up digital payments. There was no need for demonetisation to push digital payments. And GST’s built-in audit trails were already persuading millions who had not filed an income return in the past to declare the income exposed by GST and filing returns. Narendra Modi and the BJP had bitterly opposed both Aadhaar and GST when they were in Opposition but have no qualms, when holding office, about taking credit for what these innovations have achieved.

Fault lies with us

Demonetisation was thus a total policy failure, but any attempt to pin the blame on any procedural flaw in the decision-making process is meaningless. The fault lies in us, the people, who elect as leaders those who make such colossal policy misjudgements, and later, instead of penalising them, reward them with continued electoral success.

In the times when kings ruled, the saying went, yatha raja, tatha praja — as the king, so the people. Under conditions of democracy, when people elect their rulers, we should modify that saying to ‘as the people, so the Sultan’.

This article was also published at The Federal as SC on demonetisation: Sound judgment on unsound policy on January 3, 2023

Also read Fiscal Deficit as a Shape-Shifter in India by the Author on IMPRI Insights

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