On 8 November 2016, Prime Minister Narendra Modi announced that, as of midnight that night, the Rs 500 and the Rs 1000 notes would no longer be considered legal tender. The prime minister stated that the move was aimed at clamping down on black money in the economy so as to fight corruption and reduce the funding of terrorism in the country. Since the announcement, however, several economists have voiced their scepticism about the policy’s ability to combat the issue of black money or black-market transactions.
Amit Bhaduri is one such economist. Bhaduri is a professor emeritus at Jawaharlal Nehru University, and a founding member of JNU’s Centre for Economic Studies and Planning. His research spans several important fields including capital and growth theory, development economics and Keynesian and Post-Keynesian macroeconomics—which argues that aggregate demand, being the sum of all spending by households, businesses and government, is the driving force of an economy, and advocates that the government intervene during economic slumps such as a recession. Bhaduri is currently a professor of political economy at the University of Pavia in Italy and a visiting professor at the Council for Social Development in Delhi. On 12 November, Kedar Nagarajan, a web reporter at The Caravan, spoke with Bhaduri. During this conversation, which later continued over the phone, they discussed whether demonetisation would be effective in achieving the objectives laid out by the government, alternative policy measures that the government could have adopted, and the impact that this move may have on the Indian economy.
Kedar Nagarajan: How much black money in the country is actually in circulation in the form of currency and how much of it is in other forms such as gold and benami (unnamed) property?
Amit Bhaduri: No one has any real estimate about this. Estimating black money is like looking for a black cat in a dark room. We know that there is a sufficient amount, but it is very difficult to estimate. It is as impossible [as trying] to get an accurate estimate of how much unemployment there is in the country.
KN: How will such a policy actually help clamp down on black money?
AB: I think there has been a misunderstanding of what the curbing of the currency notes means. There are two aspects to this, and they are contradictory. One is to bring the black money into circulation, and the other is to demobilise it. Bringing it into circulation would mean bringing all the money that the government collects into circulation in some form or the other. Demobilising, when I say, I refer to those who have large cash stacks and will therefore be scared to bring it to banks and so on. This is what I think is at the crux of this demonetisation.
KN: Will the Reserve Bank of India (RBI) be able to recover the cost that it would incur in order to circulate fresh notes as a part of this move?
AB: Yes, it will. But if one really wants to curb black money, mechanisms such as strengthening the tax system and going after the super rich in the country are more disruptive measures that will cost more [for the government]. This move will not really curb black money in any real sense, but I am sure that the RBI will recover the cost that it incurred.
KN: The Janata Party attempted a similar move in 1978, when it demonetised Rs 5,000 and Rs 10,000 notes. Then, reportedly, only 15 percent of the entirety of notes in circulation was recovered. Is there any reason to believe that a larger percent of the notes in circulation will be retrieved this time?
AB: Last time, from what I understand, the government’s entire policy was to immobilise black money. This time the policy that is in place is not really to do just that. In 1978, the policy was based on a moral position. This time, they are trying to make some of the money come back to them. It will have two-three very clear impacts. The first is that banks will be much more liquid and there will be pressure on the interest rate to go down, and most probably government bond prices will go up. There is an inverse relationship between government bonds and the interest rate.
The second area where you can definitely expect the footprint of the current policy is in hawala transactions. In this case, jewellers through other channels will push some of the money out and this will show itself in the form of increased demand for hawala transactions and an increase in the hawala rate.
The third effect, which I will say tentatively, will be a short-term effect on perishable goods—the price will go down. People do not currently have the money, so unless the money comes in, the price of these goods, which are purchased predominantly through cash transactions will have to go down.
What happens in the long run is very dependent on what the government and the banks do with the money that comes in. Typically, people make a mistake when they assume that more liquidity in banks will automatically increase investment. This is not true, because this will happen only if banks and financing institutions see definite profit accruing from an investment. In the US, investment did not increase when liquidity did, and that is what caused the recession. [In the aftermath of the global recession in 2008,] when [the US President George W] Bush pumped in money to save the banks, the banks were flushed with money but they did not invest in anything because they felt that there were no profitable projects. As a result, only the Goldman Sachs people received higher bonuses. Something like this is very likely to happen if the investment climate does not develop and if the government does not decide to pump the money into the development of infrastructure projects. If they do this, it would be a little like Keynesian policy, which is really not in line with this government’s policy or any neo-liberal economic policy. I did not see any left political party making this point.
KN: In 1978, the then RBI governor IG Patel was not in favour of the move as he believed that it was premeditated strictly to target members of the opposition. Given that states like Punjab, Uttar Pradesh, Goa and Gujarat will go to polls in the coming year, do you believe that this sudden move had similar intentions?
AB: You are asking the wrong person, because while I have political opinions, I wanted to stay away from giving it. I will say this though—it is quite remarkable that they [the government] managed to keep this a secret for such a long time. There has certainly been an asymmetry of information given the way some of the opposition leaders and other state non-BJP political leaders have reacted to this. However, in my opinion, this move is largely superficial and is operating on an economic phenomenon called the “announcement effect”—you announce your intention with a bang. But whether it will be followed by anything, I strongly doubt. The government has done nothing about black money in the form of gold, real estate and natural resources. They have not come down on illegal mining or allocation of land in an unfair manner to certain businesses.
KN: The preamble to the High Denomination Bank Note (Demonetisation) Act, 1978, introduced by the Janata Party, noted that high-denomination bank notes facilitate illicit transactions. This time, the new note being introduced is of a higher value than the Rs 1,000 note being taken out of circulation. What is the logic behind this?
AB: My own feeling is that they could not have transferred so many Rs 100 notes and that is probably why the new denomination [is being introduced]. The Rs 500 note has not been introduced yet. Large notes are administratively easier.
KN: A 2012 report by the National Institute of Financial Management on unaccounted income reportedly found that cash was the least-preferred medium for storing unaccounted wealth. What other initiatives should the government have taken if they meant to clamp down on assets acquired through black-market transactions?
AB: What initiatives you take depend very much on which group of people or class you want to satisfy. The government has gone as far as it can, which the opposition is right in pointing out, to make life difficult for the middle class and the impoverished. Measures such as taxing the rich would have actually gone against industrialists that conduct black transactions—cutting down subsidies to them. I am talking about things that are not in line with this government’s policy.
Two areas where the government has been very thoughtless, to put it mildly, is not to have seen the immediate areas where black money will try to take shelter. Places such as gold, silver and other jewellery are areas [on which] the government should have immediately put some kind of a tax or a cap. The second area is real estate and the secondary market. A lot of people hold apartments and later try to sell it at a premium level. There will still be an impact on real estate, but it won’t be one that the government has guided.
KN: What are the possible long-term impacts of such a policy on the informal sector of the economy?
AB: The inequality that has been structurally imposed on this group is something that no one talks about, and it can’t be compared to the rich who live without paying tax. I cannot make a prediction about how such a policy will affect their livelihood in the long term, because they are already being forced out of the “legal” economy. All I can say is that there is no correlation between coming down on black money and combating economic inequity.
KN: If this move brings about an overall increase in the number of savings accounts in the country, in what way will the economy be impacted?
AB: Not to a great extent, but it will move a portion of the economy further towards being cashless. The next best thing to cash is a savings account with a card. In this sense, it is compatible with the government’s policy. More savings accounts will make banks more liquid for the next year. This liquidity generally will show through a downward pressure on interest rates, unless the RBI intervenes. This may result in increased incentive to invest, but paradoxically in [the cases of] housing and real estate. [Usually,] housing and real estate are areas where investment rate is likely to go up, because when liquidity in the banks increases then interest rates on loans from banks decrease. However, this policy will make housing and real estate the depressed sectors of the economy, so it is likely that the two [effects] will cancel each other out. This will be the monetary effect. The fiscal effect on the government in terms of tax policies and so on, will depend on whether the government wants to use this money that comes into the banks.
KN: Many companies appear to have welcomed the move, saying that it will steer our economy towards becoming cashless.
AB: I think it is really silly to expect that this move will make the Indian economy ready to go cashless. Corporate India will welcome the move because this does not affect them much.
KN: Will this move increase the amount of income tax collected in the country significantly?
AB: Yes, it will. Perhaps not to a very large extent, but it will certainly increase the base and the height of income tax. More people will come under the net—people who will now be forced to declare their black money, will move to higher income groups, and will therefore be more taxable.
KN: How will this move impact the price of gold?
AB: The price of gold and the price of silver throughout 2016 was higher on an average than the price in 2015. If you now look at the curve [between 5 November and 12 November,] I think there will definitely be an increase in the price of gold.
KN: Will such a move actually assist in curbing the financing of terrorism?
AB: This is purely rhetoric to win the consent of people who are not thinking. I see no connection between this policy and curbing terrorism.
This interview has been edited and condensed.