Thursday, 13 July 2017

The RBI's Silence Means Modi's Demonetisation Was An Even Bigger Miscalculation Than Anyone Realises

On July 12, 2017, almost 8 months after the announcement of demonetisation, RBI Governor Urjit Patel told a Parliamentary Standing Committee that the RBI was still counting the money that had been received by the banking system, and hence he could not state how much money had actually come in.

This was doubtless an extraordinary admission. It speaks pretty poorly of India's banking system that there cannot even be a rough estimation of this amount, since all exchanges were stopped on December 25, 2016, giving the banks more than 6 months to count the cash.

I'm going to make a bold guess here and say that the RBI Governor is lying. Yes, you read that right. The RBI Governor is lying. He knows exactly how much money has come back into the system, but is unable to reveal it. Why?

Urjit Patel - Stuck between a rock and a very hard place

At the time of the demonetisation announcement last year, the amount of money in circulation in 500 and 1000 rupee notes was estimated to be 15.5 lakh crores. There was talk that the government was expecting about 13 lakh crores to come back into the banks as a result of the forced exchange, and that the remaining 2.5 lakh crores was "black" and could not be returned in the full glare of publicity. It was thought that black money holders would throw these worthless notes into the river (some of that did happen). This was how black money was going to be "hit".

Further, since 2.5 lakh crores of (in essence) promissory notes ("I promise to pay the bearer") were never going to be presented, it meant that the RBI would be absolved of 2.5 lakh crores worth of debt to the general public! This extinguished debt was going to be a one-time windfall that the RBI could transfer to the government as a huge budget surplus that could then be used to fund so many initiatives.

Now here's my theory.

I believe that the expected shortfall in currency returns did not materialise. On the contrary, I believe more money than the expected 15.5 lakh crores has come back into the system. It implies that far from demonetisation having struck a blow against black money holders and counterfeiters, the system has been cheated, and it has been cheated in more than one way.

1. Black money has been effectively turned white using demonetisation, since virtually all the deposits made have been under the no-questions-asked limit of 2.5 lakhs per bank account. A lot of private deals between black money holders and ordinary account holders must have been struck to enable this laundering, and the government is none the wiser. Minus a commission to the account holders, the original owners will eventually get back all their money. The whitewashed money will therefore largely return to the black economy, and the taxman will remain empty-handed.

2. Counterfeit currency in 500 and 1000 rupee denominations has been successfully exchanged for genuine currency in smaller denominations. Think about it. If the money that returned is more than what the RBI had put into circulation, it only means a large number of counterfeit notes have also been submitted and exchanged for genuine notes in smaller denominations. Demonetisation has unwittingly devalued the currency. By how much is anyone's guess. The RBI surely knows but is not telling.

3. Not only has the government not got its bonanza from the RBI in the form of the expected extinguished debt of 2.5 lakh crores (and hence no funds to spend on its pet initiatives), it is now in greater debt because of the demonetisation exercise. The increased deficit, as any economist will tell you, will add to inflationary pressures.

4. It means poor people have suffered for nothing. It was remarked during the months of November and December 2016 that the Indian people were demonstrating exemplary patience. Poor and lower middle class people underwent great hardship during these months, standing for hours in bank and ATM queues, and managing their lives with a chronic shortage of cash. Yet the thought that it was all in a good cause, and that holders of black money were suffering even more, kept them in relative good humour. But now, if it turns out that black money holders have managed to have the last laugh, and that common people have suffered for nothing, won't the voting public be outraged?

5. Paradoxically for a move that caused such widespread suffering, demonetisation boosted Modi's personal popularity. He was seen to have struck a blow for the common man against corruption, and the people were willing to suffer to see his efforts successful. The word "masterstroke" was often used, along with the phrase "He has delivered!" Modi seemed like a clever and decisive leader who had outwitted the enemies of the country and placed India on a path to growth and prosperity. Now everything has been turned upside-down. Modi no longer looks clever. He looks like a fool. The crooks have taken him for a ride.

Outwitted - an uncharacteristic look for a perpetually smug politician

This is politically explosive stuff. If it becomes common knowledge, Modi will be politically weakened, perhaps so badly that he may lose the 2019 election.

And that is why I believe RBI Governor Urjit Patel is trying to dissemble, obfuscate and delay his way out of the mess he has been forced into. His political masters have forced him into this sorry situation.

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