Only way out of demonetisation disaster is remonetisation

For an long time now, Prime Minister Narendra Modi has been silent on economic questions — especially on demonetisation. He could have stated that he and his Cabinet underestimated the extreme difficulties of the note ban, and that he would do his best to improve the travails ordinary citizens have faced.

Perhaps, most leaders in Modi's position would have done so, but he remains tight-lipped on the issue.

This is likely to hurt him politically as the upcoming polls are likely to reveal.

The NDA has few excuses to offer for the disastrous policy. Western economists like Kenneth Rogoff have repeatedly pointed out that demonetisation is not recommended for developing countries, where cash flows are relatively low.

It has also been pointed out that the note ban should be put in place only for high-denomination currency. However, the ₹1,000 note is only about $15 in US dollars, which economists like Rogoff say is too low to be demonetised.

Others like Lawrence Summers, former president of Harvard University; Bengt Holstrom, 2016 Nobel Laureate for Economics; Kaushik Basu, Chief Economist, the World Bank and Amartya Sen, Nobel Laureate in Economics had similar positions.

Three-and-a-half months have passed since the drive came into force. Yet, important facts are not yet in the public domain. RBI governor Urjit Patel has been unable to provide the details of amount deposited in cash in the central bank. A Bloomberg report estimates that 97 per cent of the demonetised currency was in the RBI and associated banks.

If the RBI governor is unable to provide crucial details to the standing committee on finance, or to the Public Accounts Committee (PAC), it is clear that the policymakers did not know what they were doing.

In late 2016, the government imported 8,000 metric tonnes of currency paper. This was apparently not enough and hence followed by the import of 27,500 metric tonnes of currency paper.

Why didn't the government do so earlier? What this means is the printing of the new currency notes will be delayed with cash flows still low.

When minister of state for finance Arjun S Meghwal announced that new "lower denomination" currency notes would be printed, it appeared that the was reacting after it was clear that enough currency paper was in store.

This would include ₹100, ₹50, ₹20 and ₹10 notes. But what about old notes of the same denomination? They too would be demonetised and deposited in banks. Why go to such trouble and demonetise all the old currency?

While this enormously tedious process is underway, our people are hurting. The rural sector is badly hit — availability of cash is limited as ATMs and banks have less cash than provisions in urban areas.

The poor farmers, facing cash constraints, are at the mercy of highly exploitative moneylenders and this leaves them in debt.

The informal sector, India's largest employer that mostly deals in cash transactions, has lost employees and jobs; sales have plummeted and unemployment steadily rising.

At the same time, there is no ameliorative policy instituted by the government. It seems the ruling coalition is pretending things will get better on their own. That never happens.

Finally, the media has come up with advertisements on how to remonetise. Simply put, the formula is spend as much as possible in the urban areas, so there is greater demand in rural areas.

But where is the extra cash? How does urban spending lead to cash transfers to the rural areas?

Urban spending almost invariably leads to cash accumulation.

It is also argued that expenditure must be cut down in urban areas. That, however, doesn't mean unspent urban cash will automatically penetrate the rural economy.

Remonetisation cannot be done without spending more cash from urban or rural sectors. It is not the area where the cash comes from during the note ban that is important.

The acute shortage has to be replenished with a fresh infusion of cash to increase the liquidity in the economy.

Today, even the ₹1,000 notes are not available. The new "lower denomination" notes promised by Meghwal have yet to be printed.

It will take at least six months for the new currency notes to be made available — and distribution of currency will longer. In the meanwhile, the economically-weaker sections and the middle class — the bulk of India's population — will suffer.

This will cause another problem: the newly designed currency will have to replace old notes of the same denomination, an onerous procedure. So there is no easy way out of the rigours of demonetisation but to remonetise.

As Kenneth Rogoff has pointed out, demonetisation requires five to seven years to systematically phase out high-denomination notes. In India, no notice was given to the people before undertaking the mammoth task.

The printing of the ₹2,000 notes started only two months before demonetisation, while the printing of ₹500 notes started only about two weeks before demonetisation.

Taken together, this is the most ruinous policy in Indian history. The coming months will show how the sturdy Indian people respond.