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Demonetization - A Perspective

Demonetization - A Perspective
Blogs from Our Experts | January 27, 2017

Some fruits smell better than they taste. That is how we would describe demonetization.

The obvious benefits of demonetization – reducing black money, impairing terrorist funding, reducing counterfeiting etc. are noble goals. Similarly, drawbacks such as short term hit to economy and disruption to day to day life are also obvious. Whether one can truly achieve the noble goals at the cost of drawbacks is an open question.

Let us highlight some of the more insidious side effects of demonetization and the accompanying rush to force plastic money on the unsuspecting populace.

We are not too hung up on the short term hit to the economy are cautious with the timing and strength of recovery. People with an engineering background will be familiar with the heightened risk of failure during the time when systems are shut down and restarted. A short term hit can easily extend if a harmful set of unknown unknowns decide to show up. There are examples of such experiments and the closest example of the current demonetization is Italy when it joined the European Union and Liras were exchanged for Euros. In a lot of respects, Italy is and was like India. Italy had a vibrant parallel economy before joining the union. In subsequent years, Italian economy never consistently recovered to its pre union economic growth.

Our biggest gripe with the demonetization done in a ham fisted way is that it has set India back by decades in trying to become a true global power. One of the hallmarks of a true global power is the availability of special drawing rights (SDR) at the International Monetary Fund (IMF). Currencies which form SDR are known as reserve currencies and no power is truly a global one without having its currency as part of SDR. Ask China, which spent years for the privilege. The overnight edict and removal of the currency is not going to inspire confidence in international community and especially the investing kinds. At the minimum, government could have made some sensible arrangement to ensure that Indian currency being held legitimately by people not living in India is exchanged in a systematic manner. It must not require a visit to India to exchange such currency.

On a poignant note, PM Modi is lucky that we do not live in a society that has a balanced legal system. Because if we had a proper legal system, the Government of India would have been sued left, right and center by people who have lost their lives out of stress, anxiety and standing in lines trying to exchange their hard earned livelihood. This is us being sarcastic because we are sure that the government thinks losing a few lives for the sake of greater good is just. It is not just as government decides whose life is precious and whose is not.

In cash rich economy, cash acts as more of economic grease than people think – both in spurring spending and easing transaction, especially when the legal system is neither expedient nor based on proper contractual laws. The drying of such grease can create a lot of unintended consequences.

Finally, this demonetization can be characterized as a true disruption (where the result is unknown but will be extreme). Disruptions often present strategic risks where it is hard to assess their potential nature and impact due to non-availability of any historical precedent and uniqueness of the external environment. Therefore, strategic risks originating from such events cannot be managed in traditional ways and will require

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Kamal KaseraFixed Income and Currency

Fixed Income and Currency Research

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