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Six months down the line, is demonetisation still the Devil?

Six months down the line, is demonetisation still the Devil?

By Jatin Bavishi

A lot of ink has already been spilt over the alleged impact, rationale and reason over the decision of the present government to cease backing Rs 500 and Rs 1000 notes as legal tender. Not intending to pump any more opinion into the already existing plethora of knowledge, the purpose of this piece is to bring to the forefront the reason why the one important rationale behind demonetisation, viz., to transform to a less-cash economy, made sense (at least to the authorities) and its subsequent effects.

Changing times: From fiscal dominance to monetary supremacy

Governments have broadly two policy measures at its disposal—monetary and fiscal. Since the 1980’s, the former has assumed greater significance over the latter. This was enabled partly by the academia which played its role by theorising the superiority of ‘rule-based market mechanism’ versus a ‘discretion-based bureaucratic allocation’.

According to economist Mihir Rakshit, dismantling of the ‘fixed exchange rate’ regime, which gave more room for monetary policy to operate, was also an important reason. At the same time, ‘targeting inflation’ became the primary concern. Theoretically, money supply (currency notes in circulation) and inflation have a positive correlation—a contractionary monetary policy, by reducing money in the hands of the public, reduces inflationary tendencies (by increasing ‘interest rates’ in the economy) which are an effective tool to curb inflation. This has led to an intensification of efforts to make Central Banks the paramount agency that conducts monetary policy free from political intervention.

Even within the ambit of fiscal policy, its role has been reduced to maintaining fiscal deficits (expenditure of the government over revenue earned) and the likes. There has also been a change in the medium of fiscal intervention which has been increasingly routed through the money market. India has been lured by these trends. Budgets and other policies over the past few years have proceeded by giving meaningless concessions in interest rates rather than through outright public expenditure.

The large swathes of cash in India has been cited as an important reason for the resilience it has shown to capitalist crises in the past. This nonetheless comes at a cost—reduced rate of returns for capital invested and a dilution in the efficacy of monetary and pseudo-fiscal policies. Hence, to give more power to the Central Banks, the idea to exhaust the ‘institution of cash’ was undertaken.

Demonetisation was not a shot in the dark and has definite theoretical underpinnings. To recapitulate, monetary policy has come to dominate fiscal policy, and even the fiscal policy has become ‘monetary’. The logic behind going cashless should be understood in this context.

A half-yearly appraisal

After the nation was jolted by the radical currency ban, growth is back on track in most sectors and stock markets are surging. However, many poor people still scramble to find work as the country’s vast informal sector continues to struggle. It is important to note that these are big businesses and capital-intensive sectors which have low employment elasticity (a measure of the percentage change in employment associated with a 1 percentage point change in economic growth).

Moreover, cash transactions are once again the norm. According to the RBI data, the number of digital transactions increased by 100 million to 200 million during 2014-16. This went up to 300 million till November last year. During the months of November and December 2016 when 86% of the cash was withdrawn the number of digital transactions shot up to well over 500 million. In the first three months since the currency regulations were withdrawn, the number of digital transactions fell to 350 million. This downward trajectory suggests hitting pre-demonetisation levels soon.

Six months is a short period in the life of any political process. Proper realisation of the objectives of demonetisation can only occur in due course of time.

Featured image source: Indian Express

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