Demonetization: The essential objectives

[Disclaimer: All the views expressed in here are personal and do not reflect the opinion or the position of the organization that the author works for.] 

It is becoming evident from the long lines at ATMs across India, and the troubles faced by the farmers and small-time traders, that the implementation of the demonitization initiative has been quite poor.  Clearly, it could have been planned better and executed better.  As Supreme Court of India warned, if things don’t improve, we could see riots in this country.

But the poor implementation is not good enough reason to conclude that this exercise will not achieve its objectives.

So what are those objectives? 

Unlike most people in India, including those who actually introduced this initiative – namely the Prime Minister and his team, I don’t have unrealistic expectations from the current initiative of denotification of the existing 500 and 1000 rupee notes.  

According to me, the objective of this exercise is not that much about curbing counterfeit money, nor about trying to ‘get out’ the black money from their hideouts.  Yes, the introduction of new currency notes would obviate the problem of counterfeit notes, but only for a while, because if the enemy is insistent on copying and releasing even the new notes, they could do so, given some amount of time.  And, unlike what most people hope, there is no need for black money to be deposited into the banks.  If that money cease to exist, it is good enough.  The shortfall in circulation or non-existence of the black money is good enough for the Government to infuse more printed notes, thereby giving itself a fillip in public spending on infrastructure projects. 

Also, the objective is not to remove the higher denomination notes just because it makes it easy for hoarding black money.  With introduction of 2000 note, which is higher than the erstwhile 1000 note, that objective is anyway not even addressed.  And most importantly, India can never become 100% cash-less society either. Cash will continue to be a dominant form of tender, but cash-less transactions will increase exponentially.

So, the moot question is: why support this demonitization initiative if the above ‘stated’ objectives by the Prime Minister and his team are not so important?

I think there is another unstated objective which, according to me, is far more important.  It is about putting our house in order. 

1. To change the way we do business going forward

For any country to be effective, like any organization, the formal discipline of doing business is important.  For a company to be effective, one of the first steps is to streamline the processes, make the stakeholders accountable and trackable, so that you have a grip on what’s happening in the company.  Only when you have control on the proceedings and the actors, can you plan for efficiency, profitability and pursue excellence.

And yet, that’s not the case with our country.  With bulk of our business transactions being conducted in an informal, unaccountable way, there is no way one could keep a check or track on what’s happening.  This doesn’t allows us to strive for improving the system and get the best results.  Most of the rewards, if any, are squandered away.

Imagine a company like Microsoft.  Instead of the company making profits on the sale of its software, if each employee is selling the software on the side, how would Microsoft survive? It would go defunct.  That’s exactly what was happening in India. 

Far too many transactions, trade, business, real estate, jewellery, employee salary and wages, were all being done without accounting for them.   That’s loss of tax revenues for the state, allows for unmanageable inflation, and creates a shadow and alternate economy that competes with the mainstream economy by creating uncontrolled disruptions – imagine one employee of Microsoft suddenly releasing 1 Million copies of its software into the market, competing with the company itself.  What would be the profit to the company? You can only imagine.

  

Streamlining the businesses not only helps the State, but also helps the traders and the wage earners who it is hurting right now owing to cash crunch.  Because they currently conduct their business in hawala, or black, or in unaccounted way, the prices and quality of products cannot be regulated, their business agreements cannot be legally honoured - the lack of accountability leads to inefficiencies and sporadic losses.  But if these businesses are streamlined, the overall business health improves, the traders get secure, and they can use their legitimate assets to raise capital, and apply for insurance, and get legal help where necessary.  If things don’t go well, they can file bankruptcy and save their families in a legal way, instead of facing blackmail, threats, mental pain and agony.  Meanwhile, the wage earners will develop a credit history, use that to avail car loans, home loans, and buy health insurance.   This will secure their lifestyle. 

For far too long, our businesses have not had proper accounting methods, their transactions were not reported, and taxes were not paid.  Only 3% of India pays taxes.  Most of the transactions are based in cash – mostly to avoid taxes, but they end up not creating the necessary formal accounting procedures.  The cash that is obtained without paying taxes is called black.  Some of it is stored as cash, but most of it is converted into buying property or gold.  But even the transaction on buying property in India is shady – where only a little portion of the property is paid in white, while the rest is all black.  This is once again done to save on property tax.  So, the vicious chain continues.  Most Indians have got into a habit of not paying taxes, telling themselves it is OK not to pay taxes.  Give such self-feeding mechanism of saving your taxes a few decades, what we get is a completely broken system.  And that has been India.

Putting a small company in order after 3 years of bad accounting takes few months to clean up.   This country has been doing bad business accounting for many decades.  A move like this, though a shock treatment, is essential to set the ball rolling towards proper accounting methods.

The biggest outcome would be: we would have achieved a change in attitude, of the people, of the businesses, on how we trade, and how we buy and sell.   Our DNA would have changed.  All of us will insist on proper method, and oppose improper methods in our transactions.

Like how an Indian landing in US suddenly starts following its rules without putting up any resistance, following rules in accounting, adopting formal policies, doing it the right way, will become natural to Indians. 

Therefore the primary objective of this initiative is to streamline our businesses forcing them to adopt legal and accountable methods, which the current initiative of demonitization will achieve.  This has far reaching implications on the overall economy of the country, and that takes us to the second objective. 

2. Improve the overall economy. 

Though there could be a lull in the economy during this transition period, eventually the economy will get a fillip.  With more deposits, the banks will lend out more loans, at lower interest rates.  The government will earn more tax revenues from accounted transactions thereby leading to lower income tax for people and businesses.  This will give more spending power to people, and increase industry in the country.  This will further increase the GDP and further increase the tax base.  Real estate transactions becoming accounted will give the State more revenues, decrease the real estate prices, and the buyers will now avail the legal way to finance it without resorting to convert their white money into black.  Knowing the exact circulation of the currency in the market allows the government a good handle on inflation, which in turn has a bearing on reducing the interest rates.  

Doing it the proper way gives financial security to people and businesses.  They will no longer feel compelled into storing or stashing their savings in the form of cash, property or gold.  Secure businesses and secure people take bold decisions in business.  Such an environment creates more entrepreneurs.  It allows for businesses to scale in legal way, go public using stock market.  The accountable way of transactions will discourage people from parking their money in real estate or gold, and instead put their money into institutions like banks, funds or stock market, which in turn will help Indian businesses to scale and grow.

Yes, the government has bungled its implementation, but the decision itself is bold, transformative, and laudable, and will bring in positive results in the long term.