Modi’s disruptive innovation

  By Vijay Darda | 11-11-2016

Special Report 

In the field of business and technology, this is the era of disruptive innovation. Displaying his quintessential Gujarati entrepreneur’s character, Prime Minister Narendra Modi has unleashed the most disruptive innovation for the economy. He fully understands that India is a predominantly cash economy, and has thus withdrawn almost 86 per cent of the currency overnight. His decision to demonetise the high value Rs 500 and Rs 1000 bank notes is the boldest possible disruptive innovation to check the menace of black money.

At once holders of black money are faced with a Hobson’s choice. Either they put the money in the banking system, follow the rules or that money is worthless paper. It is a win-win situation for the prime minister irrespective of the choice the holders of black money exercise. In either situation, the system would be flushed of unaccounted cash. It is nobody’s case that the entire high value currency represents the parallel black economy nor do we have any firm estimates of the black money, but in the process of demonetisation whatever percentage comes back into the system would signify a boost to the GDP, the revenue income and the taxation system. Besides, it would act as a booster dose to the debt-ridden banking system, with all the major banks either reporting losses or a decline in profits.

It is obvious that the move represents a significant disruption of the economy. While the attention is focussed on the hassles faced by the people who have to get the currency notes replaced or the problems in carrying out transactions without the assistance of currency notes (immediate payments at every point), the real impact of the decision would be felt by politicians, bureaucrats, real estate dealers, jewellers and diamond merchants – all people with a proven track record of handling large chunks of unaccounted cash. 

Now the penalty that has been proposed for those who declare more than `2.5 lakhs in their bank accounts that is not commensurate with their previous tax returns is the usual rate of taxation plus 200 per cent fine (this is akin to virtually confiscating the money) is likely to be a deterrent for the persons with black money. In the past when this route was used for unearthing black money in 1978 only 15 per cent of the cash came into the systems.

Observers point out that at that time the high value denomination notes constituted less than 10 per cent of the cash in circulation, but now this figure is as high as 86 per cent, so that cannot be a basis for comparison. But the move comes with a certain amount of pain, that is real and cannot be simply wished away. For instance, the farm sector and especially the one that deals with perishable products. This runs mostly on cash and if the traders do not have the cash to lift the produce from the mandis then the decline in demand would be real. Likewise, the problems of families that have marriage scheduled between November 10th and December 30th the cash crunch is simply crippling. Similarly, for patients admitted to private hospitals and with planned or unplanned surgical treatments that entail huge costs – cashless transactions are not an option. The other segment to suffer would be the small wage earner who is below the income tax bracket, and has substantial savings for future expenses. The limit for exchange of old notes is crippling for such people.

The only hope for such people is that the gain in terms of lower inflation is worth the pain. Or else it does not make much sense to call Rs 500 a high denomination note, when you can buy just 2 kg of dal with it.

There is a compulsion to have high value currency in the market, and this also explains the need to introduce Rs 2000 notes to factor inflation (after all it is much easier to replace four Rs 500 notes with a Rs 2000 note) but it does not seem to inspire confidence that this would reduce the generation of black money.

The managers of the economy are fully aware that the denomination of the currency notes in circulation has nothing to do with the generation of black money. The system to check that has been less than efficient, and there is a real danger that the current demonetisation exercise may prove over time to be something akin to mopping the floor with the tap running in so far as curbing the menace of black money is concerned.

In the immediate future, the impact could be seen on the state assembly elections due in Uttar Pradesh and Punjab that even otherwise witness a play of liquor and money, and drugs in the case of the latter. Even if there is no real cash crunch as the politicians will continue to use high profile choppers and maintain their lifestyle, the move would be a good alibi to starve the workers and the activists of the funds.

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