Views of a Nepali Economist

On November 8, Narendra Modi suddenly banned the 500 and 1000 Indian Rupee notes, and thereafter popularized a word not many had heard before: demonetization.

Modi stated that this action was in response to the endemic corruption and black money in India. The logic is that black money in India is hidden under mattresses in 500 and 1000 Rupee notes. Modi thinks that banning the large denomination notes will render all that black money useless. However, 86 percent of India’s cash is in 500 and 1000 Rupee denominations. Also, much of India engages in cash transactions. So, it is not only the rich who have suffered from the ensuing chaos. Around 50 demonetization-related suicides have been documented in India so far. None of those 50 appear to be rich Indians.

So, how corrupt is India? For the year 2015, Transparency International’s “Corruption Perceptions Index” ranked India 80 in the world among the surveyed 168 countries. In South Asia, India fared better than Nepal (85), Sri Lanka (90), and Afghanistan (166), but worse than Bhutan (27) and Bangladesh (68). Maldives and Pakistan were not surveyed. So, India is in the middle of the pack in both the world ranking and the South Asian ranking.

While many Indians have lost their lives due to post-demonetization chaos, much more support and laud the action. To gauge the public’s reaction, Modi launched the NaMo app to collect the public’s vote on the issue. The results so far indicate that 93 percent of those that voted through that app approve of the Prime Minister’s action. However, only 500,000 people have voted so far, and chances are high that majority are BJP supporters who would blindly support any crazy idea that Modi can conjure.

Analysis and statistics will tell us in the future whether Modi’s demonetization action was a masterstroke or a dud. But, the policy is fraught with dangers.

There is a perception that corruption is ongoing in the name of ending corruption. Arvind Kejriwal—the Aam Aadmi Party leader—and others have accused Modi of informing his friends beforehand of the ban. While that is difficult to prove, what is easy to prove is that 1000 Indian Rupee notes were being bought by smart “entrepreneurs” for 600 in some parts of Nepal. If that is happening in Nepal, I can only imagine what is happening in India, mostly rural India where people have no access to banks. The opportunities have suddenly become rich due to Modi’s scheme.

Many people in other countries will suffer, too, as a result of this ban. There are millions of Indians all over the world who keep a certain amount of these large denomination notes with them. I have personally spoken to three of my Indian friends who live outside India, and they mention they each have around IRs 15,000-20,000 with them in 500 and 1000 denominations. That money comes in handy every time they visit India. How many billions worth of 500 and 1000 Rupee notes that Indians overseas have that are now suddenly worth nothing? Nobody knows.

This is a spectacular policy failure, especially because India wants to become a world economic power. It wants its currency to be traded worldwide, like the US dollar and the Euro. It even came up with a new symbol for the Indian Rupee with that purpose. However, Modi’s demonetization scheme just crushed that ambition. Can anyone ever imagine the United States suddenly deciding to ban all their 100 dollar bills? That would collapse the world economy. Thankfully, India is not the United States and the world economy is safe despite the demonetization folly. However, the demonetization action also means the Indian Rupee is nowhere close to becoming an internationally traded currency.

Even if the demonetization scheme achieves its purpose this time around, who is to say corruption in India will not continue in the future? What if the new 500 and 2000 Rupee notes do not curb corruption? Will India, then, issue 500 and 3000 Rupee notes?

The Indian government—in fact, all governments—need to understand that corruption exists because of other policy failures. For example, the Prevention of Corruption Act of 1988 considers both bribe-taker and bribe-payer in India equally guilty and both receive equal punishment under the law. That clearly goes against the intent of the Act to reduce corruption because a bribe would never be reported because both the sides stand to lose from the revelation. Other legislations, such as those that deal with bank and securities fraud, grant amnesty from prosecution to those who expose such frauds. However, the Indian law’s unclear language on amnesty and the onerous onus it places on the accusers has resulted in toothless action.

Kaushik Basu, the noted Indian economist, has been arguing for clear amnesty language for decades. He has proposed that the language of the law be amended to reflect that giving bribe is legal but taking it is not. In addition, if proven successfully that a bribe has taken place, the person receiving the bribe would not only have to suffer the legal consequences but also return the amount of the bribe to the briber payer. Basu argues that this would ensure the interests of the bribe payer and receiver are not aligned. Once the bribe is paid, the payer would have all the incentives to expose the bribe receiver.

Every corrupt country has to start somewhere to tackle the problem. India—as well as its poorly ranked neighbors—would be wise to give Basu’s ideas a chance. It is a more sensible policy, it won’t crash the world economy, and it will not make the poor commit suicides.

Labels: black money, corruption, demonetization