Messing around with the money in people’s pockets – or stuffed in their mattresses – can prove politically painful, as Indian Prime Minister Narendra Modi is discovering. Two weeks ago, when the world’s attention was focused on the US presidential election, Modi sprang a surprise. In a televised announcement, he declared that India’s 23 billion 500 rupee and 1,000 rupee banknotes – HK$57 and HK$114 respectively – would cease to be legal tender with immediate effect.
For the Indian population, the news came as a monstrous shock. India is overwhelmingly a cash economy, with the two denominations of notes rescinded by Modi making up almost 90 per cent of the cash in circulation by value. Unsurprisingly, the Prime Minister’s move caused widespread chaos, with reports of crowds mobbing banks in an attempt to exchange their old notes for new, ATM machines breaking down, business grinding to a halt for a lack of cash, workers going unpaid, desperate savers committing suicide in the belief their hard-earned wealth had been wiped out at a stoke, and hospital patients being left to die because staff refused to accept their out-of-date notes.
The mayhem was entirely predictable. The last Asian country to attempt something similar was North Korea, which in 2009 announced it would replace its old banknotes with new ones “to strengthen the national currency and stabilise the circulation of money”. Unfortunately it also decreed that households could only exchange up to 100,000 won of the old notes – about HK$450 – a move that immediately wiped out almost all the capital of the nascent private sector. The result was instant economic collapse and widespread hunger as the price of rice shot up 30-fold in just two months. The two hapless officials who received the blame for the fiasco were executed by firing squad a few weeks later in front of a specially invited audience.
Even more disastrous was the 1987 redenomination of the kyat ordered by Burmese dictator Ne Win. Obsessed with the magical properties of the number nine, Ne Win declared Burma’s existing banknotes invalid, replacing them with 45 kyat and 90 kyat notes – denominations divisible by nine. His command may well have satisfied some obscure mystical imperative, but it also wiped out the population’s accumulated savings, triggering mass protests and their brutal suppression the following year.
For all that, you can see why India’s Modi took such a drastic step. One of the main aims of his two-and-a-half-year-old government has been to bring India’s vast parallel economy – reckoned to be worth anywhere from 20 per cent to 75 per cent on top of the country’s official gross domestic product – into the formal sector, where it can be taxed and where there are fewer opportunities for criminality and corruption.
To this end, the government launched its Aadhaar identity card programme, under which government benefits are paid directly into Aadhaar-linked bank accounts. However, progress has been disappointing. Although the number of bank accounts has doubled to around 400 million, the majority of Indian households and small businesses still operate exclusively in cash, with the value of banknotes circulating among the population equal to 12 per cent of GDP – much of it unaccounted “black money”.
To try to bring this money into the official system, Modi’s scheme only allowed Indians to exchange INR4,000 – now expanded to INR4,500 – of old notes for new. Any cash holdings in excess of that amount must to be deposited in a bank account by the end of this year to retain their value, with anyone depositing more than INR200,000 likely to face investigation by authorities.
Despite the panic Modi’s move triggered, his bombshell is unlikely to achieve much more than a modest reduction in petty corruption and small scale tax evasion. The big players have more sophisticated ways to circumvent the rules. However, by clamping down on the informal economy, Modi has caused considerable short term hardship, which is likely to have detrimental consequences in the longer term. By throwing sand in the wheels of the informal economy, Modi’s initiative is set to cause a slowdown in growth next year. And given India needs to create about eight million new jobs each year to employ its rapidly growing young workforce – compared with the three million it is currently creating – a slowdown is something the country can ill afford.
There will also be a political cost. Modi’s aim of bringing more activity into the formal economy makes good sense, but if it is to work, ordinary Indians will have to buy into his vision. By springing such a disruptive move on the population – a move moreover that was all stick and no carrot – he has damaged trust in India’s institutions and may have undermined his hitherto considerable popular appeal. In the long term, the prime minister’s move may still pay off, but given the execrable way it was mishandled, it is unlikely to deliver the near-term political dividends Modi originally hoped. ■
Tom Holland is a former SCMP staffer who has been writing about Asian affairs for more than 20 years