On my trip back to Benguluru from
Mumbai, I realized that traffic on famed Bangalore streets appeared
to be much thinner than usual. As they say, cab drivers have the best
pulse of the city, so I decided to chat up with my cab driver on how
the recent demonetization and withdrawal of Rs 500 and Rs 1000 notes
is affecting him and the city in general.
I half expected him to strongly
complain about the sudden move and how the common man on the streets
is facing tremendous issues because politicians in far away Delhi has
decided to clean up the black money. However, I was surprised to hear
cab driver's positive opinion and subsequent praise he heaped on
Prime minister Modi. In his half broken Hindi, which he spoke with
great spirit, he informed me on the heaps of notes being burnt in
Benguluru halli's, his 15,000 savings on hand that he is unable to
use now, and his views on changing political dynamics of whole
country because of this move.
The current surge of patriotism in our
country is unmistakable. But have we committed a hara-kiri in pushing
the fastest growing economy in the world in a tailspin of recession,
unknown economic ramifications and political uncertainty. Lets have
a quick look to analyze this.
Demonetization in India is a cyclic
affair and is a political tool as well. Every 30-35 years, Indian
governments have implemented this tool, however with limited success.
The subsequent impact of these demonetization drives which happened
in 1946 and 1978, is neither well documented nor studied in depth. As
we can see in GDP growth rate chart for last 50 years, India's
economy was well under water for next two years following 1978
demonetization.
Output in manufacturing sector fell in
both 1979-80 and 1980-81 and crisis spread to construction, transport
and trade sectors as well. The recession and fall in private sector
investment was severe inspite of public spending going up in these
two years. Aggregate consumption and fixed investment slowed
considerably in year 1979-80. Reduction in wages in various sectors
was to the tune of -4% to -8% across various sectors in these two
years. All these factors contributed to a negative GDP growth rate of
-5.2% in year 1979-80, thus resulting in one of the most severe
recessions of last 50 years. Political uncertainty and economic
stagnation resulted in regime change in center in 1980 when Janata
government fell.
However, as hopefuls always maintain,
this time it is different. Urban India has moved to Internet banking,
online transfer, credit card, debit card and cashless payments. On my
two day trip to Mumbai, I had only four hundred rupees cash in my
pocket, and paid for airfare, hotel and taxi via credit card and
still had my prized possession of four hundred rupee notes intact in
my pocket when I came back to Benguluru. However, as my knowledgeable
cab driver informed me, cards and online transfer is only used by a
small minority even in urban India. And when it comes to rural India,
cash economy is the only available option, which is suspended
currently for at least the next few weeks to come. The long
serpentine queues and minor law and order situation in front of ATMs
today is maybe just the tip of the iceberg.
The impact on economy will be more
severe than anticipated. The usual suspects are cash based sectors
like real estate, election spending, small traders, agricultural
trading, small retailers, jewelry, weddings, luxury brands, and
many more sectors which contribute in a large way to Indian economy.
Indians will have less cash and will spend less, hence it directly
contributes to lower GDP growth for the next 1-2 years.
To increase economic growth in a
country, typically governments try to purchase bonds and push more
money circulation in the economic system. This is known as Keynesian
stimulus in economic terms. The current demonetization will suck
large amounts of cash from the economic system, and hence will be
counter productive for India's economy. Cash money hoarders will
prefer to burn their cash, instead of paying 200% penalty and hence
total money available in Indian economy will reduce, pushing India to
recession. Less money available in system contributes to less
expenditure and hence directly results in reduction of economic
activity.
Reduction in business and economic
activity, results in a cycle of reduction of wages and available
money in hand of common worker, which in turn again reduces the
amount of his/her purchases made on food, clothes, transport and
common expenses, hence impacting business and creating more cyclical
slowdown. I was reluctant to share the bad news with my taxi driver,
that probably in next 1-2 years, he should prepare for less people
taking a business trip from and to Bangalore, which will result in
less taxi trips for him and impact his take home salary.
The biggest impact will appear when
this gets coupled to impending rate hikes in US economy. Fed
authorities have signaled a rate hike regime in US, which is nothing
but movement of money to US bonds, hence reducing the money
available for investment in developing economies such as India.
Combine this with reduction in money
available within Indian economy and results can be temporary slowdown
at best and full fledged recession at its worst.
Coming back to the point I raised in
article earlier, we have possibly committed a economic hara-kiri in
pushing the fastest growing economy in the world in a tailspin of
recession and unknown economic ramifications. The best followup
actions for Indian government now is to bring banking system on its
feet back as soon as possible, increase public spending drastically,
plan in advance for next 2 years and take large scale initiatives in
job creating sectors to minimize monetary impact. And meanwhile, I am
planning to take bus transport instead of taxi for my next trip out
of city to save some cash!
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