Why Modi is unscathed despite demonetisation bungle

A year has passed since the launch of India's controversial demonetisation drive. In a dramatic night-time address that stunned the nation and much of the world, Prime Minister Narendra Modi announced last November that the country's 500-and 1,000-rupee notes were no longer legal tender.

Citizens would have until the end of the year to exchange the old notes for new ones, but would be required to answer questions about the source and tax status of their cash. Mr Modi justified the move as a necessary step towards combating "black" or undeclared money, and with it, rampant corruption, tax evasion and a host of other ills afflicting the Indian republic. The decision voided 86 per cent of the cash in circulation in India overnight.

Now, one year later, the question that naturally arises is whether demonetisation succeeded. The answer depends largely upon the prism through which the question is viewed. Economically, the decision made little sense and did little to achieve its stated aims. Yet, politically, demonetisation appears to be a winner with broad segments of India's population supportive of Mr Modi's efforts to fight corruption no matter how ineffective the method.

One of the primary objectives of the cash ban was to stem the flow of billions of dollars worth of black money coursing through India's economy. On this front, demonetisation has been an unequivocal failure.

According to a recent report issued by India's central bank, nearly 99 per cent of the invalidated currency was re-deposited or exchanged for new bank notes and ultimately put back into circulation.

Architects of the campaign expected tax evaders to forfeit their illicit cash rather than risk detection and possible prosecution. They were sorely mistaken, with millions of violators devising innovative ways to whitewash their black money.

Demonetisation has also harmed India's short-term economic growth. Figures released earlier this year revealed that India's first-quarter growth had fallen to 5.7 per cent, almost a full percentage point lower than the 6.6 per cent government analysts had predicted initially. During the same period last year, gross domestic product growth stood at a robust 7.9 per cent.

That hundreds of millions of Indians were willing to endure the hardships created by the cash ban tragically illustrates the magnitude of India's endemic corruption problem and the deep public frustration surrounding it.

The sudden and drastic reduction in the cash supply inevitably dragged down the economy as several cash-reliant sectors, including real estate and construction, ground to a virtual halt. The agricultural sector also contracted, with cash shortages leading to falling demand, a collapse in prices and a rising number of destitute farmers. This is a damning indictment of India's self-proclaimed pro-growth government.

But perhaps the biggest casualty of the cash ban has been the average Indian, with the country's poorest citizens hit particularly hard. India's economy is 90 per cent cash dependent and the abrupt cash ban created a spectrum of hardships for hundreds of millions of Indians across the country. In addition to the disruption in day-to-day economic activity, scenes of barren cash machines, pandemonium outside banks and daily suffering became commonplace. It became quickly apparent that the Modi government had badly bungled the roll-out of one of its signature policy programmes.

Prominent Congress party leader and an MP, Dr Shashi Tharoor, seems to have captured widespread sentiment by characterising demonetisation as "an unmitigated disaster, ill-conceived, unprepared and poorly implemented". The result, he concludes, has been "all pain, no gain".

Dr Tharoor's devastating indictment of the cash ban and its government champions finds support in the data available thus far.

But while the cash ban may have been the wrong move economically, it may prove to be the right one politically.

Although experts both inside and outside India expected Mr Modi to pay a heavy political price for demonetisation, his fortunes in this arena appear to have only improved over the past year. In March, voters in the Indian state of Uttar Pradesh handed Mr Modi's Bharatiya Janata Party (BJP) a landslide victory at the polls. The state is India's most populous and also among its poorest. Taking place less than four months after the cash ban was implemented, the election was seen as an important test for India's Premier in the chaotic aftermath of demonetisation.

The huge win signalled that Mr Modi's political standing was not only still intact, but had also possibly grown more secure.

Counter-intuitive on its surface, the election result demonstrated that large segments of the Indian public supported Mr Modi's goal of fighting corruption even if the means he used to do so did not work. Put simply, Mr Modi earned credit for the attempt rather than the outcome.

That hundreds of millions of Indians were willing to endure the hardships created by the cash ban tragically illustrates the magnitude of India's endemic corruption problem and the deep public frustration surrounding it.

As Mr Jayant Sinha, an MP and the BJP's Minister of State for Civil Aviation, recently wrote: "The people of India recognised that a surgical strike was required to curtail illicit activities and blessed demonetisation. Thus, in political terms, demonetisation has already proven to be a resounding success."

And there may be reason for cautious optimism beyond pure political considerations. Supporters of the currency ban point out that India's economic growth is likely to get a boost in the medium term as the country's tax base grows as a result of demonetisation. Experts agree.

Moreover, digitisation in India's mobile banking sector experienced a surge following Mr Modi's announcement. Digital payment provider Paytm, backed by China's Alibaba Group Holding, reported 170 million new users, a 435 per cent traffic increase and a 250 per cent increase in overall transactions and transaction value in the weeks and months following the cash ban.

• The writer is an affiliate at the South Asia Institute at Harvard University and a Law and Security Fellow at United States think-tank New America.

A version of this article appeared in the print edition of The Straits Times on November 23, 2017, with the headline 'Why Modi is unscathed despite demonetisation bungle'. Print Edition | Subscribe