By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends most of her time in Asia researching a book about textile artisans. She also writes regularly about legal, political economy, and regulatory topics for various consulting clients and publications, as well as scribbles occasional travel pieces for The National.
Economic chaos in India continues, as further details emerge concerning the government’s inadequate planning for implementing its plan to demonetize all Rupees (Rs) 500 and 1000 notes in an anti-corruption effort. Prime Minister Narendra Modi in a November 8 speech announced that these notes– accounting for more than 85% of cash outstanding– would no longer be legal tender as of midnight that night. I outlined the plan in this post last week.
[Jerri-Lynn here: To make it easier for those who don’t know the rupee’s current value offhand and don’t want to look it up to understand this post, Rs 500 is today roughly equivalent to $7.34, while Rs 1000 is about $14.68.]
Demonetization has sparked widespread economic suffering, especially among the poorest Indians, as I discussed in this post from earlier this week. I also examined how the government seriously underestimated the technical challenges that accompany making a currency changeover of this magnitude, and only appointed a task force on Sunday to address one of these challenges, the tricky technical task of recalibrating ATMs.
Since I published that post, additional information has come to light, suggesting that the Modi government– including the Finance Ministry and the Reserve Bank of India (RBI), the central bank– is far behind the curve in implementing demonetization, especially in producing the necessary new currency to supply demand. There remains an acute shortage of cash for day-to-day transactions– a shortage that is now expected to take months to resolve– rather than the weeks that the government previously estimated.
This short video of an English language interview with former Finance Minister Palaniappan Chindambaram discusses the Modi government’s miscalculation:
P. Chidambaram gives a very logical explanation of Rs.2000 notes and paints a scary picture of “Demonetization” scenario. Must watch. pic.twitter.com/a3eVIPw4mi
— …. (@ynakg) 17 November 2016
The key takeaways:
“They have blundered,” says Chidambaram. “They have blundered hopelessly. They are trying to race against time.”
2,100 crore in currency notes must be replaced [Jerri-Lynn here: under the Indian numeric system, a crore is equivalent to 10,000,000].
The capacity of existing printing presses is 300 crore notes per month.
If the government wants to replace (and print) 2,100 crore notes, by equivalent denomination notes to those made non-legal tender by demonetization, it would take them seven months simply to print the notes, which is why Rs 2000 notes are instead being printed.
There is no economic justification for the higher value notes. If the government is demonetizing Rs 500 and Rs 1000 notes, why is it introducing Rs 2000 notes? His answer: only to reduce the number of notes that must be printed.
It will still take 5 to 6 months to print the necessary currency notes to replace the value of the notes withdrawn.
To print sufficient Rs 100 notes [Jerri-Lynn here: a far more usable denomination for ordinary Indian cash transactions] would take five times as long.
Now I should mention a few facts for non-Indian readers. Chidambaram is far from a disinterested observer, having served as Finance Minister in the previous Congress Party-led government. There’s no reason to conclude, however, that he’s ill-infomed or what he says is inaccurate when he discusses the present government’s inadequate planning for demonetization. And I should note that his claims have been backed by other reporting. (He also has a reputation for being intellectually astute.)
(For those readers who have greater interest in the issues that Chidambaram raises, I include a link to a longer, thirty-minute interview with him (also in English), conducted by M.K. Venu, founding editor of The Wire, an online news source committed to being financially and editorially independent.)
As LiveMint reported on Thursday,
A week after the government withdrew high-denomination notes, it is struggling to meet replacement demand with smaller-denomination currency bills.
While the new Rs 2,000 note has started circulating in the banking system, far fewer new Rs 500 currency pieces are ready.
The Security Printing and Minting Corp. of India Ltd (SPMCIL), the government agency that produces notes and coins, has printed only 15 million pieces of the new Rs 500 note, said two people aware of the matter.
The order for the new Rs 500 note was 400 million pieces by November, but the presses at Dewas (Madhya Pradesh) and Nashik (Maharashtra) are running below capacity, leading to a delay in the release of this note.
Printing policy was apparently set to produce the highest replacement value of currency, rather than based on any detailed understanding of how currency typically circulates, and in what denominations, in the Indian economy. Again, according to LiveMint:
“We planned to first bring the 2,000 rupee notes as the focus was to create high-value notes to ensure the smooth replacement of the old 500 and 1,000 rupee notes. We would have to print four 500 rupee notes for every one 2,000 rupee note. If we would have focused on printing the 500 rupee notes, the entire printing exercise would have taken much longer,” said an official who didn’t want to be named.
I am currently visiting Kolkata, India’s second-larger city, which has a population of more than 13 million people. New Rs 500 notes continue to be unavailable (as of November 18). Although Rs 2000 notes are available, these are not useful for conducting most day-to-day transactions. From first-hand experience I can also say that it is virtually impossible to get change for the new Rs 2000 notes. Smaller denomination notes– Rs 100, 50, 20, or 10– have remained legal tender throughout the demonetization exercise. But the supply of these is insufficient to meet overall demand for cash, leading many to opt instead for informal credit transactions. To give some sense of how outsize the Rs 2000 notes are, “[A] week’s worth of vegetables for one person costs no more than Rs 150, a takeaway order of a full tandoori chicken costs Rs 280 (with a further Rs 80 for two orders of naan bread), most taxi rides around central Kolkata don’t even top Rs 100, and ten tablets of aspirin cost Rs 3,” as I noted in an earlier post.
Inconsistent RBI Policy
The circulars issued by the RBI and the Finance Ministry convey the impression of ad hoc, reactive policy, rather than a comprehensive, well-considered plan. For example, as of Tuesday, a customer with proper identification could exchange up to Rs 4000 in old Rs 500 and Rs 1000 notes for new currency, or smaller denomination notes (which, as I have mentioned, was legal tender). Old notes beyond that threshold could be deposited into a bank account, and sums later withdrawn in legal tender currency, subject to daily and weekly caps.
On Wednesday, the Finance Ministry increased the value of old notes that could be exchanged to Rs 4500. But on Thursday, the Finance Ministry abruptly reversed course, and reduced the exchange limitation to Rs 2000, effective on Friday. At the same time, the Finance Ministry introduced several exemptions as summarised by The Hindu (the full article reproduces the circular’s exact text):
Based on representations, farmers will now be allowed to withdraw up to Rs 25,000 each week against loans sanctioned to them or payment received through cheque or RTGS.
To enable smooth procurement, traders registered with the APMC market will be allowed to withdraw Rs 50,000 per week.
For those preparing for a marriage in the family, the father, mother, bride or bridegroom will be permitted to withdraw up to Rs 2.5 lakh in cash. Only one such withdrawal will be permitted per marriage. [Jerri-Lynn here: Under the Indian numeric system, one lakh is quals 100,000].
Central government employees up to grade C will also have the option of getting up to Rs 10,000 advance salary in cash.
The real economy has obviously slowed down significantly, due to a lack of sufficient legal tender currency to conduct ordinary economic transactions. But this is a problem that cannot be immediately alleviated, according to Clive, an expert in bulk cash management, and with whom I have exchanged several recent emails (which he has given me permission to quote freely). Now, to be sure, Chindambaram’s assessment of the time required to fix the problem may be unduly pessimistic. Crucially, he doesn’t consider whether there is worldwide capacity for quickly producing necessary replacement currency notes.
Over to Clive:
There’s a finite capacity limit for a bank note producer to get the notes ready for distribution. While bulk note manufacturing is done at a fairly high output rate, it’s not that fast (as you’d guess, the end product has to be absolutely perfect and it has to be checked and checked again — and the notes’ security features need separate checking processes).
Bottom line: if existing indian printing arrangements are insufficient to supply necessary notes in a timely fashion, it appears there’s insufficient worldwide capacity to supply India’s bank note needs. India’s problem doesn’t seem to be one that can be solved in a few weeks– the government’s estimates notwithstanding.
Unfortunately, even that unduly optimistic time frame may be too late for alleviating the considerable negative real economic impact demonetization is having, as already reports are surfacing that key Indian distribution channels may be shutting down, due to lack of sufficient currency to conduct day-to-day transactions. The cash shortage is further expected to slow India’s rate of growth. The Economic Times reports that:
[B]rokerages and economists [are] revising their GDP growth estimates sharply downward as a result of the cash squeeze created in the economy.
Till the other day, the domestic economy was projected to grow at above 7.5 per cent in FY17, with the International Monetary Fund (IMF) itself raising its projections by 0.2 percentage points this October to 7.6 per cent for 2016-17 and also for 2017-18.
In July, World Bank projected India to grow at 7.6 per cent in 2016-17. Rating agency Fitch earlier this year had projected India’s real GDP to accelerate to 7.7 per cent in 2016-17 and 7.9 per cent in 2017-18.
The economy expanded at 7.6 per cent in financial year 2015-16, outpacing China for the second year in a row.
Post-demonetisation, GDP growth projections for the Indian economy for FY17 has slipped to as low as 3.5 per cent.
Sadly, it is the poorest Indians who will be hurt the most by this growth slowdown.