Friday, December 02, 2016

Modi's demonetization was bad idea, is badly executed, would lead to institutional failure, warns "The Economist"

Demonetization as seen by "The Economist" 
By Our Representative
In a scathing critique of Prime Minister Narendra Modi’s demonetization drive, top British weekly “The Economist”, in its print edition dated December 3, has controversially commented that that “withdrawing 86% by value of the cash in circulation in India was a bad idea”, and is being “badly executed.”
Quoting John Maynard Keynes, whose ideas fundamentally changed the theory and practice of macroeconomics following post-first world war recession, “The Economist” quotes him as disapproving of VI Lenin’s demonetization in Soviet Russia in 1919 thus: “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.”
“Trust is fragile, and precious”, “The Economist” warns in its commentary titled “The dire consequences of India’s demonetisation initiative”, adding, “Managing an economy’s money is among the most important tasks of the government. Clumsy use of monetary instruments comes with high risk.”
The weekly insists, “More financially mature economies than India would struggle to cope with such a scheme, but this one floundered at once. Though Indians have until the end of the year to swap their defunct bills, the roll-out of new ones has been bungled.”
Pointing out that critics are “rightly” aghast, the powerful periodical which is most widely read among intelligentsia across the world, the weekly says, “Much of the wealth of those enriched by the black economy would be insulated, because lots of their lucre is held not in cash but in property, gold or jewellery.”
It adds, “Such heavy-handed measures could undermine the credibility of important government institutions. Fear that they might be used again in future could weaken confidence in the currency as a store of value—paving the way for some broader institutional failure, like hyperinflation.”
Underlining that “long-run trust in the judgment of the state might be threatened”, the weekly says, “A broad cash crunch and broken supply chains threaten a sharp economic slowdown... India’s ‘demonetisation’ is a cautionary tale of the reckless misuse of one of the most potent of policy tools: control over an economy’s money.”
“Some economists hope the money will be recycled back into the economy through a fiscal stimulus, which might help soothe some of the pain caused by demonetization”, “The Economist” says, though adding, “The status of this would-be windfall is uncertain.”
“However clever the plan looked on paper”, the weekly says, “It is both extraordinarily blunt and risky. Demonetisation will probably make only limited strides in shrinking the black economy while affecting all of India’s 1.3bn citizens, the poorest most of all.”
“In much of the Indian economy, and especially outside big cities, where cash transactions are most common and financial infrastructure least developed, the sudden invalidation of a vast amount of outstanding currency represents a significant monetary shock”, it says.
“Not all of India’s shadow economy—which provides real employment and income, if not real tax revenues—can migrate quickly and easily above board. Whatever cannot easily be shifted represents a potential loss of economic activity, and a drag on broader Indian economic growth”, it predicts.
“Similarly”, it says, “If a cash crunch forces small firms without access to credit to shut down, the eventual alleviation of the cash shortage might not lead to an immediate and complete revival of economic activity.”

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