Demonetization - Game Changer Or a Missed Opportunity

The afternoon news on a certain channel on November 8, didn't have anything spectacular about it. One piece of news was about the PM's Cabinet meeting to review security. Routine. Or, so it appeared. At 8 I was on my way for a cuppa when I came by a mobile notification of demonetization of Rs. 500 and Rs. 1000 tenders. It was an announcement by none other than the Prime Minister himself. As the news unfolded, the extreme secrecy unfolded.

Spectacular Beginning

Everyone's face was gleaming. Every law abiding citizen was smiling ear to ear. Some reacted slightly differently - rushing through in the next 30 minutes to the nearest jewelry shops. To convert the stashes into yellow metal. One thing led to the other and back to back I received mails from designer watch boutique, high street shops, the grocery supermarket - all of them extending their working hours until midnight! Interestingly, there have been unverified reports that currency was being traded for gold at significant discounts up to 50%.

As a part of the same announcement, the medicine shops, petrol pumps, and few exceptions were allowed to accept large tenders, as a practical measure. The ATMs were supposed to vend only Rs 100 denomination from November 10. There were processes laid out for exchanging larger tenders for smaller ones, or for depositing large tenders until December 30, 2016.

The excitement that started on the evening of November 8 hasn't diminished so far. Be it the excitement in the ATM queues, or the banks. Everyone is keen to be ahead of his brother, neighbor, friend - to lay hands on new cash. Especially in Banks. So much so that they didn't mind standing for hours together. There was a gold rush!

Meanwhile while there were concerns of short supply of cash, something more interesting was also happening. Merchants other than those allowed continued to accept cash in large tenders. If you are into audit, you have a pair of prying eyes. Why would they accept? How else can this process manifest? Is there a reward? In large parts of India cash was accepted a legal tender. As much for the large tenders. Incidentally, many merchants still maintain records in paper. Very often you'd notice pages being left empty in the receipt books. Whether it is acceptable by law, is another thing. But the more important question is whether this practice would allow them to record transactions retrospectively. If so, can large tenders evade the system?

Plenty of such scenarios, but without going into any of them there was a fair level of acceptance of flaws in execution of the plan. Multiple corrections have come in a reactive mode - application of indelible ink on depositors nails to indicate their having availed of the facility. By then it was estimated that about Rs 2 - 3 Trillion or about $ 30 - 45B had already been deposited. Would that mean that the system had been compromised? No one can answer, unless they have personally worked around. In which case they won't.

What Went Wrong

There is a wide acceptance of the flaws in execution. It may be a good idea to take a ringside view of this and figure out what could have been done better. For that let's restate what went wrong - at a high level

1. The objective wasn't in contention. The means was. Execution is pretty much part of the solution. Flawed execution would in probability lead to results different from projected, if any.
2. A move like this would keep people on toes. Yes, people don't know what would come next. Maybe. Maybe not. Common man may not have any to worry about. But those that held black currency - it follows 80/20 principle - know how to work around the system. Much like the suspected abuse in Jan-Dhan accounts deposits, traders' accepting old currency, and soft-pedaling on the exception channels.
3. For one there is an acknowledgement that there is a flawed execution, the political ramifications, etc. Given the seeming kneejerk reactions - several of them across levels, and the govt being going on the defensive, there is already a fear that this may not yield tangible results in the short term (read black money from the system tapped by Dec 30, 2016) and long term (read economic ramifications too delayed to justify, and political ramifications). With these possibilities, do you think govt would rush through to their next move?

What Changes Might Have Worked

No two individuals will ever agree on the right path, more so for such a pan-India initiative. Nevertheless, these is a broad agreement about flaws in execution, controls and even some aspects of the strategy. To my mind, the following represent a small set of changes which might have did the job lot more effectively.

• Strategy - Success of strategy lies in its execution - be it with startups or with large structure organizations; the experience so far with demonitization has underscored this. However, strategy development itself as well needs to account for execution environment. For instance, data on percentage of large currency in circulation should have been used to preempt appropriate arrangement during the transition. At large tenders accounting for 85% of currency in circulation and 90% of payment transactions being done in cash - it would have helped to validate the strategy against these. Same for ATM designs/ capacities, etc
• Benefits - When driving a nationwide transformation like this, the citizens at large would like ask tough questions - like what do I get by letting my money become part of the country's economy? Nothing is more convincing that showing the benefits that would accrue to current/ future generations. Few areas that have reverberated in my discussions with different groups of people across social strata include - reduction in tax, reduction in interest rates, introducing social security, etc.
• Clear Target - For instance - at a macro level - the amount of deposits expected, and hence black money by March 31, 2017. This would have helped track progress, with fair room for variance. On the contrary, in absence of that there aren't any tangible reference points and discussions risk being opinionated.
• Staggering the activities - There are 3 key activities implied through demonetization - withdrawal at ATMs, exchanging large currency at Banks, and depositing in Banks. Step I: It might have been a good idea to start with ONLY ATMs for the first week. It'd have allowed the executing agencies to test the process, make appropriate changes to that. The Bank back offices could have been used to prep capacity for the in-Bank transactions to follow. Step II: Following week could have been for in Bank exchange of old large tenders. By then the ATM channel would have been streamlined, and allows the focus to be on the Bank front-office. Step III: Last in order could have been the in bank deposits. This being last in order doesn't affect anyone. That would have helped optimize the demands on the system, allowed corrections in line and any controls being brought in before large damage is done. Exception management could have been provided for.
• Controls - This is among the more crucial links of the chain. The system taps into the black currency but without tax / penalties it should have attracted.Absence of controls allows black tender hoarders to wink the system and continue to beat it. Robustness of any system, especially the financial systems is determined by the comprehensiveness of it's controls. Knowing the demographic spread, last mile risks, and ease of circumventing the system, controls have to be moved up the list of priorities. Lapses in controls at any stage must attract strong criminal punishment to resist any urge whatsoever. Use of surveillance, digital technologies etc needs to be done optimally.
• What is it in for me? While this activity is meant for the entire population of India, the focus was clearly to tap those that contributed to the black/ parallel economy. The govt had mooted multiple phases to tap into this prior to this announcement, and still people find jugaad solutions to work around. Across these moves and governments - there has been a hefty tax or penalties on declaration. Until it is in banking system, the cash with them was on par with the equivalent value of white money. So was black money. On declaring that the person loses 50 to 80% of it on account of tax or penalties. Is this why people are avoiding declaration and prefer their money in parallel economy? If that is one, maybe a key reason - is there a different solution? Even for an argument sake, would it help to incentivize declaration of black money? For instance, you'd be allowed to convert it to gold and will not be taxed on declaration, and maybe exempt of tax on the first year thereafter. After all, it brings back the amount back into circulation, there is no fear of parity erosion or even tax for 1 year so he can stabilize into the new mode.

These are my thoughts on how the efficacy of the process could have been better.

What do you think?

Disclaimer: These views are mine, and don't reflect any political bias or prejudice.