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India’s crackdown on cash corruption is really all about politics

India’s crackdown on cash corruption is really all about politics

When India’s Prime Minister, Narendra Modi, announced that 86% of his country’s currency would be “just worthless pieces of paper” in a matter of hours, he immediately boosted his reputation as the scourge of tax-evaders and the corrupt. Unfortunately for everyday Indians, the hassle of adapting to the sudden change is bigger than many expected.

The policy demonetises 500 and 1,000 rupee notes, which Indians are now expected to change at banks and ATMs. This is an attack on what Indians call “black money”, cash that has been concealed from the tax authorities and/or used for criminal activity; it’s also meant to curb the spread of counterfeit currency. But it’s unlikely to achieve much – and ultimately, it’s at least as much a political move as it is an economic one.

So far, the upshot has been something approaching a cardiac arrest in India’s informal economy, which by some measures accounts for about 45% of GDP and around 80% of employment, and relies entirely on cash-based transactions. As for cash-based corruption, the policy may not make much difference.

There is abundant evidence that those who are involved in illicit activities and tax avoidance actually keep only a small proportion of their cash earnings, even as little as 6%. Most of their hidden funds don’t exist in cash; instead they’re reinvested in real estate, land, gold or laundered through foreign accounts.

The decision to introduce new 2,000 rupee notes means that keeping large amounts of cash will actually become easier, as the same amount of currency will now occupy half as much physical space. And while there will be an impact on counterfeit currency, this is likely to be short-term, since the new notes have roughly the same (poor) security features as the old ones.

In short, the demonetisation move will not attack the basic roots of the black economy, nor provide any disincentive to the hoarding of cash in the future. It is significant that similar previous attempts, such as in 1978, did not yield any significant results either.

Crunch time

Once Indians began exchanging their now-obsolete currency, the logistical implications of Modi’s move became all too apparent. Long queues formed outside banks, where the old notes (up to a limit of 4,500 rupees, or £53, per day) can be exchanged or deposited in bank accounts – all deposits above 250,000 rupees (nearly £3,000) will be taxed and scrutinised.

Matteo Miavaldi, a Delhi-based journalist, told me that people queued for up to 12 hours to swap their notes and sometimes weren’t able to get any cash. When they could change their redundant notes, they often got the new 2,000-rupee ones, which no-one is able to change for anything smaller. And according to the finance minister, Arun Jaitley, it will take up to three weeks before the country’s ATMs will be recalibrated and able to dispense the new notes. Overall, it will take months before the transition is completed.

The shortage of cash has had several other consequences. Street vendors and shops are unable to buy provisions, which is causing shortages (rumoured or real) of basic goods in certain areas. Even when merchants are able to buy supplies on credit, few people have the cash to purchase their goods, reports Miavaldi. Taxis, rickshaw drivers, barbers, maids and doctors are all facing the difficult choice of either accepting the old notes, or providing their services on credit.

Patience is a virtue. EPA/Raminder Pal Singh

In rural areas, where most Indians live, the situation is much worse. Chakradar Buddha, a social activist based in rural Andhra Pradesh, told me that to reach a bank, people have sometimes to travel for up to 30-40 kilometres in areas with no or very limited public transportation. Most rural Indians don’t have bank accounts; only 60% of all Indians do. This forces them into repeated visits to the bank, due to the very low amounts of cash one can change per day.

This in turn means losing precious days of work, right in the middle of sowing season. Many of those who do go to work are told they will be paid at a later date, something most agricultural labourers can ill afford. Sometimes three labourers are paid with one old 500 rupee note, which they can then exchange on the black market for a 10-20% fee.

And yet, for the time being at least, many people are either welcoming the move or bearing with the situation in the service of a greater good. Modi asked the people to endure 50 days of pain in exchange for longer-term benefits, and it seems that the government’s message is indeed working.

Politics in action

Much depends on how long it will take to restore normalcy. Buddha reported a marked change in rural people’s mood. Whereas in the first two days the public were generally on board with the measures, the general feeling is now that the government has not thought about the places where they live, which are even less well-equipped than the cities to manage the situation. If unaddressed, this frustration could easily turn to anger.

Overall, the demonetisation’s greatest impact will be political. In one fell swoop, it has reinforced Modi’s image as a strong and fearless leader who is able and willing to take difficult decisions for the national good. As corruption tops the list of voters’ concerns, that image is a significant political advantage – provided that the situation doesn’t degenerate or the mood turn too sour. The Supreme Court warned that if normalcy is not restored soon, there may be riots. It’s difficult to see how such chaos could be brought under control.

The move will also have a major impact on important state elections set for early 2017. It’s well known that political parties fund their campaigns mostly through black money, part of which gets distributed in villages and towns in the days before voting. Modi’s move has certainly taken his political adversaries by surprise, and perhaps even caught many in his own party off guard; all of them might suddenly face a severe shortage of campaign cash.

This will not determine the fate of the elections, but it certainly gives Modi a competitive advantage. As things stand, his capacity to raise funds is unrivalled. And one thing above all is clear: his campaign for the national elections in 2019 is now underway.