New India : Post Demonetization ?

Whether you like him or hate him, you have to laud Mr Modi for his courage to take bold decision that can disrupt the society/nation. There have been many business leaders in recent times who have adopted disruption as model to change the industry dynamics but very political leader have adopted such model for governance.  It is double edged sword and not many are willing to risk so much when the stakes are so high.  Before you carry any impression of this post being the diatribe by one of his staunch followers, I would highlight that I only acknowledged his courage to take such bold decisions. Whether the decision is good or bad that time will only tell us but it will definitely have far reaching impact on our society.  I have attempted to put across my objective assessment of the event and its possible consequences without taking ‘for or against’ view. 

East Asian crisis is said to have imprinted financial crisis fear in minds of the people living in those countries at that time and hence for years later they have preferred to save rather than spend unlike their western counterparts. This fear led these countries to maintain much higher reserves as safety net for any future crisis. Similarly in India, high inflation observed in last decade has led to erosion of wealth for savers in India and this has given rise to new generation of spenders. I believe demonetization has potential to have such behavioral change on our society and therefore have tried to focus such long term effect rather than taking myopic view that focuses only on immediate consequences.

Greed and fear are two emotions which determine large part of people’s behavior when it relates to money management.  Current demonetization of high value currency notes will immediately alter the current equilibrium of these emotions in people. People at large seem to have overcome the fear of corruption/black money and it is the greed that seems to be driving their behavior towards current form of society. Years of inaction against corrupts/black money hoarders has reinforced the moral hazard.  Like all moral hazard problem, everyone knows it exists but don’t know how to avoid the same. Mr Modi seems to believe that his decision will end this moral hazard issue in the society. He is trying to make it difficult for corrupt people/black money hoarders to avoid erosion in their wealth by his policy decision. Hypothesis here could be that the pain such people will go through while losing their wealth which they have always believed to be theirs would be immense and would prevent them from hoarding black money in future. The consequences they will face will serve as deterrent for others in the society to commit on this path of corruption & black money. Also people who have paid their taxes on time will get pleasure of seeing the pain of others who don’t fall in their group and would reinforce their FEAR in future. (In fact it is this pleasure which led to initial positive assessment of his decision). If this succeeds then we may see an end of parallel black economy that has existed for years. It would make it difficult to fund terrorism, bribe officials etc since source & use of funds can be known easily. Already news have been flashing of the difficulties naxals are facing to exchange their loot and they may also see erosion in their wealth. Here FEAR is expected to bring about positive change in people.

Let’s try to take contrarian view about the same event. The high valued notes earned by the people have suddenly become worthless instills FEAR about monetary currency. The current monetary system exists mainly because of the people faith that it will be honored without much hassle.( Of course in current form, one can deposit or exchange currency notes up to certain limit but it is certainly not hassle free.) If people start having doubts about high value currency notes then in future they will not like to accept it or keep it as saving instrument. Would they then prefer gold over them in future since in our society gold’s acceptance has never been questioned yet? Further its global acceptance provides additional comfort for liquidation and removes one’s dependency on nation central bank. This can lead to situation wherein savings would not get channelized into useful development but into gold hoarding. Of course government and central bank may have other means to change this behavior but it would take years to acknowledge and act on the same.  Lot of black money hoarders were believed to have rushed to buy gold, USD post demonetization announcement. Of course they intended to convert black money into gold for future use. But will this immediate gold buying end once these two months are over? Answer could be NO!!! Government would like to believe it will create enough incentive to move people to digital currency. Phew, new disruption model for country where literacy rates are so low; where gullible people have been duped so many times in past that they don’t even trust the banks.
Black money incentives risk taking, discretionary spending among the people. Demonetization will lead to overall decrease in wealth in the society as such and would either strengthen central government or central bank balance sheet. Even if government increases its expenditure, it will take time for this wealth to be accumulated by the society large. Now what do we expect from such society which witnesses mass wealth (legal/illegal) destruction due to act of government? FEAR ? People would spend less, less corporate gains, lower number of new jobs etc. Coupled this with highest population in age of 20-30 years, global slowdown & protectionism and rising terrorism imagine the potential social unrest it can create in huge nation like ours.  In both above cases, FEAR seems to have negative consequences for the society.

The actual consequence of this event may lie in between both the extremes described above.  It is very difficult to gauge people’s behavior and predict the future especially when population is more than billion. But it is certainly one of the exciting times to be in India to experience the same.  Government and its policies will definitely have key role in influencing people behavior. But I firmly believe it is us and our behavior that will shape up the future of this society and government response will be guided by them. So let’s keep our emotions in check; objectively assess situation with open mind post immediate fallout before forming any firm opinion about the event.