Well who could have seen this coming?
Indian Prime Minister Narendra Modi on Sunday urged the nation's small traders and daily wage earners to embrace digital payment channels, as a cash crunch following the government's surprise ban on high-value bank notes drags on.
Modi, speaking in his monthly address on national radio, said the government understands that millions have been affected by the ban on 500-rupee and 1000-rupees notes, but defended the action.
"I want to tell my small merchant brothers and sisters, this is the chance for you to enter the digital world," Modi said speaking in Hindi, urging them to use mobile banking applications and credit-card swipe machines.
"It's correct that a 100 percent cashless society is not possible. But why don't we make a beginning for a less-cash society in India?," Modi said. "We can gradually move from a less-cash society to a cashless society."
More than 90 percent of consumer purchases in India are transacted in cash, Credit Suisse estimates. While a smartphone boom and falling mobile data prices have led to a surge in digital payments in recent years, the base still remains low.
Modi urged technology-savvy young people to spare some time teaching others how to use digital payment platforms.
Two weeks ago, India’s Prime Minister Narendra Modi demonetised an estimated 86% of rupees in circulation, offering conversion into a bank account or into smaller currency notes until 31 December, after which these notes will have no redemption value.
Together with forgeries in circulation, it could be over 90% of all circulating money. The terms of redemption are so inconvenient for anyone other than black-marketeers, that for all purposes $50bn equivalent of rupees have been eliminated from the economy at a stroke, pending the introduction of new currency notes.
The sadness in all this is that Modi should have foreseen the extent of the disruption to the poor and rural communities, but has obviously forgotten the hard lessons of life learned in his youth as a lowly chai wallah. It could be that the Reserve Bank went along with it as a government puppet, consoling itself with the thought it would be a good way to write off obligations, believing a significant quantity of notes is likely never to be redeemed by black-marketeers and tax evaders. It effectively reduces the central bank’s obligations to the private sector at the expense of those the state likes least. However, the $10-20bn equivalent the state will make from it is less important than the disruptive economic effect and the likely impact on the rupee’s future purchasing power.
The purpose of this article is to look at the economic consequences of Modi’s action. Initial estimates by western macroeconomists of the effect on GDP seems to be benigni. It could be because their contacts in India are typically the more highly-paid city bourgeoisie, who rarely spend cash except for tips, using bank and credit cards more normally for everyday purchases. These people would almost certainly welcome moves to bring illegal trading under control and extend the income tax base, playing down the negatives. However, the cash immediately removed amounts to about 2.5% of GDP, eventually to be replaced at an unspecified time in the future by the new notes bearing a portrait of the Mahatma. But while these notes are shortly to become available, it could take months to convert ATMs and ensure their widespread availability.
If the long-term consequences will be...