Unintended Consequences of Demonetisation

The demonetisation scheme was launched without the govt thinking through consequences, hardships or logistical complexities of such an undertaking

Indian businesses have spawned some unique management practices. In his book When The Penny Drops: Learning What’s Not Taught former Tata Sons executive director R. Gopalakrishnan credits former ICICI chairman N. Vaghul with coining the term “Mafa”. Among the many variants of the acronym, the one that works best for India is “Mistaking Action for Achievement”.
Mafa seems to be a unique Indian trait, found frequently in Indian organizations. Executives, keen to show initiative, are often found launching ill-conceived projects with little or negligible homework. Managements, it seems, are content to see senior executives bustling around launching one abortive project after another, rather than thinking through strategy, returns and risks. Introspection is considered a luxury, a sign of indolence; shoot first, ask questions later.
The demonetisation scheme is an appropriate example. The government launched the exercise without thinking through the consequences, the hardships or the logistical complexities of such a mammoth undertaking.
The daily, arbitrary changes in rules puts demonetisation squarely within the theatre of the absurd. 
But, more importantly, the project also has numerous unintended consequences. In 1936 American sociologist Robert K. Merton wrote a popular paper titled “The Unanticipated Consequences of Purposive Social Action“. The central idea of the theory is that policy action by government can often lead to undesirable outcomes, or unintended consequences, that were not part of the original plan.
The policy landscape is littered with numerous examples. Many commentators link the US government’s determined push to make affordable housing universally available with the 2008 mortgage-fuelled, trans-Atlantic financial crisis. Research shows tightening anti-money laundering rules could end up increasing costs for official remittance channels, forcing remitters to lapse back to unofficial channels. Government incentives in Brazil’s auto sector are said to have caused over-investment, lowered capacity utilization and eventually affected productivity, employment and incomes.
The Indian government’s “surgical strike” on currency notes also has unintended consequences. Here’s how.
Unintended consequence-I: One of the avowed motives behind the 8 November edict was to flush out bank notes hoarded by tax evaders. And while this might succeed somewhat, faulty implementation has given birth to another unintended consequence: re-incentivizing hoarding. A delay in re-monetizing the system, after having sucked out 86% of currency by value, has created an unplanned scarcity. Banks do not have adequate supply—in branches or in alternative channels—of either old Rs 50/100 notes or the new Rs 500. It has forced many economic agents to squirrel away notes. The shortage has acted like a massive shock to the economy. Consequently, instead of draining the swamp, the demonetisation process now threatens to turn it into a crocodile pit.
In a statement read out during the fifth bi-monthly monetary policy press conference on 7 December, Reserve Bank of India deputy governor R. Gandhi said: “The Reserve Bank and the Central Government note presses are working to their full capacities and all efforts are being made to reach the notes to every part of the country… We reiterate that there is adequate supply of notes and hoarding of notes helps nobody’s cause.” The statement clearly shows that the central bank is cognizant of hoarding, and daily news breaks of various raids and recovered currency notes also prove that demonetisation has actually re-ignited the basic hoarding instinct.
Unintended consequence-II: It is now patently clear that the government did not adequately plan for the aftershocks. The exercise has deprived people from retrieving their own money from what were considered fail-safe bank deposits. 
This has a severe unintended consequence: It can erode people’s trust in banks, which has taken years of hard work and perseverance to build. A democratically elected government’s unilateral diktat, increasing the distance between a depositor and her legitimate deposits, can act as a perverse incentive: people may henceforth shove a few banknotes under the mattress before surrendering the rest to banks. This behavioural pattern is hardwired in the Indian psyche, having survived decades of a command-and-control regime which were marked by severe scarcities. 
It is also natural risk mitigation to build buffers against future autarchic government decrees that might once again restrict access to legitimate savings. Nobody likes queueing up for hours to reclaim their own money. While there won’t be a stampede to exit the banking system (and in fact there may be more Jan-Dhan bank accounts opened over the next few years), the demonetisation move has definitely corroded, if only marginally, confidence in the banking network.
There is an apocryphal story about a government rule boomeranging during the Raj. Seeking to clean up snake-infested Delhi, the British rulers announced a bounty for every dead cobra. While genuine snake-catchers got busy, some ingenious Indian entrepreneurs got even busier: they started breeding cobras, killing them and collecting prize money. When the government got wind of this, they shut down the programme abruptly, forcing snake breeders to release their wards back into various parts of Delhi. Hopefully, demonetisation won’t leave behind too many creepy-crawlies.

The above article was first published in Mint newspaper on December 14, 2016. It can also be read here.
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