When Narendra Modi announced the demonetisation of high-value currency notes on 8 November, the systemic shock he delivered guaranteed that there would be reverberations for months across the political, social and economic spectrum.
The virulence with which some of the opposition parties have attacked the move also lends credence to the argument that this is a game-changer. If demonetisation was going to be a political or economic dud, there was no need for the likes of Arvind Kejriwal, Rahul Gandhi and Mamata Banerjee to make fire-and-brimstone speeches, with the last-named politician vowing to oust Modi from national politics. "Today, I take the pledge that I may die in the process, but I shall remove Narendra Modi from politics," Mamata said in Kolkata two days ago.
So the one thing both Modi and his opponents are agreed on is that demonetisation is a big disrupter. The big question is who or what is it disrupting? And what will change when things are back to "normal".
Now that we have arrived near the mid-point of the 50-day time Modi sought to make things normal, we can speculate on how demonetisation will impact politics, economics and public behaviour in the foreseeable future.
Here's what the crystal ball is saying right now:
Politics: Will demonetisation impact the Uttar Pradesh, Punjab, Goa and Uttarakhand elections next year? While the BJP's good showing in the recent Maharashtra and Gujarat local body elections suggests that demonetisation may be helping the ruling party, that would be too hasty a conclusion. It is early days yet, and people's patience has not run out. The public is, at this point, willing to give Modi the benefit of the doubt, and a more definitive verdict on demonetisation will be delivered only in the Uttar Pradesh assembly elections due in early 2017. By the time that happens in February-April, the government will be facing flak for slower growth and loss of jobs, assuming the cash crisis lingers.
However, if the crisis is over by January-end, which seems unlikely due to the slow pace of replacement of old currencies (only Rs 2.16 lakh crore has been replaced when Rs 8.44 lakh crore has been deposited with banks), demonetisation will not be a negative factor for the UP elections. In other words, demonetisation can be a negative for the Modi government if it does not manage the cash situation well, but it will be a positive only if it can show it is benefiting the common man. Modi must close the loop between short-term inconvenience inflicted on ordinary people and the benefits that accrue from this.
With a budget due on February 1, benefits to the aam aadmi can at least be announced. If cash is put into Jan Dhan accounts, the tide could turn in the BJP's favour. But it is not clear if the Election Commission will allow such vote-inducements in the middle of an election campaign.
But UP will be won or lost not on the basis of the demonetisation plank alone; the BJP's real problem is it has no credible face to project as CM in India's largest state. That may cost it the election, not bad implementation of demonetisation.
However, post-2017, demonetisation will probably benefit the BJP if cash starts coming into Jan Dhan accounts. This is more than a gleam in Modi's eye. It is 2019 that bothers Modi's opposition, for the PM can make good his promise that black money will come into the coffers of the poor by then.
In short, demonetisation may not result in BJP gains in UP or Punjab or Goa, but is possibly a good investment for 2019.
Economic impact: Estimates of a fall in the GDP growth rate range from a low 0.3-0.5 percent to as high as 3.3 percent (Ambit Capital), with Manmohan Singh's 2 percent figuring in the middle. Fitch Ratings lowered its GDP growth estimate for 2016-17 to 6.9 percent from the earlier 7.4 percent – a drop of 0.5 percent, which sounds more realistic compared to the scare numbers of Ambit and Singh.
However, any drop this year will probably be made up next year as long as the cash situation is normalised by the first quarter of next year (January-March 2017). Consumption has just been postponed, not reduced by demonetisation. So it is quite possible that growth will revive sharply by the first quarter of the next financial year (April-June 2017) and memories of GDP fall will be forgotten.
The growth blip will be short-term as long as the cash situation eases by February-March.
Revenue impact: A key political calculation in the demonetisation move is that cash that does not ultimately return to the banking system is money for jam. Depending on how much of the demonetised currency remains outside the system by 30 December, the Reserve Bank's liabilities to the public shrink to that extent. Any write-down of liabilities can show up in its P&L account as surplus, which can be paid out to the government as dividend. Figures ranging from Rs 1.5-2 lakh crore have been mentioned in the context of this straightforward windfall for the government's coffers.
But this expectation may go awry if most of the cash returns to the banking system. As on 27 November, 58 percent of the Rs 14-lakh-crore outstanding in old Rs 1,000 and Rs 500 notes had been deposited with banks, and there is still more than a month to go. It seems likely that a lot of the money has worked its way back to banks, either as unaccounted deposits or as sales revenues of small firms, especially those in real estate.
However, even if there is no RBI dividend windfall, a tax revenue spike is likely. With the government ramming through the Taxation Laws (2nd Amendment) Bill through the Lok Sabha yesterday (29 November), the stage has been set for the taxman to collect big amounts from unexplained deposits and/or higher reported incomes. The Bill allows the government to impose a tax of 50 percent on unexplained deposits or incomes, and further immobilises 25 percent of amounts disclosed as zero-interest deposits that will fund the Pradhan Mantri Garib Kalyan Kosh.
The government can expect a large tax revenue gain, allowing it to claim some form of victory for demonetisation.
Interest rates: Logically, the huge surge in bank deposits should have allowed banks to cut lending rates, but the Reserve Bank's decision to impose 100 percent cash reserve ratio (CRR) on incremental deposits means banks will lose money on the deposits. While the CRR spike is short-term, and will be reduced as the government issues more market stabilisation bonds to increase liquidity in the system, banks will probably not be able to neutralise this loss in this quarter. The Reserve Bank will probably cut rates after the Monetary Policy Committee meeting next week, but deposit rates may fall faster than lending rates. Reason: the short-term disruption caused by demonetisation may even worsen the bad loans situation for banks, forcing them to up provisions. But rates should start falling from early next year.
Cashless economy: Apart from a rapid expansion of the tax base, the biggest gainer from demonetisation will be the digital economy. Already digital cash and e-wallets are reporting a huge surge in transactions, and if the cash crisis lingers till January, some of this shift to digital cash may be permanent. Jan Dhan accounts, already flush with some amount of laundered money, will now be used more. If the government incentivises card usage, internet transactions and e-payments, the total cash in the system can be dramatically lowered.
Remember, it took less than a decade for India to go from a few million mobile phones to one billion. It is not going to be difficult to shift more and more people to mobile and wallet payments, with untold benefits for the economy.
Real estate: The two areas where cash is over-used are politics, and real estate transactions. The Benami Transactions (Prohibition) Act has now been notified, and the Prime Minister has already talked about reforms in political funding. If these two changes happen in quick succession, real estate prices will fall and political funding will shift to less cash. But we need to keep our fingers crossed on both these measures. Real estate needs more action at the state level, while political funding reforms need consensus at the central level. But that is exactly what the demonetisation fracas demolished.
Political nerves will remain frayed for some time.