Note ban and election results 2017: Good politics is bad economics

Demonetisation move proves a roaring success for PM Modi and the Bharatiya Janata Party

Let us acknowledge one fact straight up that elected leaders never take an economic decision without considering its political ramifications first. Now we must acknowledge that politically, demonetisation was a roaring success for Prime Minister Narendra Modi and the Bharatiya Janata Party, even as it was bad economics.
 
That last statement goes against the grain of what the October-December quarter gross domestic product data showed. However, a number of economists believe that there will be a downward revision to the seven per cent headline figure as the informal sector is never properly captured in the first provisional estimates.
 

Modi’s November 8 note-ban announcement put 86 per cent of cash by value out of circulation from immediate effect by making old Rs 500 and Rs 1,000 notes invalid. For an economy so overtly dependent on cash (even now), the pain wasn’t eased by a botched up execution by the Reserve bank of India(RBI) and the government, with almost daily rule changes and chaos in banks across the country.
 

All the anecdotal evidence pointed to a negative economic impact. Businesses, especially the smaller enterprises, were hurt badly as orders were cancelled, workers laid off, and entire units shut down temporarily. Till at least mid-January, orders placed were not being delivered and hence new orders were in short supply. Tens of thousands of migrant workers are said to have gone back to their villages in the heartland.

 
Sowing in the rabi crop season slackened but later picked up spectacularly. But the real estate sector has yet to recover as residential prices continue to be muted. Auto sales, especially for two-wheelers, took a huge hit and so did the fast-moving consumer goods sector.
 
But any decision is all about how it is packaged as a message for the masses. The message from Modi was simple and it resonated with the voters: We are going after the rich and their ill-gotten wealth. It was simple because it created easy-to-digest binaries of the haves versus have-nots, of the oppressed versus oppressors.

It also showed Modi, in the eye of the masses, as willing to do something bold, something different, which Prime Ministers before him had not dared to do: Take a risk. In spite of all the news reports and pieces about chaos in bank lines, the deaths and the shut businesses, “Kuch naya toh try kiya unhone” was a common refrain.
 
The reports of raids by the tax department and the enforcement directorate of course added to the public sentiment for note ban. “It was against corruption and was for a greater good” is a statement many reporters heard from common voters while covering UP. Once you remove such a huge percentage of cash, illegal wealth will surface. But it won’t stop the generation of future ‘black’ wealth.

 
Whether this drive against black money was successful or not will be known after March 31, which is the day the Pradhan Mantri Garib Kalyan Yojana ends. Then the central board of direct taxes (CBDT) will have a clearer picture of how much of the demonetised currency deposited in banks was previously hidden. Nevertheless, the government was also helped by a very ineffective opposition whose criticism fell short of providing an alternative plan to deal with black money.
 
In a country as diverse as India, even state and local municipal elections are won and lost on a multitude of factors. Hence saying that demonetisation single-handedly delivered at the ballot for the BJP won’t be true. But it did resonate with the common voter, not just in UP, but also likely in Uttarakhand and in earlier municipal elections in Odisha and Maharashtra.

 
So again, demonetisation worked politically. But good politics seldom comes from good economics. In fact, the opposite is more true. Demonetisation proved that. Hence our food and fertiliser subsidies can hardly be reduced year-on-year while fuel subsidies are lower only because of global crude prices.
 
More examples: There are two recent proposals doing the rounds in the corridors of power in New Delhi. Both make for very good economics but are electorally suicidal. First is the proposal of a government-owned bad bank to take over more than Rs nine lakh crore worth of non-performing assets from the banking system. But why would any government want to be seen using taxpayers’ money to bail out corporates? The second is the concept of Universal Basic Income, which eliminates all other form of subsidies for the poor and replaces it with an equivalent amount of cash in their bank accounts. But again, which government would want to be seen repealing something as populist as the food security act?