Three Ugly Truths Unveiled By DeMo Chaos: Poor State Capacity, Compromised System And Trust Deficit

As we come to the end of the note-badli deadline of 30 December, there are more questions than answers on the real impact of demonetisation. We know damage has been done to the cash economy, growth and jobs, but we don’t know how much.

But some broader conclusions can be drawn and lessons learnt.

First, state capacity to execute such major reforms is poor. The mishandling of the exchange of old notes and poor preparation for the two months of transition cannot but reflect badly on the capacity of both the Finance Ministry and the Reserve Bank of India (RBI). They were simply not equipped for flawless, top-down implementation, especially in a federal polity where there is no alignment between what the centre wants done and what the state can do – or are willing to do. Implementation of any reform thus needs to be a staged process. Blundering along should not be an option in future.

Second, the system reeks of compromise and corruption. It was disheartening to see people standing in queues for withdrawing money and crooks accessing crores of new notes through clandestine deals with bankers and other corrupt officials. A seriously compromised system will stymie any moves for reforms. Reform will thus have to be pushed steadily rather than in one go.

In this context, both centre and states have to be conscious of the fact that when the goods and services tax (GST) is implemented in 2017, we must prepare for a lot of trial, error and heartburn before the system functions reasonably well. Millions of GST assessees, central and state tax officials and IT network staff have to be taught to transit to the new system. Again, it is saddening to realise that centre and states are fighting over dual control of small assessees. This is nothing but a corrupt system trying to retain its access to speed money and bribes.

Third, India is too wedded to cash for all the wrong reasons – evading taxes and staying under the state’s radar. The scale of the disruption – which is yet to be estimated – caused by the withdrawal of high-value notes suggests that Indians are inherently suspicious of the state, and unwilling to formalise their transactions to avoid the clutches of the state. This indicates that once the currency crisis eases, people may simply go back to cash. The digital payment mode may grow very slowly, and will need both a strong legislative push and taxing of high-value cash deals.

The simple learning should be that the state must become more trustworthy for citizens to learn to respect it.

Lack of trust in the state is what has created the addiction to cash, causing serious disruption in economic activity when a prime minister wants to ring in a more honest polity. The numbers show the damage done by this trust deficit. Mint reports a drastic fall of over 34 per cent in RTGS (real-time gross settlements) payments between October and December. If we take RTGS as an indicator of economic activity in the formal parts of the financial system, this must be worrisome. The cash economy chaos is impacting the non-cash part too.

But then, it is quite possible that economic activity was higher in the festival season of October, and the fall may be exaggerated.

What is heartening is to see non-cash payment averages holding up between November and December. (And remember, November had normal activity for the first eight days). Average daily transactions (through RTGS, NEFT, IMPS, cheques, credit cards, and e-wallets, among other things) are flat – Rs 3.13 lakh crore in November and Rs 3.09 lakh crore in December (upto 27 December).

Despite the damage to the cash economy, the digital part of the economy is holding up.

But that can be no consolation when we see how poorly the demonetisation drive has been implemented. Clearly, when big moves are planned, a lot more planning must go into it to prevent flawed implementation. And yes, the state has a long way to go before it earns the trust of its citizens enough to wean them off cash.