Why the corrupt rich will welcome Modi’s ‘surgical strike on corruption’

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Protesters display an effigy of Narendra Modi as they denounce his rapid demonetisation. Photograph: Dibyangshu Sarkar/AFP/Getty Images

Narendra Modi came to power in India on a promise to end corruption. Halfway into his tenure, little seems to have happened to achieve this goal. The most obvious steps – such as taking a strong line on the known illegal accounts held in Swiss banks and tax havens, or ending the ability to hold shares without revealing your identity, or making funding of political parties transparent – have simply not been taken. People were beginning to murmur that the government had not lived up to its grandiose promises.

So last week Modi did some more of the smoke and mirrors stuff that he is so good at: a shock announcement in a blaze of publicity designed to show that he is serious about ending corruption, even though the actual impact is quite different. At 8pm on Tuesday evening he announced that from midnight all 500-rupee (£6) and 1,000-rupee notes would cease to be legal tender. He said this would flush out all the black money and get rid of the counterfeit notes that were being used by terrorists in their nefarious activities.

Demonetisation of bank notes is a common practice, but it is usually done gradually, allowing time for people to replace the old notes with new ones to prevent too much disruption of economic activity. By contrast this overnight shock is hugely destabilising. The suddenness is supposed to prevent hoarders of cash being able to use it to buy other assets – but that is a poor argument, since the government could have simply announced a time-bound demonetisation and then tracked large transactions.

In fact, only a small proportion of the funds received from illicit tax-evading activities is kept in the form of cash, and almost never by large players. They tend instead to buy real estate and other property, hold gold and stocks and shares and, most of all, move the money abroad. So this move touches only a tiny fraction of the assets accumulated through illegal activities. In any case, it also does nothing to control the source: not just bribery and corruption, but also inaccurate invoicing by companies, under-reporting of sales values and overstating costs, reporting non-existent transactions and so on. These don’t require cash: they are easier and faster using electronic means. Money on its own has no particular colour; as it flows through different transactions, it changes from white to black to grey.

Indians queue outside a bank in Allahabad to exchange 500- and 1,000-rupee notes. Photograph: Sanjay Kanojia/AFP/Getty Images

But currency notes are absolutely crucial to India’s legal market economy. The two cancelled notes account for 86% of all the currency in circulation; over 90% of all transactions are conducted in cash, and over 85% of workers get their incomes in cash. With one stroke Modi dealt a crippling blow to all such exchange, affecting not just the “black market” he was supposedly targeting, but also almost every Indian. Ironically, the rich – more likely to be “cashless” – are relatively unscathed; it is the poor and the middle classes, hugely reliant on currency for daily activities, who are being battered.

The resulting chaos has been enormous, and shows no signs of ending. Pitfalls with Modi’s grand plan have been worsened by implementation ineptitude. Not enough new currency has been made available, so cash machines are empty and banks are stretched beyond capacity. People have been wasting hours in queues to collect small amounts of cash that are insufficient for normal activity. The new notes have come in the form of an even higher denomination (2,000 rupees) that is unhelpful for daily transactions, since no one has enough change for this amount.

The problems go beyond inconvenience. The lack of cash has reduced consumption and demand, which has had a knock-on effect on sales, traders’ incomes, production and employment. Traders are losing perishable stocks, daily labourers cannot find work because employers cannot pay in new notes, and small producers (who mostly don’t get bank loans) cannot get working capital from the moneylenders they rely on. Individual tragedies abound, with children not being fed, an inability to buy medicines for the sick, and, it is being reported, more than two dozen people dying while standing in queues, or being unable to pay for hospitals and medicines with the old money.

Farmers are in dire straits, some with freshly harvested crops that cannot be sold, others unable to purchase inputs for the next sowing season. They cannot afford to “bear the pain for 50 days”, as Modi asked in his emotional appeal, because they stand to lose everything for the last crop and for the coming one. And Indian women, 80% of whom don’t have a bank account, may now find they have to use their stashes of cash, and risk losing control of it, especially in the face of domestic abuse.

Ironically, a flourishing black market has emerged for the old notes, trading at a 20% discount. Big players can get away with a small loss and plan on restarting their illegal activities once the new notes are fully in circulation, since nothing is being done about that. But no one will compensate the millions of Indians who have lost incomes and employment in the intervening period. No wonder, when the government claimed that its latest “surgical strike” would involve some collateral damage, the Indian supreme court said this was more like a carpet bombing.

Modi’s penchant for optics rather than substance was always annoying; but this time it has acquired truly damaging proportions.