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India’s ATM crisis proves demonetization failed

  • In India
  • 00:00, 8 May
  • By Sudhir Vyas

NEW DELHI — For the second time in 18 months, India has a shortage of cash. And like last time, economists say, it’s primarily the government’s fault. Empty A.T.M.s and bank restrictions on withdrawals have been reported in many states this week, and some bank managers said the cash crunch had been building for months.

The government says the cash problem was caused by an unusual spurt in demand and will be eased within days. But if it persists, the shortage poses a political threat to Prime Minister Narendra Modi, whose administration has been hit in recent weeks by a series of stumbles. Most recently, he was criticized for his long silence over the horrific gang rape and murder of an 8-year-old Muslim girl that the police say was committed by a group of Hindu men to terrorize the Muslim population.

India’s last cash crisis was caused in November 2016, when Mr. Modi decided to suddenly void most of India’s paper currency. The current shortage is also rooted in government policy decisions, as well as growing public mistrust of banks after several costly scandals.

Most Indians work at informal jobs that operate almost entirely in cash, from roadside food stands to day laborers. People in such jobs had already seen some work dry up because of the shock 2016 demonetization, as well as the imposition of a cumbersome national tax on goods and services (GST) in 2017 that has sought to formalize transactions that had previously been off the books.

Depending on how long it lasts, the current cash crunch will further dent the incomes of those workers, who are a critical part of the voter base of Mr. Modi’s governing Bharatiya Janata Party. “If this kind of shortage is there and the unorganized sector gets hit again, which it will, if the cash shortage persists, then there has got to be fallout from that,” said Arun Kumar, a professor at the Institute of Social Sciences in New Delhi who studies public finance and the illicit economy. “That will be very damaging to the ruling party.”

Opposition leaders are already trying to gain political mileage from the situation. Mamata Banerjee, the chief minister of the state of West Bengal and a frequent critic of Mr. Modi’s policies, said on Twitter “seeing reports of ATMs running out of cash in several States. Big notes missing. Reminder of Demonetizations days. Is there a Financial Emergency going on in the country?

 Economists say that the cash shortage has no single cause, but rather is the result of a combination of factors. Following the 2016 currency cancellation, the government did not print enough new bank notes to keep up with India’s growing economy, betting that cash-loving Indians would embrace digital transactions. (They did not.)

Meanwhile, hoarders and black market operators started stockpiling 2,000-rupee notes. Rather than expanding the supply to compensate, the government decided to stop printing the high-value bills, forcing banks to fill A.T.M.s with lower denomination notes, which run out more quickly.

Public faith in the safety of India’s banks has also faltered over the past year, prompting people to keep more cash at home. The Modi government, warning of a growing problem with bad bank loans, last fall pledged $32 billion in taxpayer funds to bail out weak lenders. It also proposed legislation that could force depositors with more than $1,500 in an account to take a loss if their bank failed.

Jitters rose further in February after Punjab National Bank, a major state-owned lender, and government investigators accused the jeweler Nirav Modi of stealing $1.8 billion in a scheme that went undetected for years because of poor controls at the bank. “Many people got scared,” said Radha Rani, a senior manager at Indian Bank, another state-owned bank. They are keeping money in their houses or investing in real estate. They have fear of losing money if deposited in the bank.

The harvest and marriage seasons are looming, increasing demand for cash. If the shortage is not quickly eased, more customers will demand their money, potentially causing a much bigger problem: a bank run.

Multiple theories are doing the rounds about the reasons for the ongoing cash crunch that caught both the government and the Reserve Bank of India (RBI) off-guard, forcing them to admit that the shortage is no made-up story. The theories point to large scale hoarding of Rs 2,000 notes, uneven distribution of currency notes moved to currency chests in different states, and to the work of hawala operators.

At least three senior bankers, including two former chiefs of the State Bank of India (SBI), and a few economists with large private institutions, told this writer that all of these reasons could have contributed to the current mess, but the biggest reason is that the growth in currency in circulation (CIC) in the economy doesn’t match the pace of GDP growth.

To begin with, the currency shortage didn’t pop up overnight. The system was largely running short of cash since the note-ban, announced in November, 2016. This sharply increased the demand for the next high denomination, the Rs 500 note. There aren’t many countries where currency denominations have been managed as badly as India did post-demonetization. The issuance of the Rs 2,000 note post demonetization went against the idea of nudging the economy to a cashless society. The government and the RBI miserably failed to understand the simple fact that people needed more lower denomination currencies to transact, and not the 'hard-to-break' Rs 2,000 notes.

The Modi government and the RBI together built a self-made currency crisis in India beginning with the destructive demonetisation exercise. In hindsight, it is fair to say that India wouldn’t have faced a cash shortage like the one impacting daily life these days if the demonetisation-induced cash crunch hadn't dealt a blow to the economy.