What is India's first ATM

1.25 billion guinea pigs

The current currency exchange in India is unprecedented in its scope for a stable economy. The economic effects are not all positive.

Empty shops and full banks - the picture is the same everywhere in India these days. Even in the third week after Prime Minister Modi's completely surprising announcement that 86% of all cash in circulation would be invalidated, the country remains in a state of economic emergency. 22 billion 500 and 1000 rupee bills (equivalent to CHF 7.50 and CHF 15.00 respectively) are suddenly no longer permitted as a means of payment, but new banknotes and the still valid bills in smaller denominations are far from popular sufficient numbers available. The 1.25 billion people of India are suddenly forced to find their way in a largely cashless economy.

Insufficient preparation

The effects are manifold. The media report daily on curios, cheerful and tragic things from all corners of the country. In addition to the already widespread purchase letter, many Indians are increasingly resorting to forms of barter to do their daily shopping. For example, a journalist from Delhi describes how she paid her vegetable seller credit for the value of her purchase to his mobile phone account online. In some places, coins are experiencing a renaissance as a means of payment, even though the largest coin has a value of just 15 centimes. A new range of services has been created around the banks, where old banknotes can be exchanged until the end of the year. Wealthy Indians let others stand in line to shorten the long wait. How stressful this can be is shown by the fact that dozens of people have already died of strokes or heart attacks while standing in line in front of a bank.

Given the logistical challenges, problems with the huge exchange campaign were to be expected. India's music presses have the capacity to print 3 billion notes a month, but 22 billion have been withdrawn from circulation. Although the central bank is said to have been producing notes in advance for months, they cannot physically be available in sufficient numbers. In addition, there are problems with the distribution from the press to the banks and from there to the citizens. India prints all its paper money in only two places in the interior, the new notes have to be transported from there to all corners of the huge country. In certain rural areas there is one bank branch for every 20,000 inhabitants, in the poor state of Bihar there are just 7.4 ATMs per 100,000 inhabitants (Switzerland: 97.5), outside the cities the ratio is even less favorable. The already demanding preparation was made even more difficult by the fact that only a small group around Modi was privy to the action. Even the cabinet found out about it just an hour before the public. The fact that the new notes are marginally smaller than the old ones and that all ATMs have to be converted is the worst, but not the only blunder.

Although there is growing displeasure among the population about the side effects of the measure called “demonetization” in this country and the opposition is trying to make a profit from it, a noticeably large number of Indians are still positive about it. Frustrated by corruption and aloof elites who barely pay taxes, many welcome the government's determination. However, opinions on the effectiveness of the measure and its implementation differ, especially in expert circles.

Premature formalization

The devaluation is aimed at the fraudulent owners of large untaxed cash assets, but not only hits them. In an economy where more than 80% of workers are informally employed, there is no alternative to cash in many places. As desirable as the formalization of Indian economic life would be, in many respects the conditions for it have not yet been created. Using the example of a saree manufacturer in Varanasi, an Internet newspaper showed the sophisticated informal credit system, thanks to which many small traders even get financial resources for their businesses. Getting an official loan from a bank, especially one of the ailing state banks, is often impossible for such people. Without cash reserves, the sari business in Varanasi suffers as much as the vegetable sale in Delhi. The merchant from the above example cannot top up his mobile phone credit unlimited. At some point he needs cash again to buy fresh goods from the wholesale market. He doesn't currently have this. There are millions of such examples.

The Indian reality is also not nearly ready for the cashless economy, which is being invoked a lot these days and which is seen as the portent of demonetization. It is not without reason that the cash in circulation accounts for a high 12% of gross domestic product (GDP). For many transactions, especially outside of the big cities, this is absolutely necessary. The government has actually done a lot in recent years to encourage the rural population to open bank accounts, which would also make the state subsidy system more efficient and less prone to fraud. However, on a quarter of these newly opened accounts there is no credit or only a symbolic one of 1 R. Many bank customers have a bank card, but do not know how to use it. In addition, the next ATM, the next bank branch is often so far away that it is better to keep the money under the mattress.

No root cause

However, the government is not really aiming at the rapid introduction of a cashless economy either; with the issue of a 2,000 rupee note (CHF 30), the face value of the highest denomination was doubled. As soon as the money exchange is complete, cash payments for larger purchases should become even easier. Regardless of whether larger cash transactions are suspected of being a blanket black money or not, it is therefore questionable what the long-term effect of the measure will be.

This also applies because false incentives, for example in real estate transactions, have not been remedied. Because the stamp duty on sales contracts is very high at around 6%, the buyer also has an interest in keeping the official purchase price artificially low. Part of the business is therefore almost always done in cash. Hardly anything will change about that. Even as a measure against widespread corruption, the devaluation only has a limited effect. A corrupt official can also be bribed with new money. Because the government is sure not to launch another major currency devaluation in the immediate future, it cannot be ruled out that large rupee reserves will soon be hoarded again in cash, with new notes, of course.

Even fundamental supporters of the abolition of large banknotes, such as the former chief economist of the International Monetary Fund Kenneth Rogoff, are reluctant to judge India's demonetization. Long-term macroeconomic benefits are certainly possible and even likely. Mainly because of the immediate implementation without any warning, the disruptive effect and the associated costs on an individual and community level are very high. The growth losses for the next two quarters are estimated at 0.5 to 1%. Rogoff's successor at the IMF, who later became head of the Indian central bank, Raghuram Rajan, has also expressed reluctance in the past to demonetize as a means of combating black money and corruption in an economy like the one in India.

However, a lack of empirical values ​​makes forecasts difficult. Previous currency devaluations in India were nowhere near the same. There is absolutely no precedent for such a large exchange of money in a stable economy. Comparable measures are only known from countries with hyperinflation such as the Weimar Republic. This is one of the reasons why the current situation bears the characteristics of a huge social experiment with 1.25 billion guinea pigs.

Rule in campaign mode

The political risk is considerable for the researcher, Narendra Modi, because the mood can change. In terms of style, however, the measure fits the Indian Prime Minister very well. If it is not enough for the big throw, then at least for the big gesture. Since taking office two and a half years ago, Modi has launched several major campaigns: for a clean India, for strengthening the workplace, for the creation of 100 “smart cities”. The fact that the programs will probably all achieve at most partial goals should be taken into account, but does not necessarily have to be rated negatively. There are voices who claim that India can only be governed in campaign mode, because this is the only way to bundle the often mutually neutralizing forces in the heterogeneous country for real progress.

What is certain is that the excellent communicator Modi is always concerned with the matter at hand and with the presentation of his own visions and his determination. Even if the demonetization is not able to banish black money and corruption from India, also creates some new problems and one is still miles away from comprehensive cashless payments, it sends a strong signal in the direction of formalization and modernization of the economy - a core promise of Modi to his constituency. Modi's bill wasn't just an economic one. The next few weeks will show whether it will open.