Show Me The Money

Imagine waking up one morning to the news that the government has announced that, overnight, all of your cash is illegal and that you, and everybody else, will need to go to the bank and exchange your cash for new notes. Not only that, but if the government suspects that the cash was sourced illicitly, you will be slapped with a one-off extortionate level of tax.
I suspect your heart might be racing at this, but don’t worry, you can relax — this is a story from India and, as far as I’m aware, there are no plans to implement this policy in Egypt. For now, at least.

On 8 November 2016, while most of us were overcoming the shock of Donald Trump’s victory in the US presidential election, Narendra Modi, India’s Prime Minister, announced the demonetization of all 500 and 1,000 rupee notes that account for approximately 86% of the cash in circulation in India. The government informed everybody they had 50 days to go to the Reserve Bank of India (India’s central bank) or any bank branch to exchange their old notes for new ones or credit the cash to their existing, or as the case may be, newly created accounts. To maintain an iron grip on the process, very restrictive limits were imposed on how much could be exchanged, deposited and withdrawn per day.

As you would expect, complete mayhem ensued. Try to imagine more than 1.3 bn people, in a primarily cash based economy, rushing to the banks all at once in a panic to try to exchange or deposit their soon to be illegal cash? Apart from the complete chaos and disruption to people’s daily lives, we are talking about queues and waiting times that are almost unimaginable (unless you are the sadistic person who designed the Mogama’a).

The problems were compounded by the usual government mishaps in implementing a radical shift in policy of this nature and magnitude overnight. For starters, the issuance of the new 2,000 rupee note, a critical piece of the plan, was delayed. And, just when you thought things couldn’t get any worse, after the notes were finally issued, it was discovered that the existing ATM machines were not equipped to issue the new notes.

So the question you must be asking right now is — why, oh why, would anyone go through with this? As we of all people should know only so well, the road to ruin is paved with good intentions. One of the main promises of Modi in his election campaign, which he and his BJP party won convincingly in 2014, was to combat corruption and act for the common people; he is the quintessential populist strongman who has vowed to stand up to the rich and powerful, of which, like everything else in India, there are many.

The aim of the demonetization program in the short term is to combat corruption, bribery, counterfeiting of currency and the funding of terrorism and illicit activities. Interestingly, one of the long-term objectives is to force the informal economy to transition to the formal economy. The demonetization program should not be seen as a standalone effort in this respect, but part of a series of efforts to achieve this goal. In 2009, the Aadhaar card, the equivalent of Egyptian National ID cards, were introduced in order to bring people into the formal economy and increase transparency, while very recently, India passed a Goods and Service Tax bill with a similar aim.

Supporters of the demonetization “movement” have heralded the policy as a quantum leap that epitomizes creative destruction that will catapult India into a cashless economy that will fuel digital and banking innovation, eradicate corruption and bring in billions of dollars in additional tax revenues. Already, many retailers have embraced e-wallets and e-commerce, while Jio, a subsidiary of one of the country’s largest conglomerates, announced ambitious plans to be India’s number one digital platform.

Critics, however, of which there are many, have dismissed the demonetization policy as a debacle that has jammed up the economy and unnecessarily hampered India’s growth prospects. One of the immediate negative effects was the lack of sufficient change available and people refusing to accept the relatively illiquid 2,000 rupee note, leading to significantly reduced level of commerce and trade, especially in traditionally cash based sectors such as agriculture and the informal economy. NPR’s Planet Money published a special mini-episode covering an amazing story on how tough these reforms made it for people’s everyday lives (runtime 03:54).

At this early stage, it is difficult to gauge whether or not this experiment is a success or failure. There are, however, some observations that are worth considering. Firstly, demonetization is not an Indian invention and many other countries have adopted demonetization for similar reasons and policy objectives; recently, the European Central Bank announced the phasing out of all EUR 500 notes in order to combat counterfeit notes and the funding of illicit activities.

It must also be said that, whether you love or hate the idea, the demonetization program implemented by Modi is courageous and, despite the significant transition costs, has the potential to generate large future benefits. Despite what some of the critics might say, this is not some irrational doomed to fail crusade against the rich – it is a high risk high reward policy that many economists, central bankers and governments around the world are monitoring with interest. If the gamble pays off, it won’t be too long before other government’s facing similar problems will seriously consider adopting a demonetization program of their own.

During my recent discussion with Dr. Rajaram Krishnan, an economics professor at Earlham College, he suggested that the demonetization program was “at worst, a populist measure introduced by a populist government wanting to be seen as fighting corruption whatever the cost, while at best, it is an excellent first step in simultaneously fighting corruption and transitioning millions of Indians into the formal economy. But unless the government follows up with other systematic administrative and enforcement changes to fight corruption, all would have been for naught as people will adapt and game the new system. Such changes are easier thought of than executed.”

Many of the reasons stated for undertaking the demonetization program in India are relevant to Egypt. This doesn’t mean I am advocating for Egypt to adopt a demonetization program, but if we are serious about combatting corruption, combatting the funding of terrorism and illicit activity and if we really do have an ambition for financial inclusion and digitization, then we need to take courageous steps of our own.

And look, if the end of 2016 is anything to go by, the current government has demonstrated that when Egypt’s economic survival is at stake they will do what’s necessary to get us back on track, even if those measures are unpopular and come at a high transition cost. This mantra was recently recited once again by Amr El Garhy in his interview regarding the Egyptian economic reform program.

If we want to reap the full benefit of the short-term pain we are experiencing at the moment, we need to continue with the reform drive and adopt progressive ambitious high reward strategies that will transform us into the powerful high growth economy we so dearly want to be.

Beyond the Rubicon is a column written exclusively for Enterprise every other weekend by Aly Shalakany, senior partner at Shalakany Law Office, which he joined from Linklaters in London. Aly is a noted specialist in finance, projects and mergers and acquisitions; his column appears exclusively in our Weekend Edition, offering an “inside baseball” look the intersection of business, economy and finance from the point of view of a practitioner at the top of his game.