Tuesday, November 15, 2016

Demonetization - real consequences (as opposed to desired consequences)

From news reports a very confusing time line of the demonetization policy appears. There is story of Mr. Bokil in Pune [1].  It seems Mr. Bokil met Prime Minister Modi in July 2016 [2] and inspired the demonetization. Then there is the "for-six-months" narrative [3] where the entire issue was decided in a meeting between Sri Urjit Patel, Sri. Arun Jaitley and Sri. Modi and quietly put into action under the disguise of printing counterfeiting proof notes. Per this second narrative - the NSA Doval, COAS Suhag and the CNS and ACM were read into the actual demonetization roughly 1.5 hours before it was made public. The only story they were told is that they need to be prepared for civil unrest in the wake of a botched currency replacement operation - something that Sri. Modi believed was entirely unlikely - because no one at the meeting was even allowed to contact their staff and set up contingency plans.

It appears from these accounts that the policy never underwent an institutional review inside the GoI. Neither the NSCS nor the IDS nor the economic intelligence senior staff saw the policy in any form. No central intelligence organization appears to have had any direct inputs to the policy formulation. There was not even an internal whitepaper on the issue.

This is basically Sri Modi's (and whoever else he might have confided in) baby. Whatever else you may say about it - it seem Sri Modi has started believing his own press and twitterverse that he is some kind of financial, political and social reform genius. I don't know that he is any of those things but I do know that no good comes from believing your own press.

We have all heard how this is going to solve the problems of "70 years of corruption" in "70 days" etc... but what is it really going to do.

I want to examine the impact of this kind of policy on underworld finances - specifically on the flow of heroin trafficking revenues from India to Pakistan. 

Based on NCRB data we can crudely estimate how much drug use there is in India [4]. A crude estimate of how much heroin is consumed in India per year is around 100 mt [5] At the rate of $10-$20 per gm [6], we get a total number that is close to a billion dollars. The real number may be higher but we can use this as a reference in discussions going forward. 

The poor farmer in Afghanistan grows opium. He is paid in Afghanis by a Pakistani refiner. The Pakistani refiner processes the opium into refined heroin, brands it and sells it to a Pakistani trafficker who pays in Pakistani Rupees. The Pakistani trafficker sells the branded packs of heroin to an Indian distributor who pays in Indian rupees. The Indian distributor then moves the product into the hands of Indian addicts who pay in Indian rupees. The ancient banking network known as "Hawala" - converts between the currencies at an exchange rate that is determined locally based on immediate availability and global exchange rate fluctuations. 

The billion dollars are actually stored in the form of Indian rupees, mostly in Rs 500 and Rs 1000 notes. Whenever there is a local shortage in the system, the Pakistanis print Rs 500 and Rs 1000 denominations and give it to the Hawala system so that there is no direct impact on the exchange rate or local violence levels. 


That is how the underworld financial system roughly works on the narcotics side. 

I believe there will be two main reactions in the underworld to the demonetization - the first is "anger" and the second is a concerted effort to "refinance". 

The "anger" dimension leads to a very well understood place - we will have to wait to see if the Indian twitterati are actually able to sustain living in that place.  This "anger" phase will play itself out relatively quickly but the "refinance" stuff will come into play over a much longer period. 

The "refinance" initiative will take several forms. These are less well understood even in the halls of government and in public debate. I list some of the main forms below (in the following text Rs 500 can be replaced by the Rs 1000 denomination without loss of coherence) .

1) "Rs. 500 for Rs. 300" - Counterfeiters (read as the ISI) can print Rs 100 bills as easily as they can Rs 500 bills. So if they offer to change out old Rs. 500 bills for three fresh Rs 100 notes - people with undeclared income will jump on the idea. The result will be an expansion of FICN and an effective devaluation of the Rupee by 40%. 

2)  "Rs 500 for a Rs 450 I.O.U." - During the great currency crunches of the 1990s, major Dalal Street operators would trade shares with a peculiar form of private debt - a small piece of paper issued by the traders to each other with a set of numbers on it. These would be given to each other instead of paper Rupees and this private "I.O.U" system was so infuriating to the DRI and the RBI that they finally just printed the money to avoid an expansion of this private currency. In today's world - we don't have to issue tiny pieces of paper - we can simply set up a bitcoin like cryptocurrency and since cryptocurrencies are traded on open markets with little or no regard for what is traded for them - we can easily visualize a system where the Hawala currency traders purchase cryptocoins from each other to move money around - they would continue to accept the old Rs 500 notes but then charge a Rs 50 fee for it. The Rs. 50 fee is what would be use to float the new cryptocoin and as long enough investors were willing to buy into it - the transaction costs could be covered and significant profits made without loss of any real value. The result will a devaluation of the Rupee and the coupling of the Indian Rupee to a large quantity of unsecured debt

3) "Old Rs 500 + Rs 100 for a new Rs. 500 note" - As the RBI cannot track new Rs. 500 notes (all that nano GPS stuff is total bullshit) - the underworld would simply have to rob bank cars and ATMs. This is what Pakistani terrorist groups (the OAS in France)  did when Musharraf (Charles de Gaulle) shut down their bank accounts. The bank robbery can be replaced by kidnapping or carjacking - it is all the same. Whatever new Rs 500 notes are earned in this fashion can be traded for Rs 500 of old money and a Rs 100 transaction fee. You may end up buying a carjacked vehicle using a bank loan from a legit bank - but if the police find out that you are driving a stolen car, you would still own the bank money while being under police investigation for criminal activity! In this fashion - not only will the currency be devalued, bad debt created but we will also see a rise in criminal activity. 

The sad reality is that Modi demonetization plan does not account for the fact that currency by itself has no value apart form what the bearer sets it and that while currency can be used to account for undeclared wealth generation - it is not a static affair and that new sums of black money are being generated every second. Since this new wealth is monetized by Sri. Modi's new notes - a relatively trivial exchange process will take hold and market dynamics will ensure that the old "black money" is traded at an acceptable rate for the "new" black money. 

In isolation any of these schemes by themselves will not amount to much - but in combination - they will create a massive funnel that steals wealth from the very Indians this anti-corruption measure is supposed to defend. 

The only people who will suffer because of this are the poor who will find themselves literally short changed by the rich. I mean think about it - if you are poor daily labourer in Bihar or UP - what are you going to do if your Mukaddam pays you in old bills? can you really tell your Mukaddam to go to hell? you have no rights - you will simply run from vegetable seller to grain merchant trying to get rid of the old bills and in the process these people will sell you Rs 400 worth of grain and take your Rs 500. I guess your kids will go hungry while some twitter-asshole talks about how "corruption in India" is coming to an end because of this shit. 

Now the Modifans will never acknowledge such realities - but reality doesn't care about their sentiments either. 

2 Comments:

At 9:35 PM, Blogger Nanana said...

http://wap.business-standard.com/article/economy-policy/demonetisation-can-india-go-cashless-116111500889_1.html

This aslo hints at parallel black economy using old notes in the hinterland. That said, while ATMs are still mostly dry, the queues at banks in Mumbai is relatively shorter today

 
At 5:35 AM, Blogger maverick said...

Yes - that sounds about right. I think the bulk of the queues at banks in urban areas are people who have actual bank accounts going into change out relatively small amounts of cash.

The people who don't have bank accounts especially in the mofussil areas are less likely to go to banks. These rural banks are also part of a serious last mile issue. The new notes will take longer to reach there and the parallel economy will exist out there.

The thing is - demonetizing the Rs500 (or Rs1000 note) doesn't mean jack if the money doesn't ever enter a bank account. The idea that this move impacts the piles and piles of cash sitting in the houses of hawala traders is absurd. They feel a pinch for a few days until they refinance the notes - ultimately even right now they are basically moving vast sums of money with personal IOUs written on a piece of cigarette wrapper.

Whoever suggested this idea to Sri Modi didn't have a fucking clue how banking works in the real world. If this came from ArthKranti - then perhaps Mr. Modi should have known that accountants and engineers don't know a damn thing about the relationship between wealth and debt. Accountants and engineers know how to count - they don't understand that an instrument of wealth is also an instrument of debt.

The only thing that is achieved by this a short timescale instability in the valuation of these debt instruments. After a few months this will stabilize and it will all be business as usual.

In the meanwhile - we will have to put up with self-congratulatory bullshit like this.

http://www.firstpost.com/india/demonetisation-narendra-modi-nukes-pakistans-rbi-cripples-brig-lalas-fake-note-network-3107658.html

Is there some reason that the ISI can't print Rs100 notes? or the new Rs500 notes?

 

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