Demonetization represents much more than destabilization; critics argue that it has struck a body blow on economic activity in India. The decision – which was entirely unsuspected – was announced on 8 November 2016. While the pros and cons of the measure still continue to be debated, the consensus of opinion appears to be that while the proponents of demonetization may have had good intentions, the suffering it has caused to millions of Indians is unwarranted. Since Rs500 and Rs1000 notes make up some 86% of the total currency in circulation in India, especially in the vast rural areas, one economist compared the pain to what individuals might experience if 86% of their blood was removed from their bodies.

1. How Will Demonetization Affect Business in India in 2017?
By
Knowledge@Wharton
Jan 05, 2017
It’s work in progress. Three events dominated India’s economic landscape last year, but whether
they can be described as “progress” is debatable. One definitely isn’t: the unseemly brawl that
broke out over control of the Tata group with Ratan Tata returning as interim chairman after
ousting incumbent Cyrus Mistry. A lot of dirty linen is being washed in public, putting partly in
the shade the political charges being traded elsewhere.
The second is the goods and services tax (GST), whose objective is to replace all taxes levied by
the federal government and the states with one central tax. The GST is scheduled to come into
effect by April or — at the latest — by September. Although both houses of Parliament have
approved the bill and the President has signed off on it, a GST Council is now squabbling over
the details, which could delay implementation.
“The timing is not right for implementation,” says West Bengal finance minister Amit Mitra,
who is also chairman of the empowered committee of state finance ministers. He lays the blame
squarely on the center’s move to demonetize Rs500 ($7.4) and Rs1,000 notes. “We all supported
the GST under the premise that this would be the only destabilization factor,” Mitra told a TV
channel. “We did not know that there would be a much bigger destabilization in the form of
demonetization that would be let loose on the country.”
According to Wharton emeritus professor of management Jitendra Singh, while it is too early to
assess the impact of demonetization, the move raises long-term questions. “What will have been
gained from this step, and at what cost and mostly borne by whom?” he asks. He notes that rival
political parties that have protested against demonetization could “broaden their tactical agenda
to harm or even derail the GST implementation.” It also remains to be seen how the negative
sentiment against demonetization could hurt the BJP and its allies in assembly elections in Uttar
Pradesh in February-March, he adds.
“What will have been gained from [demonetization], and at what cost, and mostly borne by
whom?” –Jitendra Singh
Demonetization represents much more than destabilization; critics argue that it has struck a body
blow on economic activity in India. The decision – which was entirely unsuspected – was
announced on 8 November 2016. While the pros and cons of the measure still continue to be
debated, the consensus of opinion appears to be that while the proponents of demonetization may
have had good intentions, the suffering it has caused to millions of Indians is unwarranted. Since
Rs500 and Rs1000 notes make up some 86% of the total currency in circulation in India,
especially in the vast rural areas, one economist compared the pain to what individuals might
experience if 86% of their blood was removed from their bodies.

2. To be sure, demonetization has its supporters. While industrialists and corporate chiefs (Ratan
Tata, Mukesh Ambani, K.V. Kamath and Deepak Parekh, to mention a few) favor the move,
economists (including Nobel laureates Amaryta Sen and Paul Krugman, among others) are
critical. “The clan of economists has spoiled the party [with] their estimates of how output will
be affected as spending has stopped, manufacturing hit and several workers laid off. The net
result can be a fall of between 0.5% and 2% in GDP,” says online news channel Firstpost. “The
debate still goes on.”
According to Singh, Modi took “a bold, even visionary, step” with demonetization in attempting
to combat the black economy and counterfeiting, and cutting financial support to terrorism.
“What was always key, however, was how well the implementation process would unfold,” he
notes. “Even supporters of the decision would say that the implementation was far from perfect.”
Kartik Hosanagar, a professor in Wharton’s department of operations, information and decisions,
views demonetization against the backdrop of other economic gains. The year 2016 has overall
been “a good year” for India, he notes, listing the highlights:
 The GDP growth rate has held up at more than 7%.
 Foreign direct investment went up significantly during the year. (It rose 30% on a year-
on-year basis to $21.6 billion between April and September 2016, according to public
data published by the India Brand Equity Foundation, a government-sponsored trust.)
 Initiatives such as the ‘Make in India’ program “have borne early fruits.” Many MNCs
including Panasonic and Pepsi set up manufacturing facilities in India during the year.
 “The startup world has seen a drop in investment activity, but I see that as a return to
sanity rather than a worrisome contraction,” Hosanagar adds.
“The biggest wild card in all of this, of course, is demonetization,” notes Hosanagar. “It’s
unclear how it will all play out.” He hopes that “any impact on economic activity and GDP will
be temporary, and the long-term benefits such as an increase in cashless activity will be more
permanent.” He adds that “this is the India optimist in me speaking.”
“The biggest wild card in all of this, of course, is demonetization.” –Kartik Hosanagar
Part of the problem with demonetization was that it came as a bolt from the blue; the government
claimed giving advance notice would have the defeated its purpose. But not everyone agrees
with that view. “There was no need for secrecy,” counters Jayati Ghosh, a professor of social
sciences at Jawaharlal Nehru University. “All demonetizations through history have been done
with some advance warning. This reduces the damage to innocent people. The government could
monitor suspicious transactions after the announcement, just as it is doing now. In any case, I
would not have demonetized Rs500 notes. If high-value notes like Rs1,000 are the problem, why
replace them with even higher value notes?” (A Rs2,000 note has been introduced as part of the
package.)
Moving Goalposts

3. The government, meanwhile, seems to have moved the goalposts: The claimed objective of the
exercise has apparently changed from rooting out black money to promoting cashless
transactions. Several measures have been introduced, among them a 0.75% discount on digital
payments made for buying petrol and diesel and a 0.5% cut in the price of railway season tickets
bought using digital technology.
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In another twist, the government appears to be no longer pushing demonetization as a “cashless”
plan. It has now become a “less-cash” strategy. That is as it should be; the world doesn’t have a
cashless economy so far. In India, Bloomberg data shows the share of cash in the volume of
consumer transactions is 98% (against 55% in the U.S. and 48% in the U.K.). It is 90% in China
and 86% in Japan. Much of the cash transactions are in rural India. So, expectedly, life came to a
near standstill and much misery ensued when people found themselves unable to use their own
money. Even when the money was in a bank account, limits on ATM withdrawals compounded
the problem further.
But India is also a country where finding novel, workable solutions to problems – commonly
known as jugaad — is par for the course. While long lines multiplied in front of banks and
ATMs (several people claimed to have had heart attacks while standing in them), ways were
found to deal with the situation. By December 31, the visible impact was a Parliament at near
paralysis as politicians took potshots at each other, a plethora of banking riches coming back into
the system (some 90% of the Rs500 and Rs1,000 notes were returned), and a host of new scams
to convert black money into white with the connivance of bankers and politicians.
Nobody is denying a short-term setback. The Reserve Bank of India (RBI) has reduced the GDP
growth rate forecast for 2016-17 from 7.6% to 7.1%, the Asian Development Bank from 7.4% to
7%, Fitch from 7.4% to 6.9% and Bank of America-Merrill Lynch from 7.7% to 7.4% (for
calendar 2016). All believe, however, that growth will recover the next year.
Modinomics to the Defense
Modi defended the demonetization exercise in a televised speech on New Year’s Eve, arguing
that it had to be done. “It seemed at times that the evils and corruptions of society, knowingly or
unknowingly, intentionally or unintentionally, had become a part of our daily lives,” he said.
“Crores of Indians were looking for an escape from this suffocation.”
Modi said in his speech that after demonetization, only 24 lakh (2.4 million) Indians
acknowledge an annual income of Rs. 10 lakh each (Rs. 1 million). “Can we digest this? Look at
the big bungalows and big cars around you,” he said. “If we look at any big city, it would have
lakhs of people with annual income of more than [Rs.] 10 lakh. Do you not feel, that for the good
of the country, this movement for honesty needs to be further strengthened?” The upshot of that
is his government would now try to bring hundreds of thousands of tax evaders into the net.
But Modi will find it tough to strengthen the tax machinery sufficiently to force those people to
start paying taxes, according to critics. “If he doesn’t, then what was the point of subjecting the

4. whole country to so much disruption and pain?” writes Siddharth Varadarajan, former editor of
The Hindu newspaper, in The Wire, a nonprofit publication.
Modi also said in his speech that over the last 10-12 years, the demonetized currency was being
used in the black economy, and that excess cash in the system caused inflation to spike and
fueled corruption. “Lack of cash causes difficulty, but excess of cash is even more troublesome,”
he said. Critics have attacked those remarks as being unsound in economic theory.
Demonetization could have potentially derailed the GST, which was practically a done deal,
according to experts interviewed by Knowledge@Wharton. The impact of demonetization will
pass in a couple of quarters, but the GST delay will have more far-reaching effects.
“Undoubtedly, the GST is a bigger reform. It would be the most fundamental reform initiated
since 1991,” says Dharmakirti Joshi, chief economist at Crisil, a global S&P company.
“There was no need for secrecy. All demonetizations through history have been done with some
advance warning.” –Jayati Ghosh
Commenting on demonetization, Joshi says: “Any disruption in the flow of money, verily the
economy’s lifeblood, impacts business cycles quickly. There is no precedent to the scale of
demonetization that has taken place in India. That is why quantifying its impact is so difficult. A
few countries that replaced their old currency with new did it in a gradual manner — the
introduction of the euro in the Eurozone, or in Zimbabwe where the old currency was gradually
phased out.”
The GST Impasse
The government has only itself to blame for the GST impasse. The proposal has been around for
a dozen years. Its origins lie even further in the past: In 2000, the BJP-led government of A.B.
Vajpayee started a discussion on the GST. Prime Minister Narendra Modi had opposed it when
he was chief minister of Gujarat; now, it is the pivot of his reforms. Experts agree that the GST
could increase India’s GDP by 1.5% to 2%. It has received, in its time, the backing of former
finance ministers Pranab Mukherjee (now president of the country) and P. Chidambaram. Yet it
still gets held up.
One reason is that implementing the GST requires a constitutional amendment. The GST
Constitutional Act has already been passed by the Lok Sabha and the Rajya Sabha (the two
houses of Parliament) and, on 8 September, the President of India signed off on it. The states – in
the form of the GST Council – are reading from the same book. But it may take some time to get
to the same page.
According to Singh, while the GST has the potential to boost GDP growth and foreign
investment flows, the opposition to it could cost the country dearly. “There is the very real
possibility that some actors will take the low road, and try to delay or even derail the GST
implementation,” he notes. “If that were to occur, it will not be the first time in post-1947 Indian
history when key leaders would snatch defeat from the jaws of victory.”

5. Singh hopes that the political parties involved, including state level parties, “put the collective
long-term interests of India and all Indians above apparently enticing short-term partisan gains,
and get the GST bill implemented at the earliest.”
Viewed in isolation, demonetization and GST could be promising for India, according to Singh.
“Absent some of these spillovers, the long-term impact of the demonetization could be quite
positive for the Indian economy,” he says. “If the GST gets implemented soon, and if there is
further rationalization of the tax structure, and if opposition parties cooperate, there may be a
couple of quarters of somewhat lower growth, and then the economy would return to its positive
trajectory. But there are several ‘ifs’ in between.”
Ta ta, Cyrus Mistry
The end of the year also saw a high-profile family split. The 149-year-old Tata group, the largest
in the country and the most respected, with a global turnover of more than $100 billion, sent
shockwaves through corporate India with the ouster of chairman Cyrus Mistry.
Mistry took charge four years ago after a search panel was appointed to find a replacement for
Ratan Tata, who was turning 75. The 50-year-old Mistry was a surprise choice. And problems
were apparently building for a long time under the surface.
“Any disruption in the flow of money, verily the economy’s lifeblood, impacts business cycles
quickly. There is no precedent to the scale of demonetization that has taken place in India.” –
Dharmakirti Joshi
Mistry is now being ousted from all the Tata group companies. Says a letter to shareholders by
Ratan Tata: “Since Mistry was appointed as a director of various Tata group companies only as a
corollary to his being the chairman of Tata Sons, the right step would have been for him to resign
as director. Unfortunately, he has not yet done so, and his continued presence as a director is a
serious disruptive influence on these company boards, which can make the company
dysfunctional, particularly given his open hostility towards the primary promoter, Tata Sons.”
Responded Mistry: “I have to say that the board of directors [of Tata Sons] has not covered itself
with glory. To ‘replace’ your chairman without so much as a word of explanation and without
affording him an opportunity of defending himself in a summary manner must be unique in the
annals of corporate history. The suddenness of the action and the lack of explanation have led to
all manner of speculation and has done my reputation and the reputation of the Tata group
immeasurable harm.”
Most of the Tata group is owned by the Tata trusts, of which Ratan Tata is chairman. So there
are no two ways about how the ouster move will go. But Mistry has his supporters. His family
has a stake of some 20% in Tata Sons; the trusts hold about 66%. Besides, he is not without
friends, who include some independent directors. Nusli Wadia, a board member of Tata Motors,
has entered the fray (with yet another letter). “[JRD Tata, Tata Group chairman before Ratan
Tata] never expected anyone to toe his or the Tata line,” he told the board of Tata Motors (where
he has been an independent director). “It is both sad and unfortunate that Tata Sons and its

6. interim chairman Ratan Tata are not only not practicing this great tradition but effectively
destroying it.” Wadia has sued Tata Sons for defamation.
Singh suggests that the problems at the Tata Group run beyond those related to Mistry’s ouster.
He describes the group as “a structurally complex entity, with multiple interests at play, all of
which may not always be naturally aligned.” As Mistry’s family owns a significant minority
shareholding in Tata Sons, “it is natural to think that interpersonal issues are paramount here,” he
noted. “This is a mistake. There are difficult structural issues embedded in the context, some of
which will not go away with Mistry’s departure as chairman of Tata Sons.”
According to Singh, the Tata-Mistry controversy could have wider, deleterious effects if it is not
resolved soon. “At a minimum, it is a distraction from the effective governance and operations of
the group; it could damage the Tata brand; and it also has the potential to raise questions in the
international community about the attractiveness of India as an investment destination.”
As matters stand, Mistry has resigned from the boards of the major Tata companies (except for
Tata Sons). “The fight goes onto another platform,” he told the Business Standard newspaper
after he quit. “[I] will pursue it further. This move gives me an opportunity to concentrate my
efforts…. I will be moving legally.” Won’t the battle be long and arduous? “I have a lifetime
ahead of me,” he replied.
In a statement to the shareholders announcing his resignation, Mistry states: “Bringing to the fore
these ethical issues can have a short-term adverse impact… I feel strongly that such short-term
pain is necessary for long-term interests.”
Is that Cyrus Mistry talking or Narendra Modi?