Demonetisation’s Political Dividend: The Modi Calculus And How It Connects to 2019

Economists are scratching their heads wondering why the head of government should be risking an economic slowdown just when things were looking up. A disruptive move like the demonetisation of Rs 500 and Rs 1,000 notes was the last thing the economy needed. There may be some ephemeral gains in future, but the short-term losses are for sure.

Public sector bankers are miffed. Just when they are grappling with an overload of bad loans, their owner wants them to focus on servicing millions of customers and non-customers with cash exchanges. While they are grateful for the unexpected surge in cheap deposits, which gives them a treasury profits boost, they fret about what will happen to the loan portfolio if more small and medium businesses start defaulting in this quarter and the next.

Behind formal smiles welcoming moves to cleanse the system, business is quietly fretting about a Prime Minister they believed was business-friendly when he was actually targeting them indirectly.

Rival politicians have been flummoxed by a popular politician’s willingness to court widespread public anger by forcing them to stand in long queues. But they are unable to condemn the move to ferret out black money.

Everyone is entitled to his fears and suspicions about what demonetisation is all about. But if you were to connect the dots between Prime Minister Narendra Modi’s major moves since 26 May 2014, there is a clear pattern to his pronouncements and initiatives.

Ladies and gentlemen, welcome to the next (fifth) reincarnation of Narendra Damodardas Modi, the 14th PM of India, who intends to rule till 2024 by winning 2019. This is by no means certain, but if Modi fails, it will not be for want of trying or lack of political imagination. The economy may be collateral damage, but then that too is by no means certain. It may just come up trumps.

To find an answer to the questions why and why now, you have to look for political justifications, and not necessarily economic ones. Demonetisation is the most political of Modi’s moves.

A flashback to his meteoric rise from 2001, when he became Chief Minister of Gujarat, tells us this simple fact: Modi believes that the same story will not sell in every election. Thus, after every victory, he believes he has to reinvent himself in a new avatar. He has a new persona to sell in every election, and this is the basic motive behind demonetisation too.

Here’s a quick chronology.

After 2001, Modi tried to paint himself as a doer, by focusing on rebuilding Kutch after a devastating earthquake. But the game-changing development was 2002, when he became a Hindutva icon after the Godhra train fire and subsequent communal riots. That was his first avatar.

But after winning a big mandate in 2002, he realised that polarisation was not going to help him forever. He thus reinvented himself as the development icon, the business-friendly Gujarat CM focused on growth and investment, with the Vibrant Gujarat summits offering a template for future state-level investment jamborees. By 2007 thus, using the state’s residual polarisation and adding on a new positioning as development icon, Modi triumphed again. That was his second avatar.

By 2012, when his sights were set on Delhi, he realised that to win nationally, he had to completely transcend his 2002 image, and pitch himself as the go-getter of Gujarat who could get things done for the whole country. He hard-sold Gujarat’s achievements under him and had the global media and heads of government beating a path to his door for investment. He was pariah no more. With India Inc already eating out of his hands after the disastrous final years of the UPA, he had almost every power centre rooting for him well before 2014. That was avatar No 3.

But his message for 2014 was not the same as his message to Gujaratis in 2014. He reinvented himself yet again as the man who gets things done, something the urban middle classes wanted to believe, and also pitched himself as an inclusive leader, with his sabka saath, sabka vikas slogan. The 2014 avatar was less about being business-friendly, and more about the pro-poor man and decisive leader, who will set things right. Avatar No 4 had been created.

He would have had no need to reinvent himself again before 2019 except that the sluggishness of the economy was too structural to be cured by the midpoint in his tenure (which is this month, by the way). What the UPA had left behind was a poisoned chalice and a scorched earth, and Modi had no intention of letting this drag him down. With bank performance going from bad to worse, Indian Inc reeling from overleverage, and the Rajya Sabha preventing him from modifying growth-sapping laws like the Land Acquisition Act, Modi realised that there was going to be no easy way to create growth and jobs before 2018-19.

This is what has forced the fifth reinvention of Modi. From sabka saath, sabka vikas, he is now positioning himself as Robin Hood, the man who takes from the rich and gives to the poor. This will be his story in 2019.

If you connect the dots from the initial Modi initiatives (Jan Dhan, Aadhaar, Direct Benefits Transfer) to the latest demonetisation drive, this reinvention has been in the works for a while. While he has done nothing to damage business, and has, in fact, passed many laws that will be of long-term benefit to the economy (from foreign direct investment in insurance to subsidy reform to a new bankruptcy law), Modi has realised that normal growth will not give him enough of a surge in popular perceptions two years ahead of 2019. At best, it may happen in the last year of his current tenure, which means he could face the same fate as Atal Behari Vajpayee, where growth came in 2003-04, and he duly lost the election.

To understand why demonetisation works for Modi even if it doesn’t quite work for the economy, you have to see economics the way politicians see it: good economics is useful if the wind is blowing in your direction, but a hindrance if it is not helpful to re-election. In the final years of the UPA, despite the sharp deceleration in the economy, the government still thought it fit to bring in a Land Acquisition Act that effectively constrains future manufacturing and infrastructure growth. Land prices have gone through the roof, thus killing or restricting the sectors (real estate and construction) most likely to create jobs and growth. Sonia Gandhi saw no benefit in trying to do the right thing by the economy. She legislated the Food Security Act and Land Acquisition Act to woo the rural landed and the urban poor. That it didn’t work is another story, but it tells us how the political mind works. Re-election comes first, economics next.

Now connect the dots for Modi’s major initiatives. He launched the Jan Dhan scheme in 2014, and there are now 25 crore such accounts, nearly half of them seeing no balances or very few transactions.

Then he experimented with direct benefits transfers, using LPG subsidy reform as the trial balloon. It worked like a dream. In less than a year, subsidies were directly paid into bank accounts. Simultaneously, Modi called for the voluntary giving up of subsidised LPG by the better off to enable a shift of those subsidies to the rural poor. He thus created the right moral climate for future exclusions on the basis of income limits. Subsidy reform will probably be seen as one of Modi’s best achievements so far.

Then came the stick. In 2015 and 2016, Modi offered two schemes for the voluntary disclosure of foreign and domestic black money, and garnered around Rs 70,000 crore, half of which will come in as taxes.

He was effectively setting the stage for demonetisation, which followed the Income Disclosure Scheme (IDS) that closed on 30 September. Also notified this month was another Draconian law - the Benami Transactions (Prohibition) Amendment Act, 2016. Among other things, this law allows the government to confiscate benami properties, and also send benaamdars to jail for upto seven years.

Between demonetisation and the Benami Transactions Act, Modi has effectively shaken the black money cash tree and expects to collect a revenue bonanza. This cash is what will help Modi script his re-election proposition for 2019.

Here’s how the script could run.

Some Rs 14 lakh crore of high-value notes have been demonetised. Depending on how much of the money does come back, or does not come back, the government benefits either way.

If all of it comes back (highly unlikely), banks will be flush with cash and bring down interest rates. The government will borrow at low rates, and some of the black money that turns up for conversion to new notes will end up paying high taxes. It can also cut corporate tax rates, and give itself enough ammo for spending on infrastructure.

But let’s assume a big chunk of the money does not come back. It could be anywhere from Rs 2-3 lakh crore. This money is worthless, and the Reserve Bank of India (RBI) can well report a fall in its liabilities by a like amount, and declare a higher surplus or dividend, which by law goes to the government.

If the government gets anything like Rs 1-2 lakh crore, its money for jam. This money can go to reflate the economy, recapitalise banks, write off farm loans, and – most importantly – put money into Jan Dhan accounts. Putting Rs 5,000 in each Jan Dhan account will cost around Rs 1,25,000 crore. (The problem is in deciding whether all should get it or only the zero-balance accounts, and also whether accounts outside Jan Dhan can also be credited based on identification of BPL cases). This will also enable him to claim that black money from the crooks is now coming back to the poor – a huge political scoring point.

Even if there is no bonanza from the RBI, the government will have large tax receipts coming in, which can be used to fill up the coffers of the poor. The Benami Transactions Act is a silent threat to benaamdars. It will be a powerful tool to keep political rivals quiet (since most benaamdars are linked to politicians), and the taxman can use the threat to generate more revenues. It can also be used to keep allies in line or silence threats.

Modi probably calculates that the short-term slowdown in growth due to the destabilising effects of demonetisation is worth it if there is a political dividend waiting at the end of it.

His political rivals may be hoping that the long queues will alienate people from Modi, but it could actually happen the other way: people instinctively understand that there is no gain without pain. However much they may curse him silently right now as they stand in the sun, they may be convinced that it was worth it if Modi delivers a cash bonanza at another point. It is Modi’s version of Kennedy’s “Ask not what your country can do for you, ask what you can do for the country.” He is asking his people to do something for the country, and this is how it is playing out so far. As long as the cash queues disappear by December, he will be safe.

It enables him to play Robin Hood before 2019. Let’s call that his next avatar.