By Sanjay Pulipaka & Meenaz Munshi —

Citizens and soldiers queue to use an ATM in Leh, India. Source: Sistak’s flickr photostream, used under a creative commons license.

On November 8, Indian prime minister Narendra Modi announced on national television the demonetization of Rs. 500 and Rs. 1000 currency notes (worth roughly $7.50 and $15, respectively) to combat the menace of black money and counterfeit currency. In one stroke, approximately 80 percent of India’s currency became worthless. India’s political discourse was until recently dominated by identity issues such as cow protection, the uniform civil code, and debates on freedom of expression. Partial demonetization has ensured a substantial shift in the political discourse to economic issues. Factions within political parties and some political parties that thrive on identity politics are on the back foot.

For the first few days, many citizens welcomed the move. However, with growing currency shortages, rumours about alleged commodities shortages prompted ordinary people to hoard essential commodities such as salt. With limitations on currency withdrawals, there are long lines at ATMs and banks across the country. The immediate objective for the government is to ensure the ATMs have enough cash, and that there is trust in the public that they will have easy and continued access to currency.

The partial demonetization may negatively impact campaign spending in the poll-bound states of Punjab and Uttar Pradesh. In addition, the winter parliamentary session has a heavy legislative agenda. Parliamentary proceedings may get disrupted due to protests by opposition members over demonetization and important bills related to Goods and Services Tax (GST) may not get legislated.

Outside the Parliament, it is important for the government to ensure that the inconvenience people are experiencing does not translate into street violence. The government should also work to ensure that the current currency shortages do not cause growth to contract for more than a quarter. Even if these goals are achieved, however, demonetization will have long-term political impact. Already, West Bengal chief minister Mamata Banerjee reached out to her primary rival – the Communist Party of India, Marxist – to launch a nationwide political campaign. On the other hand, Chief Minister Nitish Kumar of Bihar – a key opponent of Modi – supported the demonetization policy, indicating the possibility of substantive political realignments.

The partial demonetization has allowed Modi to successfully portray himself as a genuine anti-corruption crusader. During a speech in Goa, he stated that the partial demonetization is only the first of many anti-corruption reforms. One clue as to what these reforms might be is his reference to state funding of election campaigns. It is likely that “combating corruption” will be an important campaign platform for the ruling Bharatiya Janata Party (BJP) in the coming months. Political parties, such as the Aam Aadmi Party, with a similar reform agenda to the BJP will now have to quickly re-calibrate their strategies to retain their core vote base.

While there is widespread support within the ruling party for these measures, in the coming months there will also likely be murmurs within the BJP that the demonetization has hit their core support group – small traders and business owners – the most. In order to restore relations with this group, the government may announce simplification of tax procedures and even reduction of taxes paid by small traders/business owners. Furthermore, sustained punitive anti-corruption measures may quickly bring diminishing returns. Therefore, it will become necessary to initiate large-scale welfare schemes in order to maintain momentum. More importantly, establishing a connection between these two efforts by stating that ‘anti-corruption’ measures have provided necessary resources to initiate welfare measures may have long-term political dividends.

Some regional parties have found it difficult to align with the BJP due to the fear of getting branded as ‘right-wing sectarian’ elements, and thus losing the minority vote. If the agenda of combating corruption gains momentum, it is very possible that some regional parties will gravitate towards the ruling alliance. If the partial demonetization and the introduction of new currency are successful, then it will reinforce the perception that Prime Minister Modi is a decisive leader. It is unsurprising that the recent ‘surgical’ strike against Pakistan was conducted in utmost secrecy because the military bureaucracy is trained to maintain secrecy. The partial demonetization involved a large number of actors, including the Ministry of Finance, the Reserve Bank of India, and other units of civilian bureaucracy. The fact that demonetization was in fact kept secret indicates the capacity of the Prime Minister’s Office to enforce utmost secrecy. Various institutions and organizations that are supposed to monitor and report on government activity will re-examine their tool-kit.

Reaping the dividends described above hinges on the government’s ability to ensure that there are adequate currency flows into the economy. If the government fails to give easy access to currency within a reasonable time frame, that failure will have a devastating impact, not just on the ruling political party but also on the nation’s economy. Such negative consequences will reduce India’s ability to negotiate the complex power-play at regional and global levels. Not surprisingly, many ordinary citizens, irrespective of their political affiliations, are hoping that this currency shift will work for the larger national good.

Mr. Sanjay Pulipaka is Senior Consultant at the Indian Council for Research on International Economic Relations.
Ms. Meenaz Munshi is Senior Associate at the IDFC Institute. The views expressed here are personal.