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It's not just about currency

New currency notes are just about the beginning, Modi is attempting to jumpstart the entire culture of Indian business

It's not just about currency

As the days pass and the dust around demonetisation starts settling, I can see among people I know that there are broadly three kinds of reactions. One, the inconvenienced yet happy; two, those who are seriously worried; and three, the utterly shocked, panicked and distraught. By numbers, this list is in descending order, with the last category being the smallest.

As far as I can see, the ruined category is filled with those whose whose money comes from illegal sources, such as bribery. In other words, their money is the proceeds of a crime and can therefore not be explained in any way. Moreover the proportion of their assets that is held as real estate and gold has also been effectively demonetised. This is something that a lot of commentators have either missed or are not convinced about.

However, those who hold vast amount of real estate as unaccounted wealth know very well that a huge chunk of the value has evaporated. It simply won't be possible to do deals which have a large proportion of cash, or indeed to safely accumulate the new cash. Without this, the value locked in their assets will not be realisable till inflation has eaten away a large chunk of it. Make no mistake, they all know that at any point in the future, they could switch on the TV one evening, only to hear Narendra Modi's voice ring out, "Bhaiyon aur behnon, aaj raat madhya ratri se..." and their nightmare will be back.

Still, this category of people will get what they deserve. To me, the far more complicated question is that of the middle group. These are, for the most part business people from the small to medium scale. Till a few years ago, most of them used to pay nothing of either indirect taxes or income tax. Now, they do pay a bit but generally only a fraction of what they should be paying. The strange thing (strange to you and me, at least) is that many of them don't consider themselves dishonest--this is just the way business of a certain type and scale is done in India.

How does this happen? I've observed this closely over the years and believe that it's almost a cultural issue. Someone starts a business--a small store, or a trading business, or a small manufacturing/assembly business. In the beginning, capital is hard to come by, profits are a struggle, and credit even more so. It's a well-known fact that almost most credit in the Indian system is sucked up by governments and big enterprises. The idea of taking out money from the meager cash flow and giving it to the government sounds financially suicidal, and for many small businesses, it is. A good part of their competitive advantage over established businesses is made up of not having to pay taxes. You may never have thought of it this way, but if someone's competitors are not paying taxes, then they can't pay taxes too. Everyone has to be dragged into the tax net simultaneously. Otherwise, those who become honest first will be driven out of business.

Meanwhile there's an entire ecosystem to support your cash business, from suppliers and customers, all the way to the CAs, tax officials and the investment avenue, which is mostly real estate. Everything functions smoothly, leaving the task of funding the country's government mostly to the salaried class and to indirect taxes.

There's very little incentive to change, and no disincentive and certainly no social stigma. No wonder so many of them actually sound like they're protesting against some deep injustice when they complain about their cash problems, and in a strange way, it's possible to sympathise with such people. It was a stable system, and one that was changing imperceptibly, if at all. It needed an out-of-the-box doer (not just a thinker, we've had enough of those) to realise that there was absolutely no way out except some really strong shock treatment. And so here we are. There's some chaos, maybe a lot of it for a while.

These are interesting times, and we're seeing a huge change, potentially at least as big in impact as the 1991 liberalisation. Those who think this is about new currency notes need to step back, well back and see the big picture. This is about attempting a culture and behavioural change for all of Indian business.