January 6, 2017    7 minute read

The Political Cost Of Modi’s Demonetisation

A New Reality    January 6, 2017    7 minute read

The Political Cost Of Modi’s Demonetisation

A lot has been written and said about the economic consequences of the Indian demonetisation since prime minister Modi withdrew 500 and 1000 rupee notes from circulation (representing some 86% of all cash circulated).

Most think that Modi had the right intentions, but his execution was poor. The economic consequences are meant to be felt this quarter with sales and business activity dipping. Many economists expect the long-term gains from the banknote ban to be positive.

Demonetisation And The State

Economic consequences, no matter how important, are not the focus of this article. The question many Indian and foreign commentators seem to have missed is: what is the political capital of demonetisation viewed through Indian dimensions? Ultimately, political results will shape the government’s remaining two years, in terms of making bold reforms.

Those political effects have ramifications for the Indian economic policy. The biggest takeaway from the demonetisation exercise is that in the immediate future, political manoeuvres will have the most impact on the financial markets.

The problem analysts are facing is that the highest echelons of this government do not let information leak, making it extremely difficult to guess what will happen next. A case in point is the impact on markets when news of respected Indian central banker Raghuram Rajan not seeking another term was overshadowed by the government’s announcement on the next trading day of a relaxation of its FDI regime.

So the biggest question is: has prime minister Modi’s party, the Bharatiya Janata Party (BJP), gained or lost from this exercise? Commentators were unanimous in their assessment that the BJP had won on the back of surgical strikes into neighbouring Pakistan as retribution against alleged state-sponsored attacks on Indian troops in Kashmir. So why did Modi, riding on a high, risk it all at this crucial political juncture?

Will Modi Make Good?

The definitive answer to the first question will be clear after the state elections to be held in early 2017. Among the five states to go to the polls, the most important is Uttar Pradesh, India’s most populous (200 million inhabitants) and politically important. Of the 282 seats won in the lower house by the BJP in the 2014 general elections, 71 (25%) of them came from Uttar Pradesh.

It is of critical importance to the BJP, who has not been in power in the state for the past 15 years. Elections in Uttar Pradesh are being viewed as a poll on the government’s performance. It is also a question of prestige for Prime Minister Modi, considering he was elected from the state in 2014. Naturally, a win would amplify the invincible aura of Modi as the leader of the masses. A loss would shatter that image and lead to a more incremental and conservative stance to policymaking.

It should be noted that since demonetisation was announced, and despite a media outcry, the BJP has not lost any ground in the polls and municipal elections. These victories range from the north-eastern state of Assam to traditional BJP strongholds such as Gujarat, to the elections in the union territory of Chandigarh.

42%of votes were cast in favour of the BJP in the 2014 national polls

All the data to date post demonetisation points towards Indians backing the sentiment behind the note ban, being ready to accept temporary hardship.

This is backed by a prominent qualitative survey which suggests that the public (especially in Uttar Pradesh, which has been hit harder due to poor banking infrastructure) were ready to wait until December 30th for life to ease back to normal.

An opinion poll by Huffington Post India seems to suggest that, while support for the demonisation is high, it is starting to slip as the chaos unleashed starts to take longer than expected to subside. Clearly, the political fortunes of Modi and the BJP hinge on how quickly India overcomes it. Many have suggested that this will happen only in early January 2017 – a good month later than Modi promised.

Answering the second question as to why Modi would risk taking such a bold move lies in the nature of Indian politics, ably represented by the politics within Uttar Pradesh. India, at the moment, is a multi-party political ecosystem with a first-past-the-post method of representation similar to the UK’s.

India’s landscape is primarily socially and economically left leaning. The BJP has the advantage of occupying most of the right-wing spectrum, while the main opposition party, the Indian National Congress, has to compete against other regional parties within the larger but much more fragmented left-wing spectrum.

Since the demonetisation occurred, the bulk of the Indian opposition has constantly attacked the government (in some cases rightly so) on its implementation. However, by attacking the government all at once, they seem to have all merged into the background.

Lessons For An Indian Statesman

It is a good moment to present a hypothesis on Indian politics. That is: it pays dividends to make bold, well-intentioned decisions in the present Indian political environment – a multi-party system – to make your party stick out from other competitors, ignoring other factors.

In a first-past-the-post system with multiple political fronts capable of winning, it is important for a significant minority of the voting populace to be strongly influenced to vote on the basis of a candidate’s initiative, rather than to have a large majority provide a positive but mellow response and vote for other alternatives based on other compulsions.

In May 2016, the BJP got 2.8% of the popular vote in the assembly polls in the southern state of Tamil Nadu. Yet, post-demonetisation, in a survey of 6000 people across the state by a popular local TV channel, 23% claimed they would vote for the BJP – even though the vast majority of people surveyed were critical of the implementation. A substantial difference, then. Local polls due to be conducted in the state will provide more hard evidence towards that hypothesis.

Uttar Pradesh is being seen as a four-sided contest. In the 2014 national polls, the BJP achieved 42% of the popular vote, which was nearly double than the next-largest party. However, the dimensions for assembly polls are different, with the popular Modi not up for direct election. Local issues take prominence over national issues. It should be noted that, barring the state of Kerala, the vote share of the BJP has consistently declined in the assembly elections around the country since the 2014 general elections – even in states that the party has won as smaller local outfits find that they connect better on local issues.


As can be seen from the graph below, the past two assembly elections in Uttar Pradesh have been won by achieving 30% of the votes cast. The BJP, which polled at 15% in 2012, will, therefore, need to double its vote share in 2017. On paper, this seems feasible given the 2014 general elections. Even if there is a drop from 42% of the vote (which can and should be viewed as a statistical outlier), there is still a good chance that it will be more than 30%.


Should the BJP win with around 30% of the vote, it would give credence to the strategy of Indian policy makers being more aggressive in their measures than making mere attempts to maintain the status quo.

Events before the Uttar Pradesh elections, such as the union budget on February 1st, could see Modi testing the robustness of the hypothesis at hand to its fullest extent with a new set of bold measures if the BJP is deemed to be lagging in Uttar Pradesh. Analysts and forecasters beware: multiple potential data breakpoints lie ahead.

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