It isn't just in India, that people are being forced to put money into banks. Banks worldwide are in trouble. Banks worldwide are needing bailouts. Demonetisation of notes is being considered as well as put into action in country after country - Europe (plan to not make 500 Euros post 2018), Venezuela (got reversed after protests from people) and now Pakistan (plan to demonetise Rs.5000 notes) and Australia (may abolish $100 note), though none of them have been as extreme as the abrupt discontinuation of 86% of the cash in the country, as India did. Governments are in difficult positions. If banks collapse, chaos will result. If they bail out banks, it is not sustainable. And worldwide, government and banks seem to have hit on the bright idea of using the people to get money into banks. Or rather, use the money of customers to continue with their mismanaged methods that have got them to this point. It wouldn't work, normally. One whiff of banks using the customer's money would have people withdrawing their money from banks. Unless - they couldn't withdraw, because there was no real way to do it.
The idea is simple. Go cashless - or as close to cashless as possible. With people unable to withdraw money, their money will remain in the banking system, even while they transact and it moves from account to account. Banks would have most of the money of the whole country to tap into. And no matter what happened, no matter how mismanaged, no matter how close to collapse, there would be no way for people in the country to prevent banks from looting them. Eventually you progress to what is called negative interest rates, where you pay banks for keeping money in them.
What could possibly go wrong?
Please note, I am not an economist. But it doesn't take rocket science to figure out that mishandled anything can only be fixed by handling it right. If banks are in a crisis, demonetisation may fill them flush with cash, but it cannot fix the problem. It will only give banks the freedom to make even bigger, catastrophic mistakes with money that isn't even theirs. Of course the government gets the side effect of unprecedented surveillance and control over lives of citizens. Soon, being harrassed by tax officials or being framed in cases would be the least of worries for dissenters. With very little effort, the government would have the power to cut off your access to all life essentials - or at least make access very difficult as yourself - your own money in your banks, access to cooking gas, your phone numbers... and it goes downhill from there. Whatever you have attached to this monolith.
Here are some very possible scenarios the current debate on demonetisation does not cover adequately:
Shrinking of the economy
Economic migrants are returning to their places of origin by the hordes. Jobs are being lost in entire sectors. Tourism has as good as crashed without money to spend freely. Most tourism in India happens away from the city in small towns and remote places where internet connectivity can be iffy. No matter the propaganda on TV, very few will (or indeed are) risking travel without actual hard cash to back up any cashless plans. A friend in the adventure tourism industry reports of hotels running empty with Christmas coming up, even when they are giving rooms at off season rates. They actually made a tidy profit, because a large chunk of a trip's expense is hotel rooms, which they got for way less than what they budgeted for. So he should be thrilled, right? um... Nope. That one trip is the only business he has in sight at the moment. Usually, they don't have time to breathe in this season. Automobile manufacturers have stopped or cut down production drastically. Local markets everywhere are shrinking. Reduced number of sellers seeing some sales in essential goods creates an illusion of normalcy, but it is an illusion, because the number of sellers have reduced to the point where the few left can try to survive on half of what they used to earn.
Agriculture has been hit unevenly. Those who got their produce sold and new crops planted before demonetisation are relatively unaffected, but most farmers are facing severe crisis with an entire year's worth of profits wrecked. The season that was just over was good. Good rain leading to good harvests. Except demonetisation resulted in their crops selling at the rates of the dirt they grew in. Devastated farmers have dumped tomatoes on roads because the prices they get wouldn't even cover taking them anywhere to sell. As reports of farmers unable to buy seed created outrage, an oblivious government did the one thing it was doing rapidly - poked a few more holes in their grand demonetisation to temporarily allow farmers to buy seeds from government outlets using the old demonetised notes. The government still appears to be oblivious, because the biggest cost of sowing crops is not the seed, but the labour and related expenses that go into it. To add insult to injury, in several places (notably in Uttar Pradesh), the government shops didn't accept the old notes anyway, because the banks wouldn't accept the notes from them - under the directions of the government.
Small industries - garment manufacturers, beedi manufacturers, etc - are rapidly shutting down or drastically cutting down workers, leaving thousands out of work. The pundits of the "market" appear to think that once cash is back (and note, they aren't even talking cashless at this point), things will get to normal. I admit I don't have their knowledge of economics. But I have the experience of living in countless small towns, villages and remote places on shoestring budgets (or credit) and I can assure you, there is no such thing as a jobs bonanza. The jobs being lost as a tsunami had trickled into existence over decades. Banks may be ready and willing, indeed eager to give cheap loans, but other than big companies and their audacious attitudes, I cannot imagine people coming out of a money crisis even thinking of risking loans before their depleted savings are shored again and loans taken to survive are repaid. Because for these people, the consequences of not repaying loans are not write-offs.
To be blunt, even before demonetisation, we weren't really adding much jobs. If the loss of jobs can be reversed, it still isn't an impressive pace. And I don't think it will reverse with the ease it was broken. It will have to recover from this trauma. Less jobs and less incomes mean less taxes after this one time bonanza and more NPAs. So the government and banks may end up losing income while they gain access to use a lot more money of depositors. That way lies bad news, in my view.
The overall situation of desperation puts India at risk of unrest and lawlessness. We already see increased violence at banks. That is the most obvious. People want money, banks don't have money, anger happens, bankers are overtired, something blows on occasion, more frequently as time passes and the pressure does not relent. The government appears to be oblivious to this, as the usual propaganda channels are recklessly blaming banks for black market trading of cash, telling people via television that there is plenty of money and so on. Bankers have died of stress at work. There has been a suicide as well. This is bad news waiting to happen unless the government wakes up fast. Which it does not seem inclined to do, given that it is still trying to prevent a "cut" of demonetised money from being deposited at all and their absurd rules and roll backs and new rules to try and make it happen are further stressing banks and depositors. But still, this is the most obvious.
Situations of mass desperation are ripe for creating hostility and generating violence with rumors and incitement. With elections coming up in several states, this is a very real risk. Given that the ruling party seems to consistently profit from elections held after riots, I don't know whether they see this as a bug or a feature.
Another kind of security risk that would be very high right now is internet banking crimes. With most of the country's money in banks, bankers overworked, and a lot of new people beginning to use cashless transactions, India right now is ripe for internet banking crimes. Furthermore, the government's reckless promotion of services like Paytm, with no liability to protect users from fraud and unknown security measures and unaccountable management, the risk is magnified drastically. Several serious issues leading to loss of money crop up daily on social media, including organized fraud and tax evasion. Our own Godavar found that Paytm has an absurd process for responding to the loss of a phone with a Paytm app on it. The Cyber Appellate Tribunal being non-functional for the last five years is the icing on this cake.
The banks are also vulnerable to threats from terrorists or other enemies of the country. Attacks on the banking system at this point have the potential of bringing the entire country to a complete standstill. And they don't even have to involve theft of funds. Even simple DoS attacks preventing cashless transactions from succeeding would create considerable disruption. It is unclear whether the government has even prepared for such an eventuality.
Money being funnelled out of citizens and into banks and foreign services
When you spend Rs.100 as cash, and the next person spends Rs. 100 as cash and so on, the Rs. 100 remains Rs. 100. If you swipe a card and incur a 2% charge, With every transaction, the Rs.100 bleeds money to service providers and there is a continuous loss of value that can be recovered from it. Rs. 100 becomes Rs. 98, which becomes Rs. 96 and so on (yes, I know I should be getting into decimals and more accurate percentages. Too lazy). This is a tremendous bonanza for banks and other service providers. It doesn't get any more free money than this. For them, not you. Keep servers running, completely automated transactions keep dumping money at you. Is it any surprise that there is a rash of providers applying to become payment banks? It is likely that rates would be lowered. And why not, if they are able to get a cut on literally every single time anyone transacts for any reason - doesn't even have to be business - say someone giving their child pocket money? But the money with people will keep shrinking like this.
Worse, we will be bleeding money out of the country with every use of payment systems owned fully or partially by foreign companies. The government may well promote fully Indian solutions (not in a hurry, Paytm is 40% Chinese and the government is promoting it the most right now). But even with Indian solutions promoted, there will be considerable use of companies like Visa and Mastercard by those who need compatibility outside India - online purchases, travel... I am no economic expert, but I cannot imagine this to be a good thing - for foreign companies to profit from massive amounts of routine transactions in India. Would probably have serious implications for the trade deficit or something.
Collapse of banks
Here I say with even more stress that I am not an economist. But I don't see how this would not happen. Even with withdrawal of cash prevented, the flow of funds from one bank to another cannot be prevented without completely ending all pretense at an economy. Sooner or later, banks with accounts of mostly spenders and small businesses will start collapsing, because money from those accounts will be used to pay those with accounts in bigger banks. Smaller businesses would be more vulnerable for collapse and NPAs given to them will disrupt matters further. Now here is the irony in this. The banking crisis is largely of banks lending to big corporations. They are the ones most likely to cannibalize smaller banks with far less NPAs. Saraswat Bank for example apparently has a pretty healthy 2.6% of NPAs. If this happens (and I hope it doesn't - as a result of failure to go cashless), it would be like punishing banks for not serving problem customers.
Where does this end?
What this whole circus achieves is cosmetic covering up of the problem. Preventing the money of citizens from being withdrawn to prevent collapse of banks cannot be a functional solution to anything. It is a violation of citizen rights. It is an exploitation of their money. It does nothing to prevent banks from taking their mismanagement further into a loss making zone, confident that the customers money cannot escape. What would a point be where anyone says "enough"? What comes next? Any other asset citizens can use to escape the banks? Gold? Silver? Diamonds? Real Estate? How many of our rightful and honestly earned possessions will be regimented for this forced rescue of banks? What point is enough? And why is it not "enough" right now instead of pulling this horrendous attack by a government on the country at the behest of businesses?