‘Demonetisation’ wasn’t really a familiar economic term for an average person in India. That, however, changed on the evening of 8 November 2016, when Prime Minister Narendra Modi appeared on national television and announced the scrapping of Rs 500, Rs 1,000 currency notes effective from the midnight. The RBI, custodian of currency, seemed to have very little role to play throughout the demonetisation exercise from Day One. Modi sold his big move with three original goals to 125 crore Indians — kill black money and counterfeit notes and root out terror funding. The other targets that were subsequently added in the government-narrative were killing corruption, creating a cashless economy and expanding the tax base and revenues.
One year after demonetisation was imposed upon the economy, none of these targets have been achieved meaningfully to give major tangible gains. This wasn’t unexpected for the simple reason that much of the black money was not in cash but in other assets; cash constituted only a fraction, hence targeting cash was never a good idea, some economists argued. The costs of this exercise have far outweighed the gains in the form of a very severe hit on the informal economy (big employer to millions of workers), destruction of supply chains, job losses and revenue loss to the Reserve Bank of India (RBI) that also showed in low dividend payments to the government. These apart, the pain inflicted on the common man who was forced to stand in serpentine queues for months on end to withdraw own money, alleged loss of lives and loss of income streams are not measurable using conventional economic tools. In hindsight, a cost-benefit analysis of the exercise makes one wonder whether the economy (which as limping back to health) really needed such a massively disruptive shock-therapy that inflicted pain on every constituent of economy, with no clear gains.
A file photo of Prime Minister Narendra Modi. Reuters
Modi’s political masterstroke
Before looking in detail to each of the stated objectives of demonetisation, one must understand that it was never a pure economic policy move. This was Modi’s biggest political gamble ever since he came to power at the Centre in 2014. Modi sold demonetisation as the big war of poor on the undeserving rich in the society. Rallies after rallies, Modi called upon the middle class and the poor to suffer pain to achieve the larger objective of a cleaner, transparent society.
Demonetisation was offered to them as their one big chance in life to challenge the socio-economic inequalities embedded in their lives. The poor happily heeded to Modi’s call and made demonetisation their personal battle against the crooks. The results showed clearly in the Uttar Pradesh assembly polls that followed, where the Bhartiya Janata Party (BJP) bagged a landslide victory reducing the opposition to a non-entity in the politically sensitive Hindi heartland. Even a year later, the public sentiment, indicative from various opinion surveys, still tilt largely in favour of Modi regardless of the pain caused by demonetisation. The next big political test for Modi will be Gujarat polls due later this month.
Let’s now go back to each of the stated objectives of demonetisation to attempt a cost-benefit analysis of the exercise.
Did it unearth black money? Undoubtedly, the big target of demonetisation was killing the so called black money or money on which no tax is paid. After a year of demonetisation, the government has not made any significant progress on recovering black money. According to the RBI data, 99 percent of the old Rs 500 and Rs 1,000 notes (totaling Rs 15.44 lakh crore), has come back to the banking system. This clearly meant that the government’s expectation that at least Rs 3-4 lakh crore unaccounted money will perish outside the banking system went horribly wrong. The government said about Rs 17,000 crore has been recovered from income tax raids post demonetisation. Also, in the aftermath of crackdown of shell companies, the government citing a preliminary investigation said in 58,000 bank accounts of 35,000 shell companies, over Rs 17,000 crore was deposited and withdrawn post-demonetisation.
But, these are all small gains compared with what is at stake. Also, much of the recovery from these accounts is subject to how much evidence taxman can produce, here one needs to wait for results. The Pradhan Mantri Garib Kalyan Yojana, the scheme offered to tax cheats, elicited a cold response with just Rs 5,000 crore coming out from 21,000 people. But, even if one puts together all of this, it will constitute only a minute fraction of the total black money estimated to be in the domestic economy, not less than Rs 15 lakh crore.
Did it curb fake currency? Post demonetisation, instances of fake currency seizures have come down sharply, said a report in The Times of India (read here). According to the report, the face value of fake notes post demonetisation totalled Rs 16 crore, less than one-third of the Rs 51.3 crore seized in 2016 and Rs 44.2 crore the year before. According to the data provided by Union finance minister Arun Jaitley, total fake currencies seized post the ban is valued at Rs 11.23 crore, which is an insignificant figure. From the very beginning, it was clear that killing fake currency can’t be a safe bet with a tool like demonetisation. It is not feasible to get data on the actual amount of fake currency in circulation in the system, but experts cautioned that it is only a matter of time before fake currency rackets start printing counterfeit notes in new currency. In fact, there are already reports of fake currencies in new notes being printed in the system.
Did it end terror funding? The government claims that demonetisation has choked terror funding. According to Jaitley (read here), post demonetisation, there has been a sharp reduction in terror activities in states like Jammu & Kashmir, and Chhattisgarh. Terror funding itself has been squeezed, Jaitley said addressing the Berkeley India Conference. It is a fact that in the initial months post demonetisation, stone pelting incidents have come down in the border areas but such instances have come back as cash returned to the system, something former RBI deputy governor KC Chakrabarty had predicted in an interview with Firspost in January this year.
Did it create a digital economy? Digital transactions showed a spike in the immediate months post demonetisation but the growth has flattened to normal levels in the months after that. The cash-to-GDP ratio, a measure to assess the use of cash by public in the system, had fallen into single digits but has again come back to double digits. The ratio was 8.8 percent in fiscal year 2017 from 12.2 percent in fiscal 2016, which has now increased to close to 11 percent. But, certain online payment transfer platforms such as UPI have seen significant growth, although from a low-base. The number of payments through UPI has increased from 0.1 million in October 2016 to 76.96 million in October 2017. But, as this report in The Indian Expresspoints out, total value of transactions via electronic payment system hit a high of Rs 149 lakh crore in March 2017, up from Rs 94 lakh crore in November 2016, digital business fell to a low of Rs 107 lakh crore in July 2017 and Rs 109 lakh crore in August.
Of course, cash remains the preferred tool for small traders and customers in semi urban and rural areas where internet connectivity remains poor. In fact, the shift from cash to digital transactions was already happening. Demonetisation has certainly offered a push to the march to digital economy.
Did it increase tax base? The government has claimed that post demonetisation, tax base has increased substantially adding 9.1 million new taxpayers. Also, the government has claimed a 24 percent increase in tax collections. But, the question is as a percentage to GDP, whether the tax revenues have gone up substantially particularly compared with the costs borne by the economy on account of demonetisation exercise.
Cost to the economy
Demonetisation added to the pain in the economy that was already facing a slowdown. The economy was not in good health, as claimed by Modi, to withstand a major surgery. It added to the stress in a sagging economy, which logged a 5.7 percent growth in the June quarter. Cash shortage for a prolonged period broke the back of the informal sector. In fact, all sectors that are cash incentive, suffered in a big way with the supply chains taking a hit. The job losses in the informal sector could explain the spike in the numbers of those opting for Government’s minimum wage programme. According to the Centre for Monitoring Indian Economy (CMIE), about 1.5 million jobs were lost during January-April 2017. The estimated total employment during the period was 405 million compared with 406.5 million during the preceding four months, September-December 2017. CMIE attributed this largely to the demonetisation impact. Businesses too have taken significant hit with most end consumer sales such as two-wheelers slowing down in the months that followed note ban.
Was demonetisation really needed?
The answer will depend on who you are asking the question to. Politically, it has certainly worked well for Modi and the BJP despite all the criticism from Opposition and a section of economists. Certainly, after one year of the biggest disruptive economic exercise in India’s recent history, the costs have far outweighed the projected benefits. There are certain gains that might help the economy in the long term, but the pain inflicted on the economic system is real. In the hindsight, one could argue that Modi could have avoided such massive shock therapy to clean up the economy, inflicting long lasing pain on the informal sector. He, instead, could have opted for action on specific targets with less disruption to the economy and common life. But admitting his policy mistake is suicidal for any career politician.
The Prime Ministers Office put up a spirited defence of demonetisation on the eve of the first anniversary of the move, saying "multiple benefits" of spiking large currency notes included loans getting cheaper and real estate prices declining "significantly".
"Loans got cheaper since lending rates declined by around 100 basis points," the PMO said in a Twitter campaign on Tuesday to defend the move of scrapping Rs 1,000 and Rs 500 notes on 8 November last year.
It said that on an average revenues of urban local bodies across the country "increased almost three times after demonetisation" — compared to corresponding period of the previous.
File image of Prime Minister Narendra Modi. PIB.
"Revenues of urban local bodies in Uttar Pradesh increased four times. Revenues of urban local bodies in Madhya Pradesh increased almost five times," the PMO said.
The digital payments, according to the PMO, received a "significant boost" of 58 per cent - from 87 crore in August 2016 to 138 crore in August this year.
"More than 13 lakh points of sale machines (were) added just in one year as compared to existing 15 lakh machines since their usage started."
It also boasted of "unprecedented increase in tax compliance" post the note ban.
The number of new tax payers added in 2015-16 was 66.53 lakh and it jumped to 84.21 lakh by the end of 2016-17 - a 26.6 per cent increase.
The number of e-returns filed in 2016-17 stood at 2.35 crore while in the first seven months the figure saw a jump of nearly 28 per cent to touch over 3 crore mark.
The move, the PMO said, also led to "massive cleaning of India's financial system".
It said that 58,000 bank accounts belonging to 35,000 shell companies deposited and withdrew Rs 17,000 crore post demonetisation.
After this, 2.24 lakh shell companies were struck off.
Among other benefits, the PMO counted that decreased proportion of high demonetisation currency in the economy helped in the government's fight against corruption and funding of terrorism.
"The estimated value of high denomination notes at the end of September 2017 is approx Rs 12 lakh crore. Without demonetisation, the values of high denomination notes would have been around Rs 18 lakh crore today.
"Thus, high denomination notes have been effectively brought down by about Rs 6 lakh crore — which is 50 per cent of the current value in circulation. Decreased proportion of high demonetised notes in the economy helps thwart corruption and funding of terrorism."
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