Did the demonetisation move help Indian economy?

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. Modi sold his big move with three original goals to 125 crore Indians —

1). kill black money

2). eliminate counterfeit notes

3). and root out terror funding

A number of other targets that were subsequently added in the government-narrative were

1). killing corruption,

2). creating a cashless economy

3). and expanding the tax base and revenues.

By any measure, the PM’s decision was incomprehensible and, in view of its adverse effects revealed subsequently by the Economic Survey 2016-17, the annual report of the Reserve Bank and other reliable sources, demonetisation turned out to be a monumental failure.

One and a half year after demonetisation was imposed upon the economy, none of the above targets have been achieved meaningfully to give major tangible gains. I have been voicing and writing in these columns and making the arguments since then that demonetisation was quackery. I have written over 50 posts on this subject since then that there was absolutely no reason to disrupt the economy by declaring, in a near-midnight strike, that high-value currency notes would no longer be legal tender. These notes accounted for 86 per cent of the total value of the currency with the public.

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. 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 over 100 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.

After Rs 500 and Rs 1,000 notes were demonetised on November 8, 2016, there had been a surge in the deposits made into Jan Dhan accounts. The deposits had reached a record high of Rs 74,610 crore on December 7, but began to decline afterwards. After reports suggested that individuals were misusing others’ bank accounts to deposit demonetised notes, the Centre, on November 18, had warned Jan Dhan account holders of prosecution under the Income Tax Act if the accounts were missed. It had also set a cash deposit limit of Rs 50,000 so that no one could use the accounts to deposit black money.

In his November 8 speech, Prime Minister Narendra Modi stated: “The 500 and 1,000 rupee notes hoarded by anti-national and anti-social elements will become just worthless pieces of paper.”

Two days later, Finance Minister Arun Jaitley told News18 that, of the 14 lakh crore notes outstanding, “some would certainly get extinguished” because “people who have used cash for crime purposes are not foolhardy enough to try and risk and bring the cash back into the system”.

On 10 Dec, Attorney General Mukul Rohtagi informed the Supreme Court that “the government had expected ?10 or 11 lakh crore to be returned out of a total of ?15 lakh crore of ?500 and ?1,000 notes that were demonetised”.

One month later, on 10 Jan, NITI Aayog member Bibek Debroy predicted that some 10% of the notes in circulation would not return. Rs 3-4 lakh crore out of the Rs 15.44 lakh crore demonetised were expected to not come back to the banks. However, according to the Reserve Bank of India (RBI), 99% of the old notes have come back so that only Rs 15,000 crore of the old notes remain with the public. Most of this is also expected to return or be accounted for. The worry is that since counterfeit currency may also have returned and got counted, the RBI may find that more than Rs 15.44 lakh crore has been collected by the banks – an embarrassment.

The government made a virtue of the return of 99% of the cash to the banks. It changed its line to say that those who had deposited their black money would now be caught since they would have to disclose the source of the money. The government also argued that because of the fear of being caught, a large number of people joined the ranks of tax filers. However, the exact figure is not clear. The finance minister announced a figure of 91 lakh; the prime minister announced from the ramparts of the Red Fort that it was 56 lakh; the Economic Survey gave the number as 5.4 lakh. The Economic Survey also said that about Rs 3,500 crore extra tax was collected or about 0.3% extra direct tax – hardly a dent on the black economy.

For sensitive matters one needs a human judgment to figure out where fraud is committed. The government’s machinery for detecting it is woefully inadequate. It could barely handle the quantum of work in normal times and cannot take on the increased load that has been put on it now. Thus not much can be expected of the notices issued to people except that it has added to the uncertainty faced by businesses and that affects the investment climate further.

Comparing year-on-year increase in tax collection is not helpful, because tax collections depend on economic conditions. One way to overcome this problem is to normalise the tax collection using measures of underlying economic activity. However, a challenge in doing this for specific quarters is that changes in rules (such as deadline for filing, mandate of advance tax), changes in administrative processes (eg. dates for refunds), or special schemes can make collections in certain quarters vary quite significantly from those in the corresponding quarter of the previous year. For instance, Q1 of 2012-13 witnessed a huge increase in collection over the corresponding quarter of the previous year, but this was because of front loading of refunds in the previous year.

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.

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.

 Seizure of black money?

A significant portion of SBNs deposited could possibly be representing unexplained/black money… Since November 2016 and until the end of May 2017, a total of Rs 17,526 crore has been found as undisclosed income and Rs 1003 Crore has been seized. Banks were expected to benefit, with increased liquidity due to additional deposits. They were expected to lower interest rates and they did. They also lowered the interest rates on fixed deposits. As these returns declined, people shifted funds to the stock markets via mutual funds. This has made the financial markets highly unstable. While the economy has slipped, the markets have gone up, creating a speculative bubble.

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 15 lakh crores.

Did it curb fake currency? 

Post demonetisation, instances of fake currency seizures have come down sharply, said a report in The Times of India. 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 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, and now BJP itself confirms that terror activates have increased, and recent collapse of PDP-BJP Government has once again brought in focus the fragile politics of our strategic state.

What was the 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.

Prof (Dr.) Kanayalal Raina specializes in strengthening nonprofit and business organizations through assessment, education and empowerment of leadership and mentoring. Helping companies to better formulate their strategies and make the process of strategy execution more tangible. Areas of expertise are Govt. funding and preparation of Business and Strategic Plans, Marketing plans, Sales and Pricing Plans, Business Scorecard, Business Performance Management. 

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