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Demonetisation Redux: A Failed Experiment

It has been one year since the government of Narendra Modi announced demonetisation, a bold, dramatic and according to many economists, profoundly reckless move. Professor R. Ramakumar of TISS, Mumbai in November 2016, wrote an article that was critical of the move. We speak with him on the eve of the first anniversary to assess whether his predictions about the effect of demonestisation have come true.

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In his forthcoming book on demonetisation, titled, "NOTE-BANDI: Demonetisation and India's Elusive Chase for Black Money", he takes a closer look at how the policy unfolded and its impact on different sectors of the economy and sections of people. The book is slated for release by OUP in November 2017.


One year onwards what is your assessment of demonetisation? 

'Demonetisation' will go down in history as one of the most reactionary and illogical economic policies ever attempted in independent India. It crippled an economy that ran on cash and was plagued by a slowdown; it destroyed the livelihoods of millions of farmers, workers, traders, women and the elderly; and it violated the dignity and liberty of law-abiding citizens. My introduction to the book, as well many chapters in the book, argue this out very clearly.


How has the initial rationale for implementing demonetisation, black money, counterfeit notes and a cashless economy, fared? 

A day into demonetisation, I had an opportunity to write a response to these three claims. One year later, I see no need to revise my position. Facts that have emerged over the past year have vindicated the predictions of critics.


First, according to the Reserve Bank of India's (RBI) Annual Report, 2016-17, the total value of counterfeit notes of denomination INR 500 and INR 1,000 detected by banks rose from INR 27.4 crore in 2015-16 to INR 40.8 crore in 2016-17: an increase by just about INR 14 crore. As a share of the value of INR 500 and INR 1,000 notes in circulation in November 2016, the value of counterfeit notes detected in 2016-17 amounted to just 0.0027 per cent. The critics were right; the extent of circulation of counterfeit notes did not, in any way, justify a drastic action like demonetisation.


Second, out of the INR 15.44 lakh crore worth notes of INR 500 and INR 1,000 in circulation as on 8 November 2016, about INR 15.28 lakh crore (or 98.96 per cent) had returned to the banks by 30 June 2017. Only 1.04 per cent remained outside. This is the most important indicator of the failure of demonetisation. The government did not expect more than INR 12 lakh crore to be back in the banks. The remaining INR 3 lakh crore was to be 'extinguished' and passed on by the RBI to the government. But now there is no black money left to be 'extinguished'.


Third, data analysed in this book between November 2016 and August 2017 show that the growth of volumes and value transacted through non-cash payment platforms slowed down, and even shrank at places. The total value of non-cash transactions rose by only 18 per cent between November 2016 and September 2017. Despite efforts to popularise mobile banking, the value of mobile-based transactions recorded negative growth rates between November 2016 and August 2017. Cash is back.


How would you assess the Modi government's campaign on the 'success of demonetisation'?  

The Central Statistics Office (CSO) estimates of growth have officially signalled that demonetisation was instrumental in intensifying recessionary tendencies in the Indian economy. Despite methodological infirmities, the growth rate of Gross Value Added (GVA) in India declined from 7.6 per cent in the first quarter (q1) of 2016-17 to 5.6 per cent in the q1 of 2017-18. This decline was in continuation of a similar decline reported for the fourth quarter (q4) of 2016-17.

Yet, the Modi government has initiated a campaign to celebrate the 'success' of demonetisation. This campaign makes two major claims. First, demonetisation resulted in the 'highest ever black money detection'. Black money worth INR 16,000 crore (i.e., the remaining 1.04 per cent of INR 15.44 lakh crore) did not return to the banking system. Secondly, there was an 'unprecedented increase in tax compliance' after demonetisation. About 56 lakh taxpayers were newly added and the number of tax returns filed rose by 24.7 per cent in 2017-18 over 2016-17.


Both claims are wrong.


First, the claim of detection of INR 16,000 crore is actually an admission of failure, because the very premise of demonetisation was the existence of at least INR 3 lakh crore as black money. In fact, the costs of demonetisation hugely outrun its benefits. One, even if we assume, conservatively, that India's GVA shrank by 1 per cent after November 2016, the resulting economic loss would be about INR 1.5 lakh crore. Two, due to demonetisation, banks were inundated with new deposits worth lakhs of crores while credit outflows largely stagnated. As a result, the RBI had to mop up excess liquidity worth INR 10.1 lakh crore from banks under the Market Stabilisation Scheme (MSS). The total interest outgo of the RBI on this count alone was INR 5,700 crore. Three, the RBI's costs incurred for printing new notes rose from INR 3,420 crore in 2015-16 to INR 7,965 crore in 2016-17: a rise by INR 4,545 crore. These costs did not include intangibles, such as the time spent by bank staff on consumer interface and paperwork over many months. Four, due to the higher costs incurred by the RBI under different heads, the total surplus transferred by the RBI to the government fell from INR 65,876 crore in 2015-16 to INR 30,659 crore in 2016-17: i.e., a decline of INR 35,217 crore. In sum, demonetisation was an extraordinarily loss-making proposition for the exchequer.


Second, the claim of rise in tax compliance after demonetisation is simply unimpressive. One, there is nothing remarkable about the rise in the number of tax returns filed in 2017-18 compared to earlier years. Compared to the corresponding previous year, the rise in the number of tax returns filed was 51 per cent in 2013-14; 12.2 per cent in 2014-15; 29.9 per cent in 2015-16; and 24.3 per cent in 2016-17. Two, even among the 56 lakh assessees newly added, about 38.8 lakh assessees (or about 69.4 per cent) reported an annual income of less than INR 5 lakh. The average annual income of these new taxpayers was only INR 2.7 lakh. In sum, the increase in tax revenue from the new assessees would be insignificant.


How will history judge India's two attempts at demonetisation? 

History, as it sits down for stock-taking, would have to judge the Narendra Modi's demonetisation as a policy that was illogical in conception, mismanaged in execution, disruptive to the economy, and acutely burdensome on the working people. This is the basic point made in the book. Do read it!


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