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Economists refute note ban’s ‘success’

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TOPSHOT - An Indian protestor holds placards of banned 500 and 1000 rupee notes during a protest against demonetisation, in Mumbai on November 28, 2016. Tens of thousands of people turned out November 28, for nationwide protests against India's controversial ban on high-value banknotes, which opposition party organisers say has caused a "financial emergency". / AFP PHOTO / INDRANIL MUKHERJEE

THE fact that almost the entire stock of demonetised currency had entered the banking system showed the ease with such individuals and organisations could get better of the system. The belief that the tax compliance would improve has not happened so far. In fact, the immediate outcome is just the opposite.

With the dust settling down on demonetisation, several serious analyses have started appearing on whether it has served the purpose for which this major and unprecedented economic exercise was undertaken. As former RBI Governor Y V Reddy puts it, there has perhaps been no other policy decision that has affected the lives of a billion people directly and all at once. It is difficult to find a parallel in terms of the range of economic activities that have been hit by an economic policy decision. The end result seems to be none too encouraging.

Demonetisation led to a virtual denial of freedom of movement, drying up sources of livelihood and deprivation for no fault of the public. Yet people did not revolt and went through the pain. This according to Reddy is because of intense feeling of disgust with the state of affairs in recent years. What is baffling is: what is the disgust about – counterfeit currency, terrorist financing or black money?
The 1.2 billion population did not protest but had enormous patience to withstand the pain because of their belief in Prime Minister Narendra Modi that he would deliver what he promised.


Four months down the line, Reddy is of the view that there is a lurking fear that demonetisation may turn out to be a non-event, except for bitter memories of pain. There is general disillusion. It did not turn out to be a game-changer. Cleansing the system of the past ills requires fundamental changes in both government and the governed, which has not happened.
It is not only Y V Reddy but another top economist Kaushik Basu, World Bank chief economist and former chief economic advisor to Indian government who is of the view that demonetisation has been a disaster. Indian economy, which is on the road to recovery, would have clocked 8 per cent growth now had it not been for the demonetisation.

Former Prime Minister Manmohan Singh, who himself is a renowned economist, has aptly summed up in Parliament that it is a monumental mistake. To Modi government’s assertion that in the long run demonetisation would benefit the people, Singh quoted Lord Mynard Keynes to say that in the long run all of us are dead.

In the liberalised world, it is left to market forces to deal with emerging economic situations. But some argue that state intervention is required because markets fail but the counter to that is, yes, markets fail at times, but the state too fails many a time. Also, one important fact that has been overlooked in this whole exercise is the image of the Reserve Bank of India. The image has certainly been dented.

Economist C Rammanohar Reddy, former editor of Economic and Political Weekly, has recently come out with a book on demonetisation and black money. He analyses in depth the damage that demonetisation has done to the banking system and the economy. He is in agreement with several economists that the Indian economy has suffered significant damage. Also the outcome of this disruptive exercise and distress it brought to the people is unclear. Even Reserve Bank is yet to come out with any clear assessment of how much black money it has extinguished as a result of this unprecedented exercise. After analysing the whole exercise in his 250-page-book, which makes an interesting reading, he is of the view that whichever way one looked at, demonetisation was not a good one. As very little of black money is kept in cash, demonetisation cannot destroy much of the unaccounted money. Even if government wanted to track down unaccounted money, demonetisation was not the way to go about.

The fact that almost the entire stock of demonetised currency had entered the banking system showed the ease with such individuals and organisations could get better of the system. The belief that the tax compliance would improve has not happened so far. In fact, the immediate outcome is just the opposite.

More than demonetisation, it would be worthwhile for government to appoint Lokpal expeditiously, prohibit and punish benami transactions, stringent rule and punishment on bribery, early rollout of GST and transparency in government procurement. These are reforms in process but they are painfully slow.

Importantly, malpractices in financial sector are one area where not much headway has been made despite government putting in place stringent rules and regulations. Demonetisation was aimed at going after black money held as cash. Gold and real estate are major areas where black money is generated and stashed and demonetisation has not helped in significant way to curb it.

Rammanohar Reddy notes that less was said about the illegal transactions that take place in the financial sector, which are recorded in the banking sector and yet escape the gaze of the income tax authorities. Over and under invoicing of trade, share price manipulations through shell companies, round-tripping of capital through participatory notes, flows to tax havens are some of the illegal transactions that take place in the financial sector. Reddy argues in the book that the generation of illicit income via such transactions conducted through banking sector may now be as much, if not more than what is created and held in the form of cash.

Citing the example of disproportionate assets trial of former Tamil Nadu Chief Minister late J Jayalalithaa and her associate V K Sasikala, Reddy said 34 shell companies operating 50 bank accounts were used to illegally acquire or sell property and conduct other illicit transactions. This happened more than two decades ago. The sophistication of illegal financial transactions that has since developed is mind boggling. Now a beginning has been made in cracking down on shell companies, but the task of dismantling illegal transactions in the financial sector is no simple challenge.

Mere legislations will not help nor for that matter demonetisation in curbing black money. The executive, legislature and judiciary have allowed black money to become a part and parcel of the Indian economy and society. Ending black money calls for a larger change in governance practices, attitudes and habits. This meant root and branch overhaul in the society is required to defeat black money. Electoral, political, judicial and administrative reforms besides systemic reforms needed to take place. Though there are several reports on these reforms being available, none seem to be getting implemented because it does not serve the political class. The entire electoral process has to undergo an overhaul and that seems to be not happening in India barring some tinkering.
So, Reddy feels in sum that demonetisation has so far turned out to be a failure and if there is no significant follow up action, there could be long-term damage as well.