Demonetisation of high value currency notes on November 8 was described by economists as ‘economic anarchy’. The government projected it as a momentous fight against black money, terror funding and counterfeit currency. Whether demonetisation was a success or failure has been a subject of contentious debate. The government claims that it is a success as one of the principal objectives of demonetisation was to gradually bring down the quantum of cash in the system and an integration of the informal economy with the formal one. However, several prominent economists have called it a meaningless and painful exercise of ‘exchanging notes’ that gave a body blow to the economy. Drowned in the debate is the economic cost and significant under-achievement of original demonetisation objectives.
The government is loath to acknowledge that demonetisation came at a heavy cost. Economists had predicted the chilling effect of demonetisation on informal sector, agriculture, employment and growth. What the government is not willing to admit is: not only demonetisation was a failure, it wasn’t worth the kind of disruption the country and economy went through. Incidentally, not only the government was informed by the RBI about the potential cost and benefit of demonetisation, the central bank had also suggested alternatives to demonetisation which could achieve similar objectives. So, what was the cost of demonetisation? What did it achieve?
Politically, demonetisation was in perfect sync with Prime Minister Modi’s image of an anti-corruption crusader. People supported demonetisation out of genuine resentment against black money. Urging people to bear it all for the sake of nation to end corruption and black money was a great idea that connected brilliantly with ordinary people. Demonetisation received overwhelming support because people were made to believe that it was all for the good and came with high decibel noise and justification of its necessity to cleanse the system. Another reason for widespread support was: people genuinely believed that demonetisation would extinguish black money menace permanently. It is why, despite changing narrative, the political cost of demonetisation was almost nothing for the government. On the contrary, the prime minister channelized people’s anger against black money into a definite gain for himself and his party.
But in economic terms it was an audacious blunder. One plausible reason for economic cost of demonetisation not getting required attention could be the absence of an international precedent or a credible economic theory to back demonetisation. Hence arriving at a definite figure was a long drawn out process. However, the consensus was that the impact on growth would be around 1 to 1.5 per cent of GDP. GDP data released by Central Statistics Office (CSO) on August 31 amply proves that demonetisation had a significant impact on growth in the last two quarters: 5.7 per cent in April to June quarter of FY-18, a three-year low, and 6.1 in January to March quarter, down from 7 per cent in the third quarter of 2016-17. This had an impact on the overall growth in 2016-17 at 7.1 per cent, against last year’s upwardly revised 8 per cent growth.
The immediate and dominant objective of demonetisation was neutralising black money. India has traditionally been a cash intensive economy. According to RBI estimates, 78 per cent of all consumer payments are done in cash. The currency in circulation before demonetisation was 12 per cent of GDP. The note ban invalidated 86.9 per cent of the total currency in circulation. Black economy was conservatively estimated to be around 20 per cent of GDP. As the stock of black money is not held in cash but wealth, black money in cash was conservatively estimated to be only around 2 to 3 per cent of currency in circulation. RBI’s annual report released on August 30 revealed that 99 per cent of the demonetised notes had been returned to the central bank. This number does not include the old notes deposited with District Central Cooperative Banks and the notes within Nepal. Thus the shortfall of Rs. 16,050 crore could be made up once these notes are returned to RBI. This invalidates the government’s earlier claim that a significant amount of currency – around Rs. 4 to 5 lakh crore – held by people would be neutralised.
As money flowed back into the system, the goalposts changed and digitisation became an emphatic theme of demonetisation. Migration from cash to digital payment is a very slow process, made even more sluggish by the convenience and preference of using cash. India is also largely a cash-based economy. Currently there are about 10 lakh outlets with 14.6 lakh electronic terminals accepting card payments. The average usage of plastic money in India is less than three transactions per user per year. While the number of cards is steadily rising, there is little doubt that India’s reliance on cash is overwhelming. Currency in the system, for instance, fell sharply between November and January, from Rs. 11,642 billion to Rs. 9,921 billion. During this period electronic payments, according to RBI data, peaked in December at 957.50 million transactions, compared with 671.49 million in November.
However, following the expansion in currency, there has been a decline in electronic payments from 893.89 million transactions in March to 862.38 million in July. This dip indicates that once sufficient currency was back in circulation, the system gradually started going back to the earlier equilibrium. The lesson here is that people were forced to migrate from cash to digital payment mainly because of cash drought and hence not sustainable in the long run as digital mode of payment is concomitant with economic development. Currently the currency in circulation, according to RBI, is Rs 15.6 lakh crore, against 17.9 lakh crore during pre-demonetisation days. This is 2.3 lakh crore or 12 per cent less than the earlier balance, hardly a gain that the government is claiming as an achievement.
Demonetisation had its pros and cons. It definitely gave the prime minister an image makeover. But it also contracted economic activity in agriculture and informal sector, disrupted supply chain, dented growth and cost 15 lakh jobs. Significant drop in GDP growth and 99 per cent of banned notes returning to RBI are major indicators of demonetisation’s failure. While the original objectives of demonetisation were not achieved, added objectives could have been achieved through other means. Perhaps the most important benefit is the fear it has generated among non-compliers of indirect and direct taxes. As for formalisation of economy, more than demonetisation it is the GST which will speed up the process.
The author is an independent Mumbai-based senior journalist.