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RBI holds mirror to government on demonetisation

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Against all available evidence, the government continues to claim that demonetisation has met its objectives ‘quite substantially’. The Opposition, on the other hand, says demonetisation was a complete failure. Apart from causing a massive liquidity crunch which led to months of hardship, closure of businesses in unorganised sectors of economy and job losses to millions of workers, demonetisation, according to the Opposition, also brought down growth by 1.5 per cent of GDP. BJP MPs who are members of the Parliamentary Standing Committee on Finance have stalled the adoption of the committee’s report which has said that demonetisation led to, at least, a percentage point of loss to GDP and unemployment in informal sectors. But finally, the suspense over demonetisation is over now: the RBI’s annual report released on August 30 is clinching evidence that demonetisation was a complete failure.

According to the central bank, 99.3 per cent of Rs 500 and Rs 1,000 junked notes have been returned to the banks. Hours after the RBI released its annual report last Wednesday, the ministry of finance held a press conference where department of economic affairs secretary Subhash Chandra Garg claimed that objectives of the note ban like checking black money, terror financing, promoting digital transactions and weeding out fake currency notes have been achieved, but declined to provide further information to prove his point. No matter what the government chooses to claim, the RBI report puts to rest any illusions that the government may have about demonetisation’s success.

By speaking in broad generalities about demonetisation’s objectives, the government appears keen to downplay its abject failure in flushing out black money from the system. It also seems keen to keep out the full impact of demonetisation from public view. Demonetisation was supposed to be a magic cure for all the maladies the country’s financial system suffers. In his various public addresses on TV and elsewhere, Prime Minister Modi had painted a rosy picture about various gains demonetisation was supposed to deliver. Now when the RBI has junked most of his claims, not only the prime minister is completely silent on the subject but pathetic attempts are being made to defend an irrational policy decision which cost the country a huge loss in terms of growth.


Thanks to the RBI, most of the government’s claims over note ban have collapsed. Let’s take some of its major objectives. Demonetisation was supposed to extinguish black money and end corruption. The government had claimed that about 3 to 4 lakh crore of banned currency would not come back to the banks.  The RBI report says that Rs. 15.31 lakh crore out of Rs. 15.42 lakh crore of high-value currency has been returned to banks. The miniscule unreturned currency, a little over 10,000 crore, is out there, which is believed to be in Nepal, Bhutan and with district cooperative banks in India. So, no black money cash has been destroyed. Demonetisation was supposed to weed out fake currency which is used to fund terror activities. There is no exact estimate of fake currency, but the RBI report also nixes the government’s claim, implying that note ban may not have done enough to curb generation of new fake currency.

Demonetisation was supposed to pave the way to cashless or less cash economy with digital payments taking over cash transactions. The government had argued that India’s currency in circulation and currency-to-GDP ratio was too high as compared to other countries. Nearly two years later, not only cash in circulation has returned to a new high but, according to RBI report, currency-to GDP ratio is also slowly on its way back to pre-demonetisation levels. While demonetisation did not address the excessive liquidity problem, it has also failed to make a dent in proportion of high-denomination currency: the proportion of high-value notes is marginally lower now as compared to pre-demonetisation days.

Finance minister Arun Jaitley has repeatedly stressed that direct tax revenue has sharply gone up after demonetisation as compared to 2014. But there is nothing unusual or incredible about it because direct tax revenue and number of tax payers has been going up by about 10 per cent each year over the past decade. When demonetisation did not wipe out black money, did not give government a windfall gain by way of dividend from RBI, didn’t give required boost to digital payments, didn’t reduce liquidity from system, didn’t make a dent in corruption and terrorist activities and people are holding more cash than before, then what did the government achieve by demonetising 86 per cent of currency in circulation?

The demonetisation exercise cost RBI Rs 8,000 crore and there were many other costs to the banking system that have not been accounted for. On the other hand, the money that did not come back into the system is only Rs 10,720 crore. Not only have the original objectives of demonetisation not been met, but the gains from demonetisation, if any, are vague and the losses have been huge. In the quarter that followed demonetisation, the GDP growth slumped to 6.1 per cent as compared to 7.6 per cent in January to March 2016. For the full year, GDP growth fell to 7.1 per cent from 8.2 per cent in the previous fiscal. As micro, small and medium businesses were hit hard and millions of people lost jobs, the deleterious effect of demonetisation on economic growth lasted for several quarters. Experts are of the view that the country may not have recovered fully from the adverse effects of demonetisation yet.

One of the vague gains of demonetisation which its defenders proffer is the trail the tax authorities have to suspicious bank deposits. But experts, including former finance minister P Chidambaram, believe that this is unlikely to work as chasing people with giant deposits is a cumbersome and long drawn-out process and the Income Tax department simply does not have the capacity to track lakhs of suspicious bank deposits. So, who should be held accountable for the misadventure of demonetisation? The RBI has redeemed itself by revealing the size of the demonetisation disaster. The government, unable to defend the punitive financial measure any longer, is silent. Last week, Union Petroleum and Natural Gas minister Dharmendra Pradhan blamed the Congress-led UPA government for the skyrocketing fuel prices in recent times. May be few years down the line, a narrative will be spun to blame the Congress or may be even Nehru for demonetisation.

ALI Chougule is an independent senior journalist.