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An Indefensible Step

Demonetisation was ill-conceived, and the RBI and government have little to show in their defence.

“Demonetisation” was supposed to wipe out “black money” and counterfeit currency, stop terrorist financing, and somehow purge the nation of all that is corrupt and wrong. Later, the Narendra Modi government told the people that the aim was to shift to an economy that transacted more through digital means and less through cash. Excess cash and large denomination notes, we were told, fuel corruption. Then the government said demonetisation could do more. It said that it would formalise the informal economy and also induce tax compliance. We were even told that the₹500 and₹1,000 currency notes that did not return to the central bank—which could be up to₹4 lakh crore–₹5 lakh crore—would be neutralised. Some people speculated that the Reserve Bank of India (RBI) would pay this as a special dividend to the government, to be used for development expenditure. A “masterstroke,” some called it. They were all wrong.

Since 8 November 2016, the Modi government has appealed to the people to bear “temporary hardship,” and promised long-term gains. Long-term gains or the like have remained elusive. Lives and livelihoods have been lost, while the government has far from convincing answers, and little to show for demonetisation’s positive effects. Despite this, Union Finance Minister Arun Jaitley, in what can only be called blatant insincerity, continues to insist that demonetisation has been “immensely beneficial to [the] Indian Economy and People” and has, along with the Goods and Services Tax (GST) “changed the structural and ethical foundations of the Indian Economy.”

This week the RBI Annual Report 2016–17 confirmed the suspicion that demonetisation had been undertaken without any understanding of the economy. A day after the report was released, the Central Statistics Office (CSO) released the latest quarterly gross domestic product (GDP) estimates. The April–June quarter of this year saw GDP growth fall to 5.7%, lower than the 6.1% estimated for January–March, the quarter just after demonetisation. The April–June quarter of the previous year saw growth of 7.9%. This decline in GDP growth rates, according to the Economic Survey 2016–17, Vol II that came out in early August,predated demonetization but intensified in the post-demonetization period.” The latest CSO data only corroborates this and contradicts the finance ministry’s 30 August statement which claims that demonetisation did not dent India’s economic growth. The economic costs of demonetisation are now clearer. Undue costs and hardships were imposed on the poorest people in the Indian economy’s informal sector and regular economic activity was disrupted for months. The RBI’s autonomy was undermined and it made a significant loss on seigniorage this year. Lastly, the government received much lower dividends from the RBI, a direct result of demonetisation.

The RBI Annual Report 2016–17 shows that 98.96% of the₹500 and₹1,000 denomination notes that were withdrawn from circulation returned to the banking system, which means only₹16,000 crore (1.04%) did not return. This could mean that those holding illegal cash were either an insignificant number, or that they found ways of depositing cash into formal banking systems. For context, in the demonetisations of 1946 and 1978, about 14% and 10%, respectively, of high denomination currency did not return to the central bank. The present government’s efforts have yielded insufficient results according to its own statements.

Printing new notes to remonetise the economy cost the RBI₹7,965 crore, more than double the amount it spent on printing the previous year. The surplus transferred to the Government of India was only₹30,659 crore, less than half of what it was the previous year. This diminished transfer to the government was in large part caused by increased expenditure for the RBI due to demonetisation. The surge of cash that entered the banking system on account of demonetisation entailed banks having larger deposits with the central bank. This meant that the RBI had to pay more to these banks as interest payments.

The government has little that is positive to show for demonetisation. The problem of corruption and black money are systemic and were viewed without context. Demonetisation was conceived and executed without adequate consultation. Black money and the fight against it is not about cash holdings, as many have pointed out right at the outset. It is about the state accounting for economic transactions so that it can tax or monitor them if it wishes. The GST promises to address aspects of this to some extent. Furthermore, to say that counterfeit currency justified demonetisation also reflects poor policymaking. Fake currency is a continuous regulatory struggle. Such one-time measures will be inadequate. Only continuous monitoring will suffice. The only development is the increase in those ­filing direct tax returns. This could be a one-off increase, but is a development to watch. However, given the amounts filed, it will not mean much for revenue collection.

The government’s claims about demonetisation’s achievements are meagre and hardly justify it. To follow up on demonetisation, perhaps to salvage what it can, the government says that it is investigating thousands of accounts, using available data of bank deposits to find offenders and take them to task. To achieve its aims, the government will need to give the bureaucracy a free hand. This has a high potential for misuse. The demonetisation fiasco illustrates this government’s unrealistic one-shot approach to deep-rooted systemic problems. This would only mean greater overreach and more arbitrary decisions that will be detrimental to India and its democracy.

Updated On : 4th Sep, 2017

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