One thing the demonetisation announced by Prime Minister Narendra Modi on 8 November, 2016 has done is that it has made a large number of people pretend to be economists and experts. Political opposition has been vociferous from day one about how bad a decision it is, etc. No one would deny the surprise element in it and how the porous corridors of Lutyens Delhi really kept it a secret till it was broadcast on TV/radio.
There are three ways to appraise such a major step taken by the Government
1) Compare with the past
2) With other countries experiences
3) With expectations or anticipated outcomes.
Comparing with the past and others
There have been earlier efforts but not with much success. In 1946, the currency note of Rs 1,000 and Rs 10,000 were removed from circulation. The ban really did not have much impact as the currency of such higher denomination was not accessible to the common people. However, both the notes were reintroduced in 1954 with an additional introduction of Rs 5,000 currency.
In 1978, the then Prime Minister of India Morarji Desai announced a currency ban taking Rs 1,000, Rs 5,000 and Rs 10,000 out of circulation. The sole aim of the ban was to curb black money generation in the country. It was termed as “an Act to provide in the public interest for the demonetisation of certain high denomination bank notes and for matters connected therewith or incidental thereto.”
People who possessed these notes were given a week’s time to exchange any high denomination bank notes. The one big difference with the announcement is Rs 1,000 and higher value notes were almost impossible to possess then for the common man given the value of these amounts then. The experience of other countries is not meaningful given our size and magnitude of the problem. So we rely on what were expected outcomes and what happened.
Many have argued in the immediate aftermath of the announcement that the success of the move depends on how many notes return to the banks and also how it will reduce levels of corruption/black money in the economy. But surprisingly, a significant portion of the demonetised currencies called Specified Bank notes [SBN] by RBI have been returned to banks. From the reports/data earlier published by the Reserve Bank of India (RBI), currency in Rs 1, 000 and Rs 500 denomination in circulation was at Rs 15.44 lakh crore [6857.82 million notes of Rs 1,000 and 17,165.06 million notes of Rs 500 amounting separately to Rs 68,5782 crore and Rs 85,8253 crore]. Taking into consideration, the value of SBNs now reported to have been counted, approximately 98.96 percent of SBNs in value terms have come back to the RBI after demonetisation. In other words, only an estimated Rs 16,000 crore worth of SBNs have not come back to the RBI so far. Even after a year, the RBI is still counting notes for their genuineness, etc.
Earlier, estimates suggested that around Rs 3 trillion would not return to the banking system because it was unaccounted money. There were long queues before banks to exchange old notes to new ones. We did not see any big businessman/film actor/sports persons/retired judges/ retired army generals/bureaucrats and of course political leaders in queues to exchange notes. None can argue that only the poor, lower and middle classes in those queues were having black money and none of the elites! This argument would be hilarious. But our black money holders are clever. All elites used their servants/dog walkers/drivers, etc. to exchange as much as possible. They also would have used some corrupt bank officials. Hence, one can surmise tax evaders had managed to legalize their unaccounted money using mules and proxies to make deposits, made high-value purchases using back-dated bills and colluded with bank officials to exchange old currency.
Measuring the success of demonetisation on the basis of how much cash has come into the system shows “an inadequate understanding”. Indeed, “the fact that the entire demonetised money has come back shows black money has been accounted for completely. In that sense, demonetisation has been a success,” said R. Gandhi, former deputy governor of RBI. It is now up to the tax department to do its job, he added. In January, the government decided to use data analytics to identify people whose deposits didn’t match their known sources of income.
In his Independence Day speech this year, Prime Minister Narendra Modi said that more than Rs 1.75 trillion deposited in banks after demonetisation was under the scanner. “The trail of deposits” of bank notes “into bank accounts may provide valuable information to the revenue authorities in tracing unaccounted money”, RBI said in its annual report. The ministry’s note also added that demonetization had resulted in a 24.5 percent increase in the number of income tax returns filed till 5 August.
For instance, RBI’s annual report shows a spike in the number of so-called suspicious transaction reports [STR] filed by banks, financial institutions and intermediaries. Banks filed 361,214 such reports in 2016-17, up from 61,361 the previous year. This is evidence that people have been forced to deposit money “illegitimately lying with them”. Also substantial amount was deposited in the so-called poor man’s account. Banks in the country have added 46.65 lakh new accounts under the Pradhan Mantri Jan Dhan Yojna (PMJDY) during the five weeks after the demonetisation of Rs 500 and Rs 1,000 currency notes on 8 November.
The total balance in PMJDY accounts increased to Rs 74,123.13 crore as on 14 December as against Rs 45,636.62 crore on 9 November, recording a growth of Rs 28,486.51 crore. Any which way the Indian black money holders did not shy away from the banking system. Only they hoped they may not be caught.
Shift to financial savings
Typically, Indian households are major savers in the economy contributing 70 to 80 percent of the gross domestic saving. Of these the physical assets –house/gold etc. –constitute a major portion and the financial assets are mainly cash/bank deposits/ etc. Data from the RBI shows that gross financial savings rose to 11.8 percent of the gross national disposable income (GNDI) in fiscal year 2017, a notable climb of 90 basis points from 10.9 percent in the previous year. Not surprisingly, the improvement into financial savings was led mainly by bank deposits. After all, Indians were given 50 days to deposit their invalid cash into their bank accounts. And that is exactly what the people were preoccupied with during the demonetisation months. So, savings into bank deposits surged 7.3 percent of GNDI in fiscal year 2017 from 4.8 percent in fiscal 2016. Other products also caught a slice or two of financial savings.
Indians invested 1.2 percent of their disposable income into shares and bonds, a massive improvement from the average 0.2 percent in the years before. A look at how stock indices have soared since demonetisation should be enough to add a sense of certainty to this. The inflows into equity mutual fund schemes are another indicator of how the stock market gained from getting a bigger slice of household savings. The insurance sector also benefited with 2.9 percent of disposable income flowing into it. In other words, demonetisation seems to be encouraging people into financial products including MFs, etc.
Many pseudo-experts argue that black money is kept in the form of real estate. Unfortunately, economists are not taught rigorous courses in accounting. Transaction has two sides. If I buy land or house paying let us say Rs 50 lakh in cheque and Rs 30 lakh in cash, then the seller gets my black money of Rs 30 lakh—it is not obliterated. Also, one finds that there is a decline in the ratio of white to black transaction in real estate sector. Earlier, what used to be 60/40 levels—that is white 60 percent and black at 40 percent –it has come down to as low as 85/15 levels. Large number of people do not want to carry huge amount of cash. Even in transactions like TV/fridge, etc., items including gold transactions in lakhs in cash come down. The regulations in terms of cash transactions have become stringent and people are concerned about IT capturing data from transactions.
One of the important points stressed by the prime minister regularly is using digital modes of transaction in day to day life. He thinks larger digitization will reduce corruption and to some extent rightly so. The invalidation also resulted in an increase in digital transactions. In a note, the finance ministry said that number of digital transactions increased 56 percent between October 2016 and May 2017 to 1.1 billion. The demonetisation exercise was announced on 8 November, 2016. Retail level one sees more use of methods like Paytm/Bhim/credit cards etc even in the level 2and 3 towns. And technology in a sense is addictive—once you start using it u continue due to ease of transaction/ability to keep records etc.
There has been significant impact on Naxal terrorists and Kashmir Jihadists due to demonetisation since old notes could not be used. Even trafficking in women from east and NE has come down. The looting of banks in J&K indicate the desperation of the Jihadi groups to get new money.
Implementation is critical
The implementation of any such idea is more critical in a country like India than the policy itself. Of course the opposition talks of hundreds of deaths due to demonetisation-but such hyperbole needs to be taken with a ton of salt. The Government could have minimized the suffering due to better planning. Initial stage BSF/CRPF/Police vehicles could have been used to transfer funds to far flung location instead of depending only on bank approved security vehicles. We also have companies-both in FMCG and Financial who have extensive country wide network. We have HLL/ITS/Sundaram Finance/Oil companies/Shriram /LIC etc who have branches and distribution network in far flung locations. These should have been co-opted as “temporary Banks” or “correspondence Banks” to distribute new notes etc. Also RBI should have alerted Government about incompatibility of ATMs with new notes and time taken for re-calibration.
Of course the element of secrecy might have been lost of so many were involved in planning stage itself. Also to remember Introduction of larger denomination of rs2000 is not related to demonetisation at all. That decision was done as early as June/July and was getting implemented.
We estimate at least 10 percent of our GDP every year is not accounted or black money. At around Rs 150 lakh crore of GDP in 2016-17 –it comes to Rs 15 lakh crore. This is annual number and hence need to tackle it on a war footing. The next best step would be to limit the holding of cash to Rs 10 or 15 lakh per individual which, if implemented will dramatically change the whole situation. Currently there is no restriction on holding any amount of cash. An expert committee formed by L K Advani in 2008, just before the 2009 general elections, which I was a part of, had proposed certain measures to curb black money menace. One of the proposals was to make the possession of cash above Rs 10 lakh or Rs 15 lakh – a crime, a punishable crime. That will automatically lead to reduction in stashing the cash. I hope this government will do it.
The SIT has made the following recommendations in the Fifth Report — Cash holding: The SIT has further felt that, given the fact of unaccounted wealth being held in cash which are further confirmed by huge cash recoveries in numerous enforcement actions by law enforcement agencies from time to time, the above limit of cash transaction can only succeed if there is a limitation on cash holding, as suggested in its previous reports. SIT has suggested an upper limit of Rs 15 lakhs on cash holding. Further, stating that in case any person or industry requires holding more cash, it may obtain necessary permission from the Commissioner of Income tax of the area. In the recent budget, Government has made cash transactions to be limited to Rs 2 lakhs in case of capital items and Rs 10,000 in case of revenue expenditure. But no limit for holding cash for individuals as well households.
Of course, lots of small businesses have been impacted since cash is the primary medium of transactions for them. Do not confuse cash with black money. This pain hopefully is temporary and Government need to pass the Mudra act to increase credit availability to small businesses and also reduce their dependence on money lenders and cash.