Context

• The publication of central bank’s annual report for fiscal year 2016-17 (RBI follows a July-June fiscal year) which put the estimated value of the currency that returned to the system at Rs 15.28 trillion or close to 99% of the currency notes demonetised in November-December 2016.
• Currency in circulation in India stood at Rs 19.3 lakh crore as on 1 June, reaching 98.94% of the pre demonetisation level, according to the latest data released by the Reserve Bank of India (RBI).

Demonetization technically is a liquidity shock; a sudden stop in terms of currency availability. It created a situation where lack of currencies jams consumption, investment, production, employment etc. The intensity of demonetization effects clearly depends upon the duration of the liquidity shocks.

2016 Indian banknote demonetization

• On 8 November 2016, the Government of India announced the demonetisation of all Rs. 500 and Rs. 1,000 bank notes of the Mahatma Gandhi Series. The government claimed that the action would curtail the shadow economy and crack down on the use of illicit and counterfeit cash to fund illegal activity and terrorism.
• The sudden nature of the announcement—and the prolonged cash shortages in the weeks that followed—created significant disruption throughout the economy, threatening economic output.
• The Specified Bank Notes (Cessation of Liabilities) Ordinance, 2016 was issued by the Government of India on 28 December 2016 ceasing the liability of the government for the banned bank notes.

Following are the main impacts

• Currency crunch in our economy
• Welfare loss for the currency using population.
• Consumption was adversely affected

Consumption ↓→ Production ↓→ Employment ↓→ Growth ↓→ Tax revenue ↓

• Loss of Growth momentum
• Increase in bank deposits and reduced interest rate
• Countering of black money
• Check on counterfeit currency

A changed narrative from Black money to a cashless economy

• The original intent of demonetisation was to address the issue of black money. There is enough work that suggests that people with black money hold a very small proportion of it in cash.
• Most of it is usually invested in gold, or real estate, or in the stock market, or abroad, and the share of black cash is 6% of the total black economy.
• The primary pitch and narrative of the demonetisation drive by Prime Minister seems to have taken a major shift to cashless economy from the initial key highlights of war against black money, corruption and counterfeit currency.
• Now Government says that idle money has come into the system, the cash-to-GDP ratio will decline; the tax base will expand. But none of these required demonetisation and could have been implemented independently.
• The government now also said that demonetisation is only one of the many steps to tackle the black economy.
• The government’s argument that cash coming back to the banks will enable it to catch the generators of black income, and there will be formalisation of the economy, may not hold.
• Then the goalposts started shifting when it became apparent that the main reason was not justified by what was happening. First it was cashless, then less cash economy, then formalisation of the economy. The final step was in saying this would give IT authorities the information to go after people who had deposited black money.

Who mostly have borne the brunt?

Large deposits by businesses do not automatically become black. The Income Tax department has to prove that the sums deposited resulted from generation of black income. According to the Finance Minister, big data analytics would track black money holders who have deposited cash in their bank accounts.

• The negative effect of demonetisation can be seen in terms of big losses to the unorganised sector, farmers and traders.
• The start-up world has seen a drop in investment activity
• The brunt of this move actually has been borne by those who never had any black money. The note shortage is slowly waning and the long-term economic and social effects are becoming evident.

Short-term costs inevitable

There were always going to be costs in the short run — people would be short of currency, businesses would be disrupted, consumption would fall, and GDP growth would take a hit.

• The government announced the Pradhan Mantri Garib Kalyan Yojana where cash could be declared, deposited, and a hefty penalty paid. For those determined to deposit their illicit wealth without disclosure, the cash has not become white. It will be scrutinised by the tax authorities and penalties levied.
• The gains may accrue in the coming year once tax authorities have scrutinized through accounts with suspiciously large deposits.
• According to Finance Minister, between November 8 and December 31, 2016, deposits between Rs. 2 lakh and RS. 80 lakh, and deposits of more than Rs. 80 lakh amount to some two-thirds of the value of the demonetised currency. The holders of these suspicious accounts will now be in the tax net for perpetuity.
• However, not all of that money deposited is black. Perfectly white cash holdings were common. To able to distinguish the black from the non-black would be the responsibility of the IT authorities. They have to analyse the deposits and correlate them with the tax payment records, which is relatively easy to do.

Gains from demonetization

• Nobel laureate Kailash Satyarthi and others working to fight human trafficking said that the note ban had led to a huge fall in sex trafficking.
• The Demonetisation has badly hit Maoist and Naxalites as well. The surrender rate has reached its highest since the demonetisation is announced. It is said that the money these organisations have collected over the years have left with no value and it has caused them to reach to this decision.
• Mumbai Police reported a setback to Hawala operations. Hawala dealers in Kerala were also affected. The Jammu and Kashmir Police reported the effect of demonetisation on hawala transactions of separatists.
• Several e-commerce companies hailed the demonetisation decision as an impetus to an increase in digital payments, hoping that it would lead to a decline in COD returns which could cut down their costs.
• The demand for point of sales (POS) or card swipe machines increased. E-payment options like PayTM and Instamojo Payment Gateway, PayUMoney also saw a rise.
• The number of I-T returns filed for 2016-17 grew by 25 per cent and the advance tax collections during that period rose 41.8% over the 1-year period, as increased number of individuals filed their tax returns post demonetization

Why Demonetisation alone is not responsible for slow GDP growth?

There are multiple villains to blame, though, the most immediate being the damper of demonetisation of November 2016 and the implementation of the goods and services tax (GST) in July 2017

Following may also be the reasons for slow GDP growth.

• There has been a sign of distrust in financial investments.
• While GST pushed up gold buying, it pushed down manufacturing. Manufacturing companies sent out their old stocks to market, holding back on production. It brought down manufacturing sector growth from 5.3% in January-March to 1.2% in April-June.
• In the post-rabi-season quarter, we expected strong agricultural growth but it was pulled down by the animal husbandry sector. In fact, animal husbandry, specifically buffalo meat exports, has been the leading contributor to growth among all the areas that are clubbed under agriculture.
• Uttar Pradesh, India’s largest meat processing state faced huge shutdowns from end-March. Livestock contributes a little over 4% to GDP and roughly a quarter of total agricultural GDP.
• Agri-sector growth dropped to 2.3% in April-June quarter against 2.5% in the same quarter of 2016.
• Robust government expenditure rose 27% in the April-June quarter, to 6.5 lakh crore. The not so good news: fiscal deficit touched 92% of its budget estimates by July.
• At the same time, some of the government’s revenue-generating plans have not being implemented. While disinvestment and spectrum sales have yet to make significant headway.
• Lack of PPP projects is clearly our biggest problem. Implementing the Kelkar Committee report and tackling the institutional bottlenecks that constrain PPP in India are the need of the hour.
• There is an institutional capacity issue. With an NPA overhang, corporates are wary and lack appetite to take risks.
• Savings from physical assets were being moved from gold and real estate to financial assets. Gold (valuable) imports go up sharply. Household savings moving away from physical assets, especially real estate may not be a good thing for the economy.
• The second largest job creator after agriculture is real estate and construction growth has already tapered.

The economy has overcome note ban impact: World Bank

• However, in what would have come as music to the ears of the government, the World Bank in April said the Indian economy appeared to have recovered from the temporary disruptions caused by demonetisation and the introduction of the GST.
• The World Bank said the country was projected to grow by 7.3 per cent in 2018 and 7.5 per cent in 2019 but pointed out that despite growth, India was not creating enough jobs.

Criticism against demonetisation

Critics say, the Demonetisation as a means of tackling the black economy, carried out on the incorrect premise that black money means cash. It was thought that if cash was squeezed out, the black economy would be eliminated. But cash is only one component of black wealth: about 1% of it.

• Black money is a result of black income generation. This is produced by various means which are not affected by the one-shot squeezing out of cash.
• Any black cash squeezed out by demonetisation would then quickly get regenerated.
• So, there is little impact of demonetisation on the black economy, on either wealth or incomes.

99% of demonetised notes back with RBI-

• Opposition criticism intensified after the RBI, in its annual report for 2017-18 on August 29, 2018, said that nearly all the money that was withdrawn returned to the banking system.
• The RBI said it had received Rs 15.31 lakh crore of Rs 500 and Rs 1,000 notes, or 99.3 per cent of the Rs 15.417 lakh crore worth of notes which were in circulation as on November 8, 2016.
• This meant that just Rs 10,720 crore of Rs 500 and Rs 1,000 notes failed to come back to the RBI, as against government expectations that well over Rs 3 lakh crore of black money would not return to the banking system.

Demonetisation proved to be not just an unnecessary disruptor — growth slipped to 7.1 per cent in 2016-17 and 6.5 per cent in the following fiscal — but also took the eyes of policymakers off the real problem inherited from UPA: The mountain of bad loans weighing down public sector banks.

Demonetisation turned out to be a diverter in the case of IBC; bankruptcy resolutions have started happening only in the last year of this government. GST’s rollout, too, would have been far smoother had it not been preceded by demonetisation.

More than 105 people had died in the post-demonetisation rush for cash across the country. Demonetisation also hit small-scale businesses.

According to the Centre for Monitoring Indian Economy (CMIE), demonetisation caused loss of about 15 lakh jobs. The CMIE compared the employment data for January-April 2017 with the figures for the September-December quarter of 2016, when demonetisation was implemented.

High spending on note printing (Rs 7,965 crore was spent in 2016-17 as against Rs 3,421 crore, in 2015-16) impacted the profit of the RBI which reflected in the dividend that it paid to the government.

The RBI had transferred a surplus of Rs 65,876 crore to the government in 2015-16 which declined by more than half in 2016-17 when demonetisation was implemented. The RBI paid a dividend of Rs 30,659 crore.

Way Forward

• The government should focus on ensuring growth, job creation and investment. The urgent need is to get the private sector to start investing. One way to avoid winds of deflation is to kick-start private investments.
• Reviving the investment cycle and tackling bad loans will be the key challenges to be tackled on a priority basis in the current fiscal.
• The government has launched a multipronged attack on corruption and black money. Government discretion has been reduced particularly in the allocation of natural resources.
• There is a concerted attempt to improve ease of doing business, and technology is being used to deliver public services without leakages.
• It is far too early to write-off any of these efforts, and demonetisation. There is a future beyond the present.

Conclusion

• Data available so far shows that cash remains king in the economy, even post demonetisation and that the government’s digital drive cannot easily dethrone cash from Asia’s third-largest economy.
• But more than slowing growth and derailing reforms, demonetisation inflicted avoidable pain on farmers, daily wage labourers and informal enterprises used to transacting in cash.
• Nor did it deal a body blow to black money. The promised windfall of Rs 4-5 lakh crore proved a chimaera
• There is a disturbing irony in that two years after demonetisation, expectations have mounted of the RBI delivering over Rs 3 lakh crore to the government — this time from its own reserves.