By Mihir Baxi
Measuring the complete impact of any policy is far from an easy task. A preliminary assessment demands understanding the macro and micro footprints of the policy in question. But there is so much more behind the curtain of statistics and economic impact, especially for a policy as politicised and embattled as Demonetisation. During an era of political polarisation in India, an objective analysis of any policy is an evasive hope. The variety of policy impacts that we must consider include the economic, social, financial, legal, and technological, among many others. Robert Shiller would certainly be one of the first to cite a narrative impact as well (But if Dr. Shiller hasn’t done so yet, let me be the first).
On November 8th 2016, Prime Minister Modi announced that Rupee notes baring values of 500 and 1,000 would no longer be accepted as legal tender. The purged money amounts to an estimated 86 percent of the total currency in circulation – a monetary value of nearly $211 billion. The government had given people up till the end of the year to either deposit the now worthless notes into their bank accounts, or have them replaced with newly issued 500 and 2,000 Rupee notes.
When the Prime Minister announced the cash purge a year ago, the narrative around the policy built it up as premeditated and scrupulous. I recall demonetisation being described to me by a colleague as ‘a master stroke’. The Prime Minister, as well as senior members of the ruling Bharatiya Janta Party (BJP) delineated the goals of demonetisation as: the curbing of corruption, black money, fake notes, and terror financing. Simultaneously, the use of electronic payments and of formal financial institutions was expected to rise.
While cities that are well served by banks helped carry out this transition, rural areas were affected adversely. In 2016, the RBI found that 93 percent of rural centers in India are unbanked, and that only 3 percent of households in rural India have access to the internet. Presenting obvious problems in depositing old currency notes and in adopting electronic payment systems.
The goal of invalidating hordes of black money stored as cash was never to be met, as 99 percent of all banknotes have thus far been accounted for by the RBI. Counterfeit currency represented less than 0.0007 percent of the total cash taken in. Thus implying either that the black money never existed, or that it was laundered into legitimacy at a remarkably successful rate. As argued on numerous occasions over the last year, dealing with black money isn’t just about cash. A majority of gains from illicit activities are in fact stored in more illiquid assets such as real estate or art. Assuming that corruption and black money are reliant on cash ignores the complexity of the informal ‘black’ economy in India, whose value chains and benefactors can simply switch to the newly introduced currency notes. The policy of demonetisation failed to tackle the incentives that drive corruption and to disrupt the value chains of the informal economy. The anti-corruption and anti-black money motivators behind demonetisation have not produced any measurable effects.
The goal of digitising the Indian economy has not fared well either. Non-UPI and non-cash payments are now down to pre-demonetisation levels. In pre-demonetisation times, only half of all Indians had bank accounts and only a quarter had internet access. The goal of digitising and formalising the economy in a mere 50 days was over-ambitious, if not over-idealistic. To be fair, digital infrastructure has been created, and the amount of cash in the economy is lower than what it would have been without demonetisation. However, the incentive to permanently adopt these mechanisms is non-existent in the face of new currency notes. The unrealistic time frame to adopt the digital economy, the lack of access to online payment systems, and the introduction of new currency notes are all responsible for the failure of India to go digital over the last year.
The lack of sufficient new currency notes after the announcement of demonetisation led to increased deposits into savings accounts. Nearly 60 percent of deposits have stayed in the financial system, and according to Viral Acharya (the Deputy Governor of the RBI), there has been a non-linear shift from household savings to financial assets. One of the chief beneficiaries of this has been mutual funds, which observed a massive push of capital inflows. The insurance sector has also witnessed similar inflows. Although new money deposits have proved to be stickier than expected, there has been an increased financialisation of deposits.
Kaushik Basu, Chief Economist of the World Bank, attributed the recent lows in India’s growth rate to the short term impact of the demonetisation exercise. The Centre for Monitoring Indian Economy (CMIE) estimated that by April 2017, the number of non-agricultural daily wage earners fell by 5 million, while the number of agricultural laborers fell by 5.6 million. Small businesses have floundered in finding access to capital, putting many out of business. The liquidity crisis which resulted in the immediate aftermath of demonetisation caused a crash in agricultural prices, disrupting debt repayment in the agricultural sector. Politically, this manifested itself in a large number of farm loan wavers – another economically irresponsible exercise with negligible benefits, other than creating vote banks for local politicians, of course. It is interesting to note that a majority of farmers who have been bailed out were provided credit by money lenders and not by official financial institutions. So loan wavers did not help recapitalise banks (many of whom were in need of capital after the recent drive to clear up non-performing assets). Further, the FMCG sector declined by 1.5 percent, and corporate credit growth has reached a 30 year low. While demonetisation alone isn’t responsible for a slowdown in Indian growth, it is chief among many factors such as bank recapitalisations, loan wavers, an artificially appreciated currency, that seem to have acted during a short time period as a drag on the country’s economy.
So let’s amalgamate what we know about the intended goals and achievements of demonetisation. The goal of reducing black money and corruption has certainly not been met. A cash purge, by any standard, was an inappropriate method of achieving such a goal because it does not tackle the incentives that drive illicit behavior. The goal of digitisation had a temporary positive effect. But the introduction of new currency notes along with unrealistic expectations about the logistics of digital payments belied the achievement of the stated objective. Savings and financial capital flows are up, and so is participation in formal banking (but only marginally). The macro impact of demonetisation has been a lot bleaker. The collapse of agricultural markets led to farmer bailouts, millions of jobs were lost and businesses were forced shut. Demonetisation has thus been a policy that achieved none of its stated objectives.
The crux of the matter is that even if more than a fraction of the policy’s intended objectives had been met, it would not have justified the policy itself, which by all measures had a negative net impact. There is a price for the administration of a hasty and untested policy. One which – before its announcement – was not subject to any form of peer review, impact analysis, or debate. And was apparently made by a handful of individuals with no expert consultation or experimentation. Whatever demonetisation did achieve came at a heavy cost, one that India is still in the process of completely realising. Harvard economist Ken Rogoff said recently that he was surprised that the damages from the demonetisation process were not more extreme.
Yet, the narrative around demonetisation has made it out to be ‘a good idea executed poorly’. The policy’s architects, including the Prime Minister, have not lost political support because of their efforts to curb corruption and black money. Poor execution aside, the effects of the demonetisation policy would have been apparent if the policy had been discussed openly, and if economic and policy analysts had been consulted during its design. The narrative should thus be laid to rest.
Some senior members of the BJP have called for November 8th, the day when demonetisation was first announced in 2016, to be celebrated as ‘Anti-Black Money Day’. I hope this doesn’t happen. Bad economic policy should not be celebrated.
The author, Mihir Baxi, is an economic analyst and researcher. His work focuses on international economic affairs.
Tweet at Mihir: @baximihir95
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