4 months of note ban: More questions than answers on Narendra Modi’s grand move

Four months have passed since Prime Minister Narendra Modi on 8 November announced one of the most disruptive economic policies in India’s history by unexpectedly scrapping Rs 500 and Rs 1,000 notes. That amounted to some 86 percent of the total currency in circulation, or Rs 15.4 lakh crore. The move, which came at a time when the Indian economy was limping back to higher growth trajectory and just ahead of crucial state polls, surprised many economists. It drew both support and criticism. The notebandi, as it is popularly called, triggered a major cash crunch in the economy in the next two months and hit the informal sector, which operates mainly in cash, badly.

Soon, the narrative of the demonetisation exercise was rapidly changed from targeting black money, corruption and fake notes to creation of a digital economy and even to bringing down real estate prices. The Modi government didn’t take the criticism on the merits of the move lightly and took on political rivals fiercely. The debate soon took the shape of a fight between the corrupt and non-corrupt. But, even some of the former RBI officials, such as former governor Y V Reddy and deputy governor Usha Thorat, cried foul about the lack transparency, frequent flip-flops in rules and the very efficacy of the idea of recalling notes to achieve the primary objective of killing black money. Even the Supreme Court questioned the government and RBI from backtracking from its promises (read here).

Rs 2,000 note

Rs 2,000 note

“The objectives of the government were laudable, but it seems as though the scheme was imposed on the country with little or no forethought,” noted economist and former JNU professor, Arun Kumar wrote in his book--‘Understanding the Black economy and Black money in India’. Those who heavily criticised the move also included Nobel laureate Amartya Sen, who termed note ban as an ‘authoritarian’ move and questioned it saying the very low percentage of black money in cash and the absence of credible estimates from the government on this.

Those like Arun Kumar, also questioned the government’s rationale on the expected rapid shift to the digital economy saying “only about 22 percent adults in India has access to internet and 17 percent to smart phones, limiting their ability to shift to online financial transactions.

At the same time “it is unlikely that black marketeers and other generators of black money will suffer because the biggest fish were able to quickly convert whatever black cash they had into white,” Kumar wrote. Former Prime Minister, Manmohan Singh called it a ‘monumental tragedy’ and a case of ‘organised loot and legalised plunder’.

But, there were many who lauded the government’s move too. This side included NITI Aayog member, Bibek Debroy, economist and former chief economic advisor to government and Arvind Virmani. Those defended the demonetisation move also included RBI governor, Urjit Patel. Economists’ criticism on demonetisation is not fact-based, Debroy said. “They (economists living abroad) base their understanding essentially on reading English newspapers. Otherwise, how would they know? English language newspapers understood many things wrongly,” PTI quoted Debroy as saying this.

Post-demonetisation the first two months, the cash crunch has eased significantly and things are almost back to normal. But, beyond the criticism and counter arguments, what have been the gains it offered so far?

There are no tangible gains seen so far, except the flood of deposits that have reached the banks when people thronged the branches to deposit or exchange their invalid currency. About Rs 12.4 lakh crore deposits have reached banks till 10 December, according to RBI data. The central bank has not released numbers post this date. But, a good chunk of this money has found its way to government securities when banks struggled to deal with large deposits in the backdrop of poor credit demand.

For this reason, banks’ holding in G-Secs rose to 30-34 percent as against the 29 percent mandated by rules. “Following the demonetisation event, the banking system received a record inflow of deposits. Whilst the surge in deposits is real, the same is not being lent out but is being used by banks to buy government securities,” said analysts at Ambit in a report titled, ‘3Q FY17 GDP data-CSO’s flight of fantasy continues’.

There has been no major recovery of black money since demonetisation. According to PTI report, which cited income tax department sources, the total undisclosed income admitted or detected as part of this action, till 19 December, has been a mere Rs 3,185 crore. There is not the latest estimate available. Fake bills in new notes have been seized from across the country since demonetisation, raising doubts about the promise of eliminating counterfeit notes. Terror networks have been short of cash and are hit by demonetisation, but things would be back to normal for them when cash crunch eases.

“Some of the activities like terror funding, etc would have come down because there is no cash available in the system. But, with this, the overall economic activities also have come down. Money, which was utilised earlier, is not available now. Once the cash comes back, all of this will start again. The point is for one or two targets, you don’t burn the entire forest,” said former RBI deputy governor, K C Chakrabarty in an interview to Firstpost.

What has demonetisation done to the economy?

If one goes by the third quarter GDP numbers, which showed a 7 percent growth in Q3, nothing has happened. Everything is as usual, and in fact, demonetisation has significantly boosted private consumption. But, not many economists trust the GDP numbers citing the lack of disconnect with multiple indicators on the ground (read here).

In the long run, most economists agree that demonetisation would improve tax base and compliance when taxmen trace the large number of new deposits and more people turn to digital transactions. Note ban has certainly acted as a trigger for a large number of people turn to digital transactions. Also, when demand for bank loans pick up, banks can use the deposits garnered through this exercise to fund productive sectors. But, one needs to wait and watch how this scenario evolves.

Questions remaining

There are important questions remaining to be answered. The Reserve Bank, even after 4 months of demonetisation, has not disclosed how much deposits have ultimately come back to the banking system since 8 November, saying that it is still counting notes. The apex bank updated these figures twice since note ban but stopped giving the updates post 10 December. Former SBI chairman Pratip Chaudhuri, in an interview to Firstpost, criticised the RBI saying the central bank is lying on the cash situation, while Chakrabarty said the central bank doesn’t have the right information at this stage. We also don’t know the latest figure on how much unaccounted cash has been recovered post this exercise.

But, one thing is clear. After 4 months, PM Modi’s dramatic move continues to enjoy ground support (according to various surveys) with people looking at the step as a long pending war against the rich and the crooks in the society. At least, demonetisation has not impacted the BJP’s poll profiles as is evident from the public mandates in civic polls from Maharashtra and elsewhere. Demonetisation is still seen as a heroic act by Modi and will, probably, remain so. The only thing missing, so far, in this fascinating story is hard data on the progress. There are more questions than answers.


Published Date: Mar 08, 2017 12:58 pm | Updated Date: Mar 08, 2017 01:15 pm