The date 8 November 2016 will go down as a significant date in Indian economic history just as 9/11 will always be remembered for the attacks on the twin towers in New York. This was the date when Prime Minister Narendra Modi announced that all Rs 500 and Rs 1000 notes would be demonetised and that we would be entering a new currency regime. Such a measure was bound to have conflicting views and there were compelling arguments on both sides. More surprisingly, both sides claimed victory in their views and it looked like a win-win situation for all the analysts. Three years ahead, how can we look at this measure?
There were three main motivations that were put forward for demonetisation. The first was that it would bring out black money. Here, there is little evidence of black money coming out and being either taxed or confiscated.
Second, it was a measure to get after counterfeit currency. Here too, there is no data to support the success as the value of such currency increased to Rs 43 crore in FY17 from Rs 29 crore in FY16. In terms of share in total currency of Rs 22.31 lakh crore, this amount is extremely insignificant.
Third, it was meant to combat or contain terrorism. While this worked in the winter of 2016, the skirmishes on the border in the state of Jammu and Kashmir continue to hold and hence one cannot say that there has been any reduction —especially so as these notes were replaced with Rs 500 and Rs 2,000 denomination.
Somewhere along the line, the reasoning changed for the protagonists of demonetisation where the idea of digitisation came in. The defenders argued that demonetisation would help digitise the economy and make future black money generation difficult as there would be an audit trail all the time. With the widespread use of e-wallets and cards, this party can claim some kind of vindication as there has been an increase in the use of digital money.
However, the penchant for cash has not come down and the overall currency in circulation has reached Rs 22.31 lakh crore in October 2019 compared with Rs 17.64 lakh crore just before demonetisation. Curiously, the incremental currency during the period October 2018 and October 2019 was Rs 2.6 lakh crore which is comparable to the incremental currency one year before demonetisation. Therefore, probably it can be said that it is a gain for both sides of the argument.
However, the collateral effects on the economy have been more on the negative side. For the five months of the fiscal, economic activity came to a virtual standstill. The Gross Domestic Product (GDP) growth has slowed down from 8.2 percent in FY17 (the year of demonetisation) to 7.2 percent and 6.8 percent respectively in the subsequent two years. Growth is expected to slow down further in FY20 to closer to 6 percent. Quite clearly, the shock has come in after this measure.
The two factors which have constrained the economy today are consumption and investment and the genesis of this decline can be traced back to 2016. This was the year when there was a good harvest and the rural story played out. However, the small and medium enterprise (SME) sector, which is the largest employer, went down when the currency was withdrawn as it was affected by the absence of currency. This had caused large scale job losses and closure of units as they dealt in cash and were not able to produce.
The banking sector came to a standstill too which led to surplus liquidity in the system and the book seen in the non-banking finance company (NBFC) sector which had overstretched them. As the formal sector slowed down, they were unable to make payments to the SMEs which affected the credit cycles and the Reserve Bank of India (RBI) was forced to intervene to give them more time for repaying loans.
The decline in employment in this segment has also slowed down the overall pace of job creation which is one of the reasons why consumption has been affected in the last two years. The SMEs had to also contend with the Goods and Services Tax (GST), which was a much-needed reform that, however, was timed quite inappropriately in retrospect as it severed to be a double whammy for them. Hence, while the overall economic slowdown has been due to a variety of factors, it would be difficult to apportion the share of demonetisation to this decline, though it has been significant.
Looking back now, can we really say that demonetisation was the best way to bring about digitisation? Normally no country goes in for demonetisation to digitise the economy. It is done gradually by curbing the printing of new notes and incentivising the public to go digital. One of the earlier members of the government had called this measure draconian, which in a way was true as it hurt more people than it benefited.
The move to digital currency has been significant though people still continue to hold higher amounts of cash. Hence the velocity of usage of digital currency has increased with convenience as this is also the period where e-commerce has witnessed a significant upsurge.
There was, however, a fundamental flaw in the assumption of this process. The denominations of Rs 500 and Rs 1,000 were replaced with Rs 500 and Rs 2,000 notes. This is hard to comprehend as if it were believed that high denomination notes help the creation of black money replacing them with even higher denomination makes less sense.
Quite clearly, the process did not work out completely and the fact that it was not known that the automated teller machines (ATMs) could not accommodate the new notes exposed the lacunae in planning. Interestingly, countries that have tried to move away from currency normally stop the printing of high denomination notes and keep in circulation only smaller denominations which automatically move people to the digital mode.
On the whole, it can be said that the exercise was definitely not successful and did not meet the main objectives stated. However, getting in digitisation will reduce the propensity to generate and store black money, which can be a positive outcome. But cash still rules as households still find it compelling. The question to be asked is, whether any government will again go for such an exercise? Probably not.
(The writer is chief economist, CARE Ratings)
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Updated Date: Nov 08, 2019 19:18:12 IST