Paul Krugman is right in calling Narendra Modi’s demonetisation'puzzling'; there are unanswered questions

On a day when Prime Minister Narendra Modi repeated his now famous mantra of ‘reform, perform and transform’ during his stop at Israel, one of his much dramatic economic steps —demonetisation — took some beating from a blunt-speaking Nobel laureate back in India. Paul Krugman, who is on a visit to India, didn’t mince words in an interview to Times of India while blaming Modi for going for a ‘shock therapy that was not well advised’ for an economy like India. “It was puzzling. I would not have done this… It was an attempt to flush out corruption with a very blunt instrument. There is a lot of collateral damage,” Krugman told the paper in the interview. The Modi government pulled out Rs 15.44 lakh crore or 86 percent of the currency in circulation on 8 November midnight to attack black money, corruption and terror funding. But, Krugman discarded the dramatic reform move saying “…It is not going to make any lasting dent in corruption and it could do a significant amount of damage to the economy.” The only relief, according to the economist, is that demonetisation didn’t do as much damage to the Indian economy as he feared. On this Saturday, demonetisation completes eight months. This isn’t the first time Krugman is speaking against the note ban. In December last year, when the note ban-induced cash crunch was at its peak, the economist had said Modi’s move is highly disruptive and something that won’t change the behavior of tax cheats. After eight months of the announcement, the comments from economic experts, like Krugman, are now more centered on the extent of damage the demonetistaion caused to the economy, rather than the gains it offered. Is Krugman too part of those lobbying against the Modi government’s policies without facts or is there any merit in his criticism? A look at the objectives of the demonetisation stated on 8 November and what it has achieved/ done so far in the economy would tell you that Krugman isn’t really off the mark in his comments. [caption id=“attachment_3781991” align=“alignleft” width=“378”]  Nobel laureate Paul Krugman[/caption] First is black money. While there is no official estimate of black money in cash in the country even before demonetisation, economists estimate this to be a few lakh crore rupees at least. There isn’t any latest estimate available in public for the total amount of black money recovered so far in the aftermath of demonetisation. It is unlikely that this figure will go beyond a few thousand crores. But, having said that, there has been some progress in the drive to hunt down illegal wealth hoarders and coming down on shell companies. In one of his recent speeches, Modi himself cited that over 1 lakh firms were de-registered and 37,000 shell companies detected after the demonetisation. While these steps are encouraging, the question is to what extent have these helped to recover illegal money so far and what amount. There isn’t clarity as of now on that. It isn’t unlikely that tax cheats would find a way to salvage their ill-gotten wealth using multiple benami accounts and using the Pradhan Mantri Garib Kalyan Yojana (PMGKY), with minimum loss and punitive action. Even under PMGKY, the government did not have much luck. Clearly, the demonetisation wasn’t a panacea for corruption and terror funding. When the flow of money stopped in the economy, these evils too slowed for the moment but has picked as the cash flow resumed. Several reports emerged thereafter involving seizure of fake notes in new currency and instances where bribes have been paid in new notes show that it is foolish to imagine change in currency denominations would put an end to the much-deeper malaise of cash-based corruption. Finally, a spike in digital transactions seen during the cash-crunch period after the demonetisation too has lost steam as remonetisation progressed. A recent report by brokerage Motilal Oswal Securities had pointed out that digital transactions haven’t picked up even after six months of the note ban. “One of the key structural benefits expected from the historic demonetisation announced in November 2016 was a shift towards digital payments. However, the aggregate value of all transactions under electronic payment systems (EPS) has failed to witness significant increase even six months post demonetisation," the report said. But, the disappointing fact is that beyond the little gains and pain, we don’t even have a full picture of how much money was deposited into bank accounts post the demonetisation. This data is critical to find out how much illegal wealth got destroyed outside the banking system during the note ban. The Reserve Bank of India is still counting the notes, even after eight months of the announcement — something that doesn’t augur well for the central bank which has been advocating transparency in its operations. Krugman, definitely, wasn’t totally off the mark in his criticism on Modi and the note ban.