With nearly 99% of banned Rs 1,000 and Rs 500 notes back with the RBI, questions are now being raised about the economic rationale and success of demonetisation, and whether it could hurt the economy not just in the near term but also in the medium term. How do the ground realities compare with some of the stated aims of demonetisation?
By withdrawing high-value currency notes, the government had reckoned that those holding unaccounted cash or black money would not deposit it in the banking system, thereby hitting this hoard. The Prime Minister had said it was important to isolate the dishonest. The expectation was that notes worth over Rs 4 lakh crore wouldn’t return to the central bank. Now, with 98.96% of Rs 500 and Rs 1,000 notes back, the bottom has been knocked out of that argument. What it indicates is that unaccounted funds could be in forms other than cash, such as realty and gold.
Although this was not explicitly mentioned as a major policy objective when demonetisation was announced on November 8, 2016, the government subsequently said that one of the aims was to bring about a shift from a cash-based economy towards more digital or electronic forms of transaction. In the first flush after the withdrawal of high-value notes, with most people short of cash because of restrictions, there was a spurt in electronic transactions — through prepaid wallets, debit and credit cards, NEFT (National Electronic Fund Transfer).
From 671.49 million transactions in November last year, it rose to 957.50 million in December at the end of the government’s deadline on cash withdrawal. Subsequently, however, electronic transactions headed southwards as the lack of infrastructure started showing, including a shortage of PoS (point of sale) machines, with manufacturers unable to supply a high number of machines in short time as the demand for these soared.
July data shows that the number of transactions was 862.38 million, lower than in December. Finance Minister Arun Jaitley has said that though it climaxed during the demonetisation period, the government was trying to sustain the momentum. Yet the fact remains that there is little or no evidence of expansion of digitisation in any major economy through demonetisation.
Cash in circulation
Jaitley has said one of the principal objectives was also that the quantum of cash operating in the system must gradually come down. Going by RBI data, notes issued decreased by 11.79% to Rs.15.06 lakh crore in June 2017, from Rs 17.07 lakh crore in June 2016. If this turns out to be a more durable change, it could be mark a paradigm shift in the economy. For, as digitisation increases and the amount of cash circulating in the system declines, the cost of printing currency for both the RBI and the government will come down too. The RBI spent Rs 7,965 crore to print new currency notes from July 2016 to June 2016 —more than twice the Rs 3,421 crore in the same period the previous year. But if currency in circulation does decline consistently, it could offset this huge one-time expenditure and other related expenses.
Anonymity of cash owners
One of the government’s arguments has been that the anonymity about ownership of cash operating in the system has ended, with more people putting it in the banking system. The government has said that it now has details of all those who had deposited cash during the demonetisation period. Through its Operation Clean Money project launched in January, the income-tax department has tracked 13.33 lakh accounts with cash deposits of around Rs 2.89 lakh crore, and received over 9 lakh responses so far. If the department is able to prove that a good proportion of this was not legitimate money, the outcome could meet this objective.
The government has often said it wants to increase the tax base, one of the stated aims of demonetisation. The move has started yielding results, it has said, citing how personal income-tax returns have increased by over 25 % as those dealing in cash were compelled to deposit it in banks. It is not that there hasn’t been a significant rise in those filing returns in the past either.
For instance, going by the summary of e-filed ITR forms in FY 2011-12, the number of individuals who e-filed forms was up 81.5% over the previous year. In 2012-13, it was up 30.75%. The real measure of success would be not just increasing the number of those filing, but how it translates into higher revenues. More people may be added to the returns-filing list but if many of them have incomes below the taxable limit, the gain will be limited. It will have to be seen how much of this expansion will lead to higher revenues down the line.
Mutual funds, etc
The government has said savings in the form of investment in equity mutual funds, life insurance premiums and other products have risen after demonetisation, with assets under management of mutual funds up 54% by June-end 2017 from March 2016. The growth in mutual funds, however, has been a story over the past few years. Assets under management of the Indian mutual funds industry have risen sixfold over the last decade, with the Systematic Investment Plan gaining popularity in the last couple of years in some smaller towns, rising incomes, and several policy measures in the last few years. Another reason is that in a low-inflation scenario, investors used to higher returns on safer bank deposits have shifted to mutual funds and other instruments, with deposit rates sliding.
The RBI transferred a surplus of only Rs 30,659 crore this year to the government, compared to Rs 65,876 crore last year. Over the last few years, such transfers have given a huge boost to the government as these non-tax revenue receipts help bridge its fiscal deficit. This time, huge printing and other costs have been blamed for eating into the central bank’s earnings — with the government being a net loser. But the lower payout was also because the RBI transferred Rs 13,140 crore towards its Contingency Fund this time, unlike in the last three years when there was hardly any bolstering of this reserve. Where the government would have been impacted this time is in the fact that the RBI had to incur a cost on carrying out reverse repo auctions in the post-demonetisation period to absorb excess liquidity when banks were flooded with cash deposits. The central bank had to pay banks, which in turn hit its interest income, besides appreciation of the rupee which would have impacted the value of its assets.