Look at the facts of demonetisation, not politics

Six months later, it is clear that it achieved next to nothing, and inflicted a large cost on the poor and the informal sector.

Written by Kaushik Basu | Published:May 11, 2017 12:10 am
demonetisation, note ban, currency ban, 500 note ban, 1000 note ban, demonetisation effects, demonetisation deaths, indian economy, indian economy news, india GDP, GDP, india GDP growth, GDP growth rate, indian express, india news (Graphic by CR Sasikumar)

It was six months ago, on November 8, that India hit the headlines the world over, with its sudden demonetisation. It was announced in the evening that, at the stroke of the midnight hour, all bank notes of Rs 500 and Rs 1,000 would cease to be legal tender. People would have the option, till December 30, to deposit these notes in the bank or change them for other notes, including newly-minted 500 and 2000 rupees.

Since then, a wealth of analysis and data have become available. Demonetisation’s half-anniversary is a good time to take stock of this historic decision. The verdict is clear. It was a monetary policy blunder. It achieved next to nothing, and inflicted a large cost on the poor and the informal sector.

India’s GDP growth rate of around 7 per cent over 2016-17 is commendable; tribute goes to policy initiatives such as the GST and the new bankruptcy law. However, these policies, coupled with two global trends, should have propelled India to a growth rate of over 8 per cent, the kind it had achieved before 2008.

The two global trends are the low international price of crude oil and rising wages in China. High oil prices have for long been a drain on India’s foreign exchange, preventing India from allocating money to other important imports. The fact that oil prices have fallen, from around $120 per barrel three years ago to below $50 now, is a massive boost. Second, China’s rising wages have dampened its export capacity, creating space for others to step in. But demonetisation took the wind out of India’s sails. My calculation is that around 1.5 percentage points of growth were lost to it.

It is easy to see why demonetisation was such an ill-conceived move. The first reason given for this policy in the government’s press release on November 8 had to do with eliminating fake currency notes. India has long battled fake rupee notes injected into its economy. The best estimate is that one out of every 4,000 notes in India is fake. But using sudden demonetisation to tackle this was pointless. First, most of these notes are in the pockets of ordinary people who have no idea that they are fake. As a court ruling in Maharashtra in February made clear, it is not a crime to be in possession of fake notes as long as that is not done deliberately. Second, these notes are harmful only in their creation. Once in circulation, they are like any other money. If it is felt that the estimated Rs 400 crore worth of fake currency in India increased money supply to an undesirable point, all we have to do is drain Rs 400 crore of currency in circulation, fake or real.

There is no surprise that the activity of faking is continuing even now. Seizures of fake 2000 rupee notes have been reported from West Bengal, Gujarat, Haryana and other places. To curb fake notes, what is needed is a steady improvement in the quality of notes, not a sudden intervention paralysing 86 per cent of the value of all currency in the country, as the demonetisation policy did. Further, we have to recognise that we will never get fake notes down to zero; even the most advanced economies have to deal with this problem.

The second reason for demonetisation was to curb black money. The hope was that people who made money and did not pay taxes would be stranded by the suddenness of the announcement. However, the wealthiest players keep the bulk of their black money in offshore accounts and in real estate. Moreover, demonetisation created a new form of corruption whereby rich people parcelled their illegal money into small batches and used ordinary people —“money mules” — to change it to legal tender and escaped detection. The total amount of black money destroyed, we now know, has been negligible.

Finally, demonetisation was touted as a method of “digitalisation”, a move to a cashless society. There is no denying that the world will eventually be fully digitalised. But in today’s world, where even the most advanced nations have not got there, to expect India to leapfrog to a digitalised economy is fantasy. The move was devastating for the poor and those in the informal sector, since about half of India’s adult population does not have bank accounts and lives by cash.

In brief, the benefits of demonetisation have been close to zero and the brunt of its pain has been shouldered by the poor and the lower-middle class. There are indirect indicators of this such as the fact that following demonetisation, passenger car sales did not fall, but there was a marked decline in the sales of two-wheelers.

India is a developing economy, but the professionalism of its policymaking — especially at the Reserve Bank and Finance Ministry — has been first-rate and this is widely recognised. Demonetisation was not befitting the country. The Economic Survey 2016-17 assures us that India is not alone in doing a sudden demonetisation and goes on to list nine countries that did so, which includes Myanmar, Russia, Iraq, North Korea and Venezuela. This is not reassuring.

In closing, there is a growing tendency in India to treat all debates as political. First you decide which side a person is on and then whether the argument is right or wrong. This will mire us in intellectual mediocrity and thwart progress. Technical and scholarly matters, be it demonetisation, a rocket launch or documenting the past, should have little to do with ideology. In deciding on them, we must put politics aside and use the best scientific evidence and analysis. Despite demonetisation, India’s medium-term prospects are excellent. Care must be taken not to jeopardise this prognosis.

The writer, former chief economist of the World Bank, is Professor of Economics and C. Marks Professor at Cornell University

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    uday pasricha
    May 19, 2017 at 12:44 pm
    These so called failures are only because of the very feeble & limited objective touted by the Government, perhaps as a poor political strategy. The main result and objective should not be to end black money, but to increase banking of the turnover from the unorganised sector including the gigantic rural trade and bring in a much higher number of tax payers and compliance. The highest benefit of banking every transaction irrespective of profit will be to increase liquidity with banks. The highest aspiration of every Indian is housing. Irrespective of price, the dominant cost is interest rate because a home can only be purchased by loan repayable over 15 to 25 years. Unless interest rates in India fall to levels around 5 or - our infrastructure projects will never be affordable and India will remain under developed. So demonetisation that pushes digitisation is a great need to bring in transparency in non plan subsidies, reduce corruption and give every Indian an opportunity.
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      A.L.Sundaresan
      May 13, 2017 at 12:42 pm
      We did not need an economist of Kaushik Basu's stature to state what sundry people have been mouthing loosely. I ask a simple question of Basu – Has he ever said in the one year period prior to demonetization that India poised for an 8.50 growth? He is now claiming that it would indeed have, if only there was no demonetization. The poor on the other hand may well have suffered but that has to be stated with solid statistical evidence not mere generalizations . The sardonic comment is that the poor apparently benefited from the forced labor working as mules in cash conversion or worse as launderers of black money by renting their bank accounts. Basu has made a completely subjective , non-empirical case . Demonetization could well prove to be the disaster that he claims. But that has to be irrefutably established with numbers which will take time. Mr. Basu has inadvertently displa his innate aversion to Modi's policies and personality. He should have done better.
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        sushil Ahuja
        May 12, 2017 at 3:59 pm
        मodi and her team thinks from ankles और भुगतना हमें पड़ता है 9871966707 @Guitaruncle
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          Rahul
          May 12, 2017 at 2:27 pm
          May be witter check with mental istance so, he or she can see the positive things in India grow. Rather than to support a terror funding and extremist.
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            Subhash Singh Verma
            May 12, 2017 at 1:16 pm
            How biased this article is!! It can only be Indian Express newspaper which could give space to such nonsensical and downright motivated opinions ! The writer forgot following pluses the DeMo has brought to the nation. 1. A parallel cash economy, which was an easy finance for all anti national, anti social and illegal activities has been disrupted... and the ds of money integrated into national accounts. 2. Removal of Cash stockpile strengthened democracy. 3. The filthy rich and corrupt kings have been put at at great difficulty and we're challenged for the first time. 4. Lastly DeMo was the voice of the poor and victims of the corrupt system perpetrated by the thug ru cl . That is why common men fully supported it. For Indian Express : your paper has become a prime source of communally divisive , corrupt and anti national forces. Take cognisance before it is too late. Educate the public on truth and don't become a tool of propa a!
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              T. N. Raj Mohan
              May 12, 2017 at 11:55 am
              Many of the readers are commenting on the political angle. Each of the comments or analysis has to be down by the reviewer from their own experience of work. It will give them better understanding of the situation and not carried away by any article published or any voice which is can speak for or against such moves by any government. In the case of Pharma industry 99 of the business transaction in the rural sector happens only on cash basis. If the move was so bad then most of the chemist would have been out of stocks and there would have been a huge uproar over medicine non availability. I fail to understand why our economic schools or economic think tank fail to give nos in specific fields. Dangal got record opening even in small towns. Cost of the tickets were very high in the first two weeks. I have the previlage of working small towns and villages where I have seen people go back to work due to demonotising effect. Why no analysis is being out out of this effect . Let's start.
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                Arpit Agrawal
                May 12, 2017 at 11:43 am
                A good article which highlights the lack of success of demonetization in achieving the s t-term benefits of extinguishing black money and tack the problem of FCNs. However, saying that it has had zero impact is an overstatement. According to recent reports, there has been movement on the front of long-term benefits: a. Cash based transaction in the notorious real estate sector have almost come to a standstill. Ref: : www.business-standard /article/economy-policy/is-there-cash-in-the-atm-6-months-later-india-shakes-off-note-ban-blues-117050700611_1 b. Tax base has increased at a much faster pace than earlier Ref: : www.livemint /Politics/WRTgYztM2cSiT0deLmMWjN/Demonetisation-effect-91-million-new-taxpayers Given the scale of the policy, short-term benefits might've been add-ons, but the policy should be judged on the basis of it's long-term impact. So, shouldn't we wait for 1-2 years to p a judgement?
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                  A Dias
                  Jun 17, 2017 at 9:31 am
                  Your statement on the basis of the livemint article is likely incorrect. A report by Vivek Kaul shows that the increase in the tax base to the tune of 91 million (which was pla up by the government) is actually not such a great number. Vivek Kaul compared the latest increase in percentage terms to the increase in the previous years and showed that it was not much and may actually be a decrease when you account for the increase in the population
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                  Tomy kv
                  May 12, 2017 at 10:53 am
                  You are very correct - the response from the readers are Definitely more political than factual. With such supporters will (any) Government admit or correct a misfired move? You have to live with it and enjoy the 'economic progress', though mostly owing to the cheapness of labor!
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