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.