An analysis of what demonetisation did to the Indian economy.
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The Demonetisation shock - Five years later - An analysis
- The story: In November 2021, it was five years since the disruptive decision by the Prime Minister Modi to scrap high-denomination currency notes overnight was taken. The economy has seen several ups and downs, and major changes, during this period. The most notable has been the return of cash.
- Less cash, Cashless: A goal of demonetisation was to make India a "less-cash" economy. Though cash levels settled at a lower normal after demonetisation was done, it is growing nearly at the usual rate since. The cash-to-gross domestic product (GDP) ratio has overshot the pre-demo levels.
- The older high denomination currency notes of Rs 500 and Rs 1,000 were scrapped to make way for new high denomination notes of Rs 500 and Rs 2,000.
- Five years after demonetisation, the share of high-denomination currency notes in the economy remains the same as it was in the pre-demonetisation period .
- "Surgical strike on illegal cash" - While DeMo was later described as a policy boost to promoting digital payments, the original policy had very different stated targets. The biggest promise of demonetisation was that it would purge unaccounted cash in the system, with those hoarding forced to deposit it in the banks. The PM's speech announcing the policy had said: “Which honest citizen would not be pained by reports of crores worth of currency notes stashed under the beds of government officers? Or by reports of cash found in gunny bags”. The implicit idea was that those who had unaccounted cash with them would be forced to either declare it to the tax authorities or just get rid of it. Many described demonetisation as a sort of surgical strike against corruption. This was also supported by some economists, such as Soumya Kanti Ghosh, the chief economic advisor of India’s largest bank, the State Bank of India. Ghosh had then estimated that “roughly around ₹4.5 lakh crore of (demonetised) money could disappear from the system”. He was proven completely wrong.
- In his budget speech after demonetisation on February 2, 2017, then finance minister Arun Jaitley gave the first hints that demonetisation had not led to large scale purge of unaccounted cash deposits.
- Banks deposits: Bank deposits saw a sharp jump immediately after the decision, but quickly came back to the normal level. In fact, Covid-19 seems to have pushed deposits to a higher normal.
- GDP growth: Real GDP growth fell sharply after demonetisation. Though a quarter or two showed higher growth rate partially due to low base effects, quarterly real GDP growth plummeted from levels of 9 per cent seen in FY17 and FY18, to 3 per cent in the last quarter of FY20.
- Cash usage: What happened to cash usage? ATM cash withdrawals fell sharply after demonetisation, and took more than two to three quarters to recover. Debit and credit card payments rose as people began using digital payment modes to a higher degree. But the impact of Covid-19 on cash withdrawal was much more adverse than demonetisation.
- Digital payments: These, in newer forms, rose faster. Unified Payments Interface, or UPI, clocked transactions worth Rs 7.7 trillion in October 2021. But the use of Immediate Payments Service, or IMPS, which was a popular mode of digital payments before UPI, has been lagging. Demonetisation triggered the proliferation of private players in the UPI ecosystem, which can be seen as probably its biggest positive impact.
- Tax to GDP ratio: Demonetisation was not the only policy change which has affected tax collections in India. It was followed by the roll-out of Goods and Services Tax in July 2017. In September 2019, the government announced a significant reduction in Corporation Tax rates, which led to a sharp fall in direct tax collections. The economy was soon hit by the pandemic, which led to a sharp fall in GDP and hence tax collections also. Now, a look at the central government’s gross tax collection vis-a-vis its budgeted targets does not show much of an improvement after demonetisation.
- What experts say: Prof. Dr Arun Kumar was one of the first to analyse this idea, on 9th of Nov, 2016 itself. He feels firmly now that the informal sector of India has been decimated, as entire lifeblood of informal economy (cash) was sucked out, and replaced very slowly. He says “cash” is not necessarily “black”, and large scale tax evasion by big players is continuing (real estate etc.). Mass poverty, misery and joblessness is back. And the huge windfall predicted (as black money won’t come back to Banking system) was proven wrong almost immediately. He alleges that the GDP growth figures are wrong as they deliberately ignore what’s happening in informal sector.
- EXAM QUESTIONS: (1) Explain the original goals set by PM Modi in the Nov 2016 demonetisation exercise. Were they achieved? Explain. (2) Why did the Tax to GDP ratio of Indian economy did not improve if black money was destroyed by demonetisation, and all players in economy had to start paying taxes? Analyse. (3) What was the impact of demonetisation on jobs in India? Explain.
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