The case of demonetisation in India

• Popular narratives play a much bigger role in economic policymaking than economists and policymakers acknowledge.
• If, indeed, these narratives are grounded more in myth than reality, the impact of such policy can be devastating.
• The demonetisation of high-value currency in India in 2016 is a classic case of policy based on faulty narratives. Paradoxically, the failure of the policy does not appear to dent the narrative and, consequently, there is very little price to pay for its failure.

2016 Indian banknote demonetisation

• On 8 November 2016, the Government of India announced the demonetisation of all ₹500 and ₹1,000 banknotes of the Mahatma Gandhi Series.
• The government claimed that the action would curtail the shadow economy and crack down on the use of illicit and counterfeit cash to fund illegal activity and terrorism.
• The sudden nature of the announcement—and the prolonged cash shortages in the weeks that followed—created significant disruption throughout the economy, threatening economic output.
• The Specified Bank Notes (Cessation of Liabilities) Ordinance, 2016 was issued by the Government of India on 28 December 2016 ceasing the liability of the government for the banned bank notes.
• Demonetization technically is a liquidity shock; a sudden stop in terms of currency availability.
• It created a situation where lack of currencies jams consumption, investment, production, employment etc. The intensity of demonetization effects clearly depends upon the duration of the liquidity shocks.

Following are the main impacts.

• Currency crunch in our economy
• Welfare loss for the currency using population.
• Consumption was adversely affected
• Consumption ↓→ Production ↓→ Employment ↓→ Growth ↓→ Tax revenue ↓
• Loss of Growth momentum
• Increase in bank deposits and reduced interest rate
• Countering of black money
• Check on counterfeit currency

Criticism against demonetisation

• Critics say, the Demonetisation as a means of tackling the black economy, carried out on the incorrect premise that black money means cash.
• It was thought that if cash was squeezed out, the black economy would be eliminated. But cash is only one component of black wealth: about 1% of it.
• Black money is a result of black income generation. This is produced by various means which are not affected by the one-shot squeezing out of cash.
• Any black cash squeezed out by demonetisation would then quickly get regenerated.
• So, there is little impact of demonetisation on the black economy, on either wealth or incomes.

Demonetisation & Popular Narrative

• The demonetisation of high-value currency in India in 2016 is a classic case of policy based on faulty narratives.
• The demonetisation story in India is based on popular myth that ill-gotten wealth is stored in stacks of currency notes and gold, hoarded in safes, boxes, or concealed cupboards. The dramatic action of demonetisation was considered powerful blow against this wealth because it was believed that this money was now rendered useless.
• Such an action on black money was deeply satisfying psychologically as the narrative of black money is almost always in deeply moral terms.
• The narrative ignores the fact black money is not really kept in cash except in small quantities but mostly accumulated through real estate and other assets.
• Although income from corruption or criminal activities is by definition black money, most black money is earned through perfectly legal activities though not declared to the tax authorities.
• Also, the narrative included that such a measure will solve terrorism by stopping terror financing (old notes no more valid & terrorists cannot exchange it)
• The way the narrative was framed made it hard for critics to explain their opposition. To denounce it outright would suggest that they have a vested interest in defending black money and corruption.
• The narrative started to change the focus from black money and fake currency to digital/cashless payments, as time passes and it was realised that it was a failure.
• Appeals to nationalism and patriotism was also invoked to sustain the narrative.
• The act (of demonetisation) was considered as an act of collective sacrifice. The people in long queues were reminded of the sacrifices of the soldiers guarding the nation’s borders and not to think of their own suffering.
• The moral high ground claimed by the demonetisation narrative overshadowed the economic criticism of the policy and the observed reality.
• Paradoxically, the failure of demonetisation policy does not appear to alter the narrative and, consequently, there is very little price to pay for its failure

Why is demonetisation considered as failure?

• Demonetisation was done on two previous occasions, in 1946 and 1978, with poor results. But, unlike the limited impact of the previous events, the demonetisation in 2016 caused widespread disruption in the economy.
• Very little of 2016 demonetisation’s declared objectives — of eliminating black money, corruption, moving towards a “less cash and more digital economy”, or increased tax compliance — were achieved.
• Expectations of windfall gains of some ₹2 trillion-3 trillion failed to materialise as more than 99.3% of the cancelled notes returned to the banks.
• According to RBI report, after verification and reconciliation, the total value of the ₹ 500 and ₹,1000 as on November 8, 2016, the day before note ban came into effect, was R₹15,417.93 lakh crore.
• The total value of the such notes returned from circulation was ₹15,310.73 lakh crore by August 2018.
• If black money had existed as stockpiles of illegal cash, clearly all of it was very efficiently laundered.
• By every measure, demonetisation as economic policy was a gross failure. But, as a narrative, it succeeded in creating a favourable or positive view of the policy.
• Despite personal hardship, long queues, and the loss of income and savings, there was a degree of ambiguity in criticising the decision.
• Most tended to distinguish the intention from the reality. That the policy was good but perhaps not implemented well seemed to be the main theme.

Who mostly have borne the brunt?

• Large deposits by businesses do not automatically become black. The Income Tax department has to prove that the sums deposited resulted from generation of black income. According to the Finance Minister, big data analytics would track black money holders who have deposited cash in their bank accounts.

• The negative effect of demonetisation can be seen in terms of big losses to the unorganised sector, farmers and traders.

• The start-up world has seen a drop in investment activity

• The brunt of this move actually has been borne by those who never had any black money. The note shortage is slowly waning and the long-term economic and social effects are becoming evident.

• Critics overlook the significant gains of demonetisation which have begun to accrue and will gather momentum

• For India to achieve prosperity for all, three ingredients are essential: a transparent, effective government, flourishing of competitive free markets, and huge investment in the poor.

• Corruption had made the government dysfunctional, crony capitalists flourished at the expensive of honest entrepreneurs, and rampant tax evasion that hindered state’s capacity to invest in uplifting the most vulnerable citizens. Note ban was announced to overcome these issues to some extent.

Short-term costs inevitable

• There were always going to be costs in the short run — people would be short of currency, businesses would be disrupted, consumption would fall, and GDP growth would take a hit.
• The government announced the Pradhan Mantri Garib Kalyan Yojana where cash could be declared, deposited, and a hefty penalty paid. For those determined to deposit their illicit wealth without disclosure, the cash has not become white. It will be scrutinised by the tax authorities and penalties levied.
• The gains may accrue in the coming year once tax authorities have scrutinized through accounts with suspiciously large deposits.
• According to Finance Minister, between November 8 and December 31, 2016, deposits between ₹2 lakh and ₹80 lakh, and deposits of more than ₹80 lakh amount to some two-thirds of the value of the demonetised currency. The holders of these suspicious accounts will now be in the tax net for perpetuity.
• However, not all of that money deposited is black. Perfectly white cash holdings were common. To able to distinguish the black from the non-black would be the responsibility of the IT authorities. They have to analyse the deposits and correlate them with the tax payment records, which is relatively easy to do.

Move to a less cash economy

• The significant gain which has begun to accrue, and will gather momentum, is the move to a cashless economy.
• In the long run, a move away from the use of cash is the surest way of curbing the black economy.
• Less cash economy can happen with shift in payment patterns. There was certainly evidence that the number of electronic transactions went up. But after the money supply started coming back, those dropped. * Whether Indians have changed the way they make payments is questionable.

Other significant gains from demonetization

• Nobel laureate Kailash Satyarthiand others working to fight human trafficking said that the note ban had led to a huge fall in sex trafficking.
• The Demonetisation has badly hit Maoist and Naxalites as well. The surrender rate has reached its highest since the demonetisation is announced.
• It is said that the money these organisations have collected over the years have left with no value and it has caused them to reach to this decision.
• Mumbai Police reported a setback to Hawala operations. Hawala dealers in Kerala were also affected. The Jammu and Kashmir Police reported the effect of demonetisation on hawala transactions of separatists.
• Several e-commerce companies hailed the demonetisation decision as an impetus to an increase in digital payments, hoping that it would lead to a decline in COD returns which could cut down their costs.
• The demand for point of sales (POS) or card swipe machines increased. E-payment options like PayTM and Instamojo Payment Gateway, PayUMoney also saw a rise.
• The number of I-T returns filed for 2016-17 grew by 25 per cent and the advance tax collections during that period rose 41.8% over the 1-year period, as increased number of individuals filed their tax returns post demonetization"