The picture’s hazy, even six months on

Six months since the end of the demonetisation effort, there is no clarity on its impact or consequences. For a cash-driven economy, such a transformation is significant as it has tried to change the way in which business is conducted.

It is still not certain whether or not equilibrium has been reached in terms of the repercussions of this scheme having played themselves out. Answers are not easily forthcoming; however, we can make some interesting observations.

First, the major objective was to attack if not impound black money. Unfortunately, the Government has not yet come up with a number regarding how much illegal money flowed from the second income disclosure scheme and the accompanying tax. The RBI too has not yet announced the quantum of money that came back into the system out of the ₹14.5 lakh crore of demonetised currency, though the market believes that almost everything returned. Hence, it is status quo on black money.

The second objective was to target terror funding which, prima facie , made sense: it was revealed that during the demonetisation drive, the incidence of terrorist activity in Kashmir had reduced. But with skirmishes against the establishment increasing of late, the comfort experienced during November-December could be interpreted as being only temporary. We cannot be sure whether or not terror financing has ebbed.

Third, the Government had sought to attack counterfeit currency, but the actual picture is not known as yet. There have been reports of such money being discovered, though these are isolated incidents. In fact, counterfeit currency is very difficult to trace; this is an issue facing almost all countries as the currency tends to blend into the system through different means.

How about the economic impact? Here too there is not much clarity. The impressionistic view is that GDP growth got impacted by at least one percentage point. The economy appeared to be moving along very well till October when a good monsoon and high consumer spending augured well. Hence, there did not appear to be anything amiss in the economy which should have registered higher growth than 7.1 per cent relative to 8 per cent in FY16. Assuming that the lower growth could be attributed to this process, it could be construed as being the cost of demonetisation on output.

Second, the corporate performance for Q3 and Q4 was downbeat. Demonetisation affected all the consumer-related sectors which are driven by cash such as consumer durable goods, automobiles and real estate, and those linked with them. There was some recovery in the auto segment in March when companies tried to offer discounts to sell vehicles that were not compliant with the Bharat IV norm. This performance could have been treated as an anomaly but for the fact that India Inc will continue to face challenging times in Q1 and Q2 of FY18 due to GST which has led to major destocking exercises that will further disrupt normal activity.

Third, the combination of the first two factors has also meant that job creation continues to be slow as there were substantial job losses to begin with especially in the SME segment where an embargo on production due to absence of availability of cash led to large-scale retrenchment. The impressionistic view is that employment also was impacted in the plantations segment in agriculture. This has turned around gradually of late but will reach normalcy only after the impact of GST gets absorbed.

Fourth, there is no clarity on the digitisation process, which became the objective of this move somewhere along the way. There are two ways of looking at this. There is evidence to show that there has been an increase in the use of digital modes of transaction such as mobile phones and electronic wallets. This cannot be disputed even though the numbers have declined somewhat after March-April.

But the data on money supply is interesting. As the supply of currency kept increasing there has been a tendency for larger quantities of currency to be held by the households. At the time of demonetisation the currency to money supply ratio (a currency multiplier) was 7.02. It peaked in January at 13.91 and came down to 8.56 by June. Hence, the penchant for holding cash has not ebbed and will be absorbed as supply increases.

Fifth, the banking system has certainly gone through turbulent times. The surplus cash has found its way into deposits, leading to the build up of extra cash with the system. The amount is quite large at around ₹2.7-3.7 lakh crore as the outstanding amount under term and overnight reverse repo. This automatically means that there is a carrying cost for banks, which may have to pay at least 4-7 per cent on these deposits depending on the tenure, while the return is around 6.25 per cent. The cost borne by the RBI/Government on an annualised basis would be around ₹18,000-20,000 crore.

These developments have been positive for the electronic mode of transactions as cards/e-wallets/transfers carry a cost which is paid finally by the customer/trader, etc. The widespread use of such facilities has positive implications for the telecom industry too with greater usage of the media as well as the manufacturers of phones as the habit catches on. This is a big positive for the system on this score.

But on the whole the demonetisation exercise as it stands today looks to have been a bold experiment which went through peacefully though the results are still unclear. The digitisation objective which came in later has certainly made progress. But the abhorrence for currency as posited by votaries of this scheme is definitely not supported by the households which continue to prefer holding cash for various reasons. Hopefully the generation of future black money will be slower with GST and other reforms such as RERA in place which will help make transacting easier as well put a check on the generation of such income in future.

The writer is the chief economist at CARE Ratings. The views are personal

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