Demonetisation - A year later. A surgical strike on black money or just a currency swap?

These days, whenever it is announced that Prime Minister Narendra Modi will be addressing the nation, social media lights up, asking people to rush to ATMs.

It may be a joke but it does reveal that Modi’s 25-minute speech a year back, which, in one stroke, rendered 86 per cent of India’s currency in circulation invalid by demonetising ₹500 and ₹1,000 notes, is still vivid in people’s mind.

“In this fight against corruption, black money, fake notes and terrorism, in this movement for purifying our country, will our people not put up with difficulties for some days?” he asked then.

To their credit, people did suffer in silence even as remonetisation took time. But the economy suffered as cash-based activities came to a halt . While large businesses suffered, micro/small and medium enterprises were battered, and many were forced to shut shop. Consequently, job losses soared.

India lost its tag of being the word’s fastest-growing major economy as its GDP growth slipped from 7.5 per cent in the second quarter of 2016-17 to 7 per cent in the third quarter and 5.7 per cent in the first quarter of the current fiscal year.

Suddenly, the 9.2 per cent GDP growth in Q4 of FY16 looked a distant memory. This, despite favourable macroeconomic conditions including low inflation, a stable rupee, strong forex inflows, low oil prices and an under-control fiscal deficit.

Twelve months on, has demonetisation achieved its intended objectives? The government calls it a success but the Opposition does not buy this. “Demonetisation was an ill-conceived move. None of the three stated objectives — stamping out black money, tackling corruption and ending counterfeit notes — has been achieved,” says former Finance Minister P Chidambaram.

To make things worse, the government’s narrative kept changing on what demonetisation intended to achieve — from fighting black money and tackling fake notes, to making India a less-cash society, expanding the formal economy and, finally, widening the tax base (leading to higher tax revenues and ultimately, lower tax rates).

Fighting black money: The initial expectation was that of the ₹15.44 lakh crore that was demonetised, about ₹3 lakh crore, being the unaccounted money, would not return to the banking system. This would result in a windfall for the government, with which it hoped to retire its debt and recapitalise banks, among other things. But on August 30, after months of suspense, the Reserve Bank of India (RBI) revealed that 99 per cent of the currency had returned. People with unaccounted money had found a way to deposit their cash in the banking system.

“This could have been avoided if the authorities were better prepared. Had they kept the new notes ready, they could have shortened the window for exchange of old notes. Two months was a long period,” says C Rangarajan, former RBI Governor. But all is not lost. The government has identified over 1.8 million accounts with deposits worth ₹1.75 lakh crore that do not match the account-holders’ income profile. “This requires a lot of effort and depends on how efficient the tax department is,” adds Rangarajan.

Also, demonetisation only attacked black money in the form of cash, which, experts say, accounts for a mere 6 per cent of the total. Measures are yet to be announced to tackle other forms of black money, such as gold, real estate and stocks. In short, the fight against black money remains incomplete.

Tackling fake notes: In August 2016, the Centre estimated that the amount of fake currency in circulation in the country stood at ₹400 crore. Demonetisation was supposed to kill this menace.

But in the first six months of FY18, fake currency worth ₹9.34 crore, including the new ₹2,000 and ₹500 notes, was seized. Eleven of the 17 security features in the new ₹2,000 note have reportedly been compromised.

Less-cash economy: The objective of achieving a less-cash economy has seen some success. RBI data show that digital transactions rose from 1.49 billion in November 2016 to 1.97 billion in January and have plateaued at that level.

At the end of October 2017, the amount of currency in circulation — ₹16.1 lakh crore — had reached 92 per cent of the level at the time of demonetisation — ₹17.5 lakh crore. Experts say this is an indication that households still rely heavily on cash and have not yet embraced digital payments fully. There has also been a clear shift in people investing in formal financial savings instruments such as mutual funds and bank deposits. All good news, but the question is — could all this have been achieved through less debilitating means?

Widening the tax base: The “signalling effect of demonetisation”, the government said, would improve tax compliance and lead to higher tax revenues. “A fear has crept in big time that the government means business and the attitude of people is shifting from tax non-compliance to compliance,” says Girish Vanvari, partner and Head – Tax, KPMG India. According to the Economic Survey – II, about 5.4 lakh new tax payers have been added on account of demonetisation.

Demonetisation was a costly affair even leaving aside its adverse effect on the economy. The RBI’s cost of printing notes more than doubled to ₹7,965 crore in FY17. Also, its total expense rose by 108 per cent to ₹1,155 crore. These costs forced the central bank to halve its dividend payout to the government to ₹30,659 crore in FY17, against ₹65,876 crore in FY16.

Considering the costs and not-so-clear deliverables, was demonetisation worth it? “The cost of demonetisation is significant and is largely front-loaded. Benefits flow over time but they are uncertain,” says Ajit Ranade, Chief Economist, Aditya Birla Group.

KPMG’s Vanvari feels that the exercise helped the stock market get re-rated and it is today trading at 22 multiple as against 16 pre-demonetisation, indicating that its value has risen. But, according to former RBI Governor Raghuram Rajan, the costs outweigh the benefits. The RBI, he has been quoted as saying, had offered an alternative approach to the note ban.

Demonetisation’s success will now largely depend on what income-tax sleuths get from the suspect deposit accounts; more people taking to digital payments, thus expanding the formal economy; and how tax-compliant people become going forward. If these do not materialise, demonetisation would end up becoming what Ranade calls “just a great Indian currency swap”.

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