Demonetization in India: The First Anniversary

On 8^th Nov'16, at 8PM,  PM Modi announced the withdrawal of 500 & 1000 rupee notes from the system, starting midnight, as a measure to tackle “black-money” & offered exchange of demonetized notes till end Dec'16. The international media attention was focussed on India & the serpentine queues that followed demonetization (DeMo) & despite about 100 people losing their lives & attempts to provoke, peace held, giving credence to the view that the laity wanted to give the PM a chance. Modi’s predecessor, Manmohan Singh, however, dubbed this exercise as ‘Organized loot & Legalized plunder” & predicted a 2% drop in GDP while Arun Shourie called it the “Largest money laundering scheme ever”. One year hence, the govt. announced that the first anniversary would be celebrated as “Anti-Black Money Day” while the opposition dubbed it a “Black day”.

In a “post truth” world, where both the ruling & the opposition camps pick up convenient data points & spout half-truths, a fact check is in order. Evaluating all the government’s promises while rolling DeMo & checking achievements during the last one year would serve as the right template

(1)Move to end corruption

With some note series never returning to the banking system post issue by the RBI, it was assumed that the cash had lapsed into a parallel economy; the then Attorney general, Mukul Rohatgi, in Dec 2016, submitted to the honourable Supreme Court that only about 10 to 11 lakhs crores would be returned, implying that about 4.44 to 5.44 Lakh would remain unreturned. Perhaps, the RBI would have extinguished & passed on the reduced liability as a windfall dividend to the govt. ; perhaps, the govt. also reasoned that about 2.5 to 3 lakh crores of black money returned would invite a tax liability – at 60% - for exceeding the known sources of income, leading to a further windfall, though post the hiatus of a litigation. One year later, the RBI concedes that of the 15.44 Lakh crores withdrawn, 15.28 Lakh crore has returned to the system; cash in co-operative banks & that circulating in countries like Nepal & Bhutan - where the Indian rupee is freely exchanged  - if returned, would perhaps mean a 100% return to the system. Substantial fines have not been recovered yet since litigation is a long drawn out process; the govt. though claims that 3.68 lakh crores & 23 lakh accounts are under surveillance. The current strength of the tax dept. though would render the scrutiny of all those accounts well-nigh impossible.

With no perceptible prosecutions in the HSBC & Liechtenstein names nor the Panama & Paradise papers many could dub the govt. as indulging in “headline management” alone; entry of leaders like Narayan Rane, Sukh Ram & Mukul Ray into the BJP might strengthen the impression that the party is not serious on either corruption or unearthing black money.

(2)End Stone-pelting in Kashmir & Naxal violence

As per the J&K police report sourced by Scroll & reproduced in an article on 24^th Aug, the stone pelting figs in Kashmir rose during July – Sept ’16 post Burhan Wani’s killing on July 8^th & subsided thereof. Incidentally, in Nov 16 the stone throwing incidents were only 102 & have been virtually flat; the minor upside in Apr-May 17 was due to the Srinagar by poll. The govt. argument that stone throwing incidents dropped 75% due to DeMo is hence factually incorrect.

The govt. claims that Naxal activities dropped by 20%. Naxal movement in the Red corridor extending from Telangana to Nepal is funded vide extortion & perhaps, fund flows from powers - inimical to India – abroad.  Incidentally, the worst Naxal attack leading to the loss of the lives of 25 CRPF jawans at Sukma in April 17 – happened after demonetization. Cutting off funds to the Naxals by providing security to the contractors to end extortion by the local police & pinpointed intelligence by the IB & ED to attack fund flow from abroad would have been a more prudent strategy & not DeMo.

(3)Remove Fake currency

As per an ISI Kolkata study submitted to the govt. fake currency in India is about 400 crores (0.02% of the entire cash economy of about 18 lakh crores); about 70 crores is pumped in yearly, largely by Pak, vide the porous Bangladesh border. Only 1/3^rd of the same is detected with an 80% contribution by 3 private banks Axis, ICICI & HDFC indicating the need for better surveillance at public sector banks; sealing the Bangladesh border should be the next step.  Using a sledgehammer approach was hence illogical.

(4)Make India a digital society

The govt. claims that DeMo spurred digital payments & showcased the increase in POS machines from 15 lakhs to 28 lakhs & launch of the BHIM app as achievements.  Touting the POS machine upside is surprising since NiTI Aayog CEO opined that ATMs, POS, Credit & debit cards would become redundant in India by 2020 since India would transition towards payments “using the thumb in 30 seconds”.  Unfortunately, ATM withdrawals which were at Rs2.22 Lakh crore in Sept ’16 reached a similar fig of  2.26 lakh crore by Mar’16 indicating that India is reverting back to the cash economy.

(5)Reduce the Cash to GDP ratio

The govt. claims that the cash to GDP ratio has dropped from 12.2% to 8.8% post DeMo putting India in the same league as advanced & Emerging economies like France, Germany, Italy, Thailand & Malaysia; however what is conveniently omitted is that the 8.8% fig is end  Mar '17 when cash in circulation (CIC) was 13.1lakh crores. The re-monetization process has since progressed with CIC in Oct ’17 crossing 16 lakh crores. Assuming the $2.3 trillion Indian economy to grow at a nominal rate of 10% (6.5% real rate +3.5% inflation rate) the cash to GDP ratio has now inched closer to 10% & if CIC growth persists at the same rate it is reasonable to predict it reaching a fig of 11.5-12% by Mar 2018. Thus we revert back to where we started.

Nordic countries have a cash to GDP ratio under 4% while Japan is at 19% & both categories of nations are known to run honest economies indicating that lower cash, though desirable does not necessarily eliminate black money. Brazil & South Africa, on the contrary, with the fig under 4% have a reputation for being corrupt economies.

At 18 lakh crore CIC pre DeMo over a 134 cr. population amounts to a per capita cash holding of about Rs 13500/- (~ $200)which is very low as compared to cash in hand of Nordic countries where the fig is higher than $900 despite CIC – GDP at 4%.

(6)Drop in Prostitution

Ravi Shankar Prasad – has made a bold claim that flesh trade dropped due to DeMo since human trafficking from Bangladesh & Nepal fell due to lack of cash. Obviously, it is a qualitative assessment since no figs were circulated to support his moral claim. It would be interesting for the govt. to answer the query: With cash back in circulation would it lead to an upside in prostitution again & if so how does the govt. plan to tackle the same?

(7)Increase in PF & ESI

The govt. claims that lack of cash propelled firms to open bank accounts for workers – paid in cash till then – forcing them to make statutory declarations. There is an increase in 1.01 crore PF accounts & & 1.03 crore ESI accounts thereby creating a safety net. EPFO members increased from 8.55 cr. in Mar 2012 to 17.14 cr. by Mar’16 i.e  2.14 cr. increase annually; if so the 1.01 cr fig touted by the govt. (unsure if it is for the Nov’16- Mar’17 period ) period is in consonance with regular trends.

The opposition has attacked the govt. on the snafu broadly on the following issues

(1)Loss of Jobs

As per CMIE, 1.5 million jobs were lost during the period Jan-Apr ’17 based on a household survey; Industry association FICCI’s report supports the dire employment scenario.  Most of the companies in the BSE 500 have shown a dip in employee nos. except those in the pharma & auto sectors.

Post DeMo qualitative reports emerged from textile clusters like Tirupur, industrial clusters like Mayapuri in Delhi etc of about lack of cash availability leading to delayed / stoppage of salaries leading to employee absenteeism or worse still reverse migration back to villages. Supply chains were severely damaged because of payments to suppliers being delayed. GST transition ensured furtherance of the pain since the MSME’s were ill equipped to handle the filing requirements. India is constrained by the lack of data on the informal sector & it is therefore prudent to argue that the informal sector was more likely to be adversely affected due to DeMo than the formal sector.

(2)Increase in Imports

Mammohan Singh had attributed the increase in imports from China of 2.41 lakh crores in the first 6 months of the current year over the 1.96 lakh crores for the corresponding period of last year to the effect of the supply chain shock.

Conclusion

Indian economy growth rate dropped from 7.9% in Q1 2016-17 & continued its downward trajectory thereafter.  It is therefore reasonable to argue that the drop of over 2% by Q1 FY 18 was not due to DeMo alone;  With exports growing from Sept 16 & public investment front loaded, the drop in private investment & consumption could be the likely culprits along with DeMo.  Instead of pump priming the economy,  DeMo led to a further drop in growth rates to a low of 5.7% in Q1FY18 for which the govt. should be held liable.

India spent about 4500 crores (3420 cr last year vs 7965 crores  this year)  over the previous year in printing of additional currency notes & could have spent about Rs 13000 crores in transporting the new notes & carrying the old currency back to the treasury. The RBI paid an additional interest of 17406 cr on the additional deposits this year while it earned 506 cr last year on liquidity mopping up operations. Hence the RBI was constrained to reduce its dividend to the govt. by Rs 35000 crores this year (65,880cr last year vs 30,662cr this year). Even a very conservative estimate of 0.5% of GDP drop due to DeMo alone (75000 crore) which combined with the reduced dividend from the RBI amounts to about 1.1 lakh crores even while the opposition claims a range between 1.5-3 lakh crores. While the opposition have painted DeMo & GST as “twin blows” it would be reasonable to conclude that while GST is good for the economy despite teething troubles, DeMo was an ill thought out move.