Understanding Demonetization in India

A Deft Stroke of Economic Policy

Shrawan Kumar Singh

• Publisher: Business Expert Press
• Year: 2019
• Print ISBN:
  9781949991055
• eBook ISBN:
  9781949991062
• Topic: Economics
• Subtopic: Banks & Banking
• Index: Economics

This book examines the very concept, history, critique, and impact on the overall economy and black money, the move toward less-cash economy and digitalization, government–RBI relations, along with an assessment of two years of demonetization.

Demonetization has created a severe macroeconomic shock. The measure was humungous in scale and led to a sharp contraction in money supply for a short period. Although demonetization's proponents have contended that it would cleanse the economy of black money and make transactions more formal and digital, its implementation certainly could have been better. The effects of demonetization on the Indian economy are debatable and will vary by sector. Its effectiveness will be talked about and studied by economists and policy makers for decades to come.

Demonetization has made only a minor dent in the GDP. It has helped to bring more people into the tax net and has reduced the size of the informal economy. With the increased use of digital payments, economic transactions become recorded. This book examines the very concept, history, critique, and impact on the overall economy and black money, the move toward less-cash economy and digitalization, government–RBI relations, along with an assessment of two years of demonetization. It would be prudent for the government to focus more on proper institutional reforms to address the issues originating from demonetization.

CHAPTER 1

Introduction to Demonetization

Demonetization is an act of canceling the legal-tender status of a currency unit in circulation. India is not the only country to introduce demonetization, and it is not the first time India has done so. Countries across the globe have used demonetization at one time or other to control certain ailments in their economies. Demonetization is an extraordinary experiment in economic policy that raises social, political, and ethical questions. There are criticisms of and counterarguments to this move by the government.

Every economic policy has certain consequences, and predicting those consequences is not an easy task. Therefore, every economic policy needs to take into account some basic considerations, including

I.	A sound theory;
II.	A rationale underlying assumptions and the evidence for those assumptions;
III.	Cost–benefit analysis, including accounting for systemic effects;
IV.	Unintended consequences; and
V.	Learning from similar actions elsewhere.

Such processes are complex and must be guided by experts in economics, business, and technology coupled with experts in policy execution. The Indian experience holds four lessons for policy makers. There should have been a clear process for receiving professional expertise, data, and analysis and a mechanism for debate and discussion of the assumptions and the impact. In this context, it is important to remember that every policy decision involves trade-offs. A fact-based cost–benefit analysis is essential (Chakravorti 2017). The impact of a policy decision of this magnitude would take years to play out. But the move would still lay the foundation for a better tomorrow if the government followed up with some measures.

Delivering the I. G. Patel Memorial Lecture in December 2006, Dr. Manmohan Singh had opined that “economic policy-making has always involved political choices since it has political consequences. . . . It was not enough that the arguments were intellectually consistent or were mathematically tested. In a democracy, such choices had to be also politically defendable and acceptable” (Singh 2006). The effectiveness of policies ultimately depends on what people want, what they believe, and what they know about their environment (Chakravorti 2017).

From a macroeconomic perspective, the interplay of demonetization in relation to its targets and objectives is complex. A single policy instrument is deployed as a one-shot, unanticipated shock to attain multiple targets with its possible structural implications (Kohli 2018). Raghuram Rajan, in his book I Do What I Do, reveals he was against the idea of demonetization. Policies ought to be accompanied by a theory about the expected impact of the policy intervention. This translation mechanism itself relies on the assumption about how real people behave in response to a change in their environment. Advocating the abolition of physical currency in advanced economies, Prof. Kenneth Rogoff (2016) expressed reservations about the government’s methods, stating that a more gradual phase-out of the large-denomination bills would have had a much less disruptive impact on an economy in which more than half of the population is unbanked. There were many problems with implementation that made this move fall short of expectations. There was a need to have almost a military-style remonetization effort.¹

A lot has been written about demonetization, some of it on partisan lines. As with many major government programs in India, it was the prime minister himself who announced demonetization and acted as the policy’s main advocate (Beyes and Bhattacharya 2016). Since then, demonetization has been the most discussed topic in the country. This is going to be a pain for forthcoming gain. This move will prove historical and the first bold step toward the need for a better understanding not only of the black economy but also of how the economy works, particularly the informal sector. Demonetization is a fundamental corrective to the economy, much like economic liberalization was in the early 1990s. With 86 percent of a country’s legal tender becoming illegal, it is but expected that finding “a new level of equilibrium” would require time (Kapoor 2016). Demonetization has changed India, its people, politics, and the money game. India will be analyzed in terms of “before demonetization” (BD) and “after demonetization” (AD).²

The term demonetization has become much more than a household name. Demonetization is a generation’s memorable experience and is going to be one of the economic events of the time. India’s economic policies have always been unique and contextual. Almost everyone seems to have a view on it. The best and the brightest in the Indian economic firmament have also spoken, and some of them have taken rather hard positions (Nayak 2017b). There is no doubt that demonetization seemed like a political watershed. It is expected that a disruptive economic policy intervention will have some negative consequences in the short run. The stated objective of demonetization was to reduce the size and scope of the black economy, to increase digital transactions, and to bring all economic transactions into the open. The unstated objective was equally important: to create a new political discourse around economic reform and engage civil society in that process. It is now possible to suggest that all these objectives were met in different degrees. That the economy, or some sections of it, suffered a slowdown is the negative consequence against which the gains have to be measured (Baru 2017).

Demonetization has not been successful in achieving its publicly stated objectives. The efforts to digitize the economy extended to hard-to-reach populations. Far from curbing the black money, it has inflicted avoidable hardship on farmers, daily-wage laborers, and informal enterprises used to transacting in cash. Policy makers should be aware of the challenge of making everyday purchases cashless. The implementation of any policy in India remains a problem because it is the most diverse and populated country in the world.

Political Gambling

Speaking to the Bharatiya Janata Party (BJP) members of Parliament (MPs) on December 16, 2016, the prime minister condemned the behavior of the opposition parties in Parliament, saying that while the government is working against corruption and black money, the opposition is defending the corrupt. He repeated this argument less than a month later when he was speaking at a conference in Bengaluru and called opponents of the policy “antinational” and “political worshippers of black money” (OECD 2016). He positioned himself as a strong leader willing to take bold decisions and committed to societal change. An even more powerful argument that the prime minister employed, however, was appealing to the patriotic sentiment, highlighting that the people of India had “made the world stand up and notice [their] historically inherent qualities of sacrifice, discipline, understanding and commitment to the nation” (Chengappa 2016).³

Many opposition parties specifically targeted the prime minister personally, alleging that demonetization was aimed primarily at undermining the opposition funding and, in turn, benefiting the BJP in the upcoming state-level elections. They also alleged that the information about the upcoming policy had been selectively leaked to key members of the BJP and their affiliates in the corporate sector. The evidence brought forward by the opposition during a seven-hour parliamentary debate to support their allegations, however, was largely anecdotal and appeared aimed at achieving political gains rather than making a credible argument for increased integrity in policy-making and governance. Public opinion on the policy became increasingly polarized. A large part of the country’s population continued to support the initiative, hoping it would penalize “rich criminals” and “hoarders of illegitimate cash” (Beyes and Bhattacharya 2017).

Critics were disappointed because demonetization had no political fallout but entailed a very significant cost to the economy. There was a fall in the growth rate of the GDP, and jobs were lost in the informal sectors of the economy that were choked of liquidity. Ordinary citizens wasted time and energy standing in queues to get their own money back from the banks. Then there were the direct costs of printing new currency notes, distributing them, and recalibrating the banks’ ATM machines.

Demonetization was ham-handed and riddled with avoidable administrative glitches. With some prominent exceptions, economists across the ideological spectrum were broadly negative about the move as an economic policy. Civil society groups also contended that the “war on black money” narrative was being used to forcibly and prematurely integrate rural India into techno-financial systems, not to fight corruption (Pandit 2016). Others raised doubts on the efficacy of the policy, noting that demonetization would not affect the holdings of those whose assets resided in tax havens, gold, or real estate (Beyes and Bhattacharya 2017).

The government took the battle to the opposition on the issue of demonetization. There is a big difference between the government and the opposition party on acting against black money. The BJP has taken a stand against black money, celebrating November 8, 2017, as anti-black money day, whereas the opposition parties observed it as a black day. The message to the people is clearly that the BJP wanted to end black money but that the opposition parties are only trying to claim political mileage.

The Congress party dubbed the demonetization initiative as “India’s biggest scam.” Further, the economic disruption adversely hit the job market. None of the objectives spelt out by the rolling out of the demonetization drive were achieved. According to critics, the demonetization exercise was a sheer failure. The campaign against black money and corruption was a nonstarter as it failed to acknowledge its source in the funding and functioning of political parties (Vembu 2017). Despite the official claim that stone pelting and protests had been reined in Kashmir, violence took place almost every day, with frequent encounters between the militants and the security forces.

According to the 2017 to 2018 Annual Report of the Reserve Bank of India (RBI), the total value of

15,417.93 billion specified bank notes (SBNs) demonetized currency worth

15,310.73 billion returned to the banking system. This means that almost all the cash (99.3 percent) has been deposited back in the banks. Initially, the government expected

3 to 4 lakh crore of black money to get extinguished outside the banking system post the demonetization exercise.⁴ This led to a severe attack on the government from critics over the purpose of demonetization. The government countered that just because the money was back with the RBI it did not mean that black money hoarders had not been held accountable. With new bank deposits, a paper trail was created.

According to a survey by the C-Voter, the combined firepower of the opposition, media, tax evaders, black marketers, and intellectual apologists amounted to less than 20 percent disapproval of the scheme on demonetization.⁵ However, the critics dismissed this survey by questioning the authenticity, methodology, and sample size. In its defense, the government argued that demonetization had to be planned on a need-to-know basis so as to avoid leaks. Secrecy and decisiveness were crucial to the success of the exercise. The object of the exercise had not been confiscation. The generation of black money in future would not vanish but would be more difficult. ...

Table of contents

• Cover
• Halftitle Page
• Title Page
• Copyright Page
• Abstract
• Contents
• Preface
• Acknowledgments
• Chapter 1 Introduction to Demonetization
• Chapter 2 Functions and Importance of Money
• Chapter 3 Demand for Money
• Chapter 4 Supply of Money
• Chapter 5 Relationship between Money and Prices
• Chapter 6 Demonetization in Other Countries
• Chapter 7 History of Demonetization in India
• Chapter 8 Recent Demonetization of Indian Currency
• Chapter 9 Demonetization in India: A Critique
• Chapter 10 Impact on Indian Economy
• Chapter 11 Demonetization and Black Economy
• Chapter 12 Demonetization as a Move to a Less-Cash Economy
• Chapter 13 Relation between Union Government and the Reserve Bank of India
• Chapter 14 The Ongoing Debate and Political Economy
• Chapter 15 An Epilogue: Two Years Later
• References
• About the Author
• Index