The announcement that shook the consumer
On November 8 demonetization will complete one year. It was a major happening that led to all round chaos and distress among citizens. Did it lead to gain or loss? Here Bhasker Assoldekar* writes that the rationale for demonitisation changed after a period of time. He says that, the drastic act is likely to bring long-term gains to the economy
A year after India’s demonetization there is still wide disagreement about the effect of the hitherto most daring announcement made by the Prime Minister, Narendra Modi in the national telecast on that fateful day.
Arguably, it was a time when the country was poised for a great economic success. It was the third-largest economy in the world. On November 8, with no advance warning two highest denomination banknotes, the Rs 500 rupee and Rs 1,000 note were demonetized rendering 86 per cent of the country’s currency invalid overnight.
Majority of the people were happy to witness such dramatic change and were happy to bear the pains of standing in the long queues. They felt it was worth since the government had taken the bold “clean-up process”.
There is no doubt, that the ostensible objective was a popular one: to root out corruption and illegitimate activity involving untraceable cash transactions which were having far reaching adverse effects.
As we are closing in on the one-year anniversary it is natural to reflect on the lessons of this policy move. The Indian experience would also hold powerful lessons for policy makers planning economic interventions in the rest of the world. Some of the most visible effects are that the GDP drop has been commendable. On the other hand, almost 25-30 per cent of the currency was expected to go out of circulation which didn’t happen. Joblessness increased in sectors such as agriculture, small units, unorganized sectors. And, the government lost revenue in the form of indirect taxes. There also was substantial fall in sale of cash based items such as jewellery, activities like tourism , spending at hotels and other luxury items.
So, what are the lessons learnt in the process? Are there any positives at all? The fact is that, demonetisation is not the end in itself. Rather, it is a conduit for India to become a less cash economy at first and a cashless economy later. More medium scale and small scale companies have now started paying taxes regularly. Overall more Indians have started paying taxes. It is also now easy for the government to track all the transactions which take place in the economy.
So, black market, tax evasion, illegal funding etc can be curbed and it appears, this move has its positive effect.
Cashless means more transparency. More transparency means more investor confidence in the economy. So, it will be an incentive for foreign investors. So we could certainly expect higher GDP growth in the next two fiscals. Then there is the jolt to the criminals who so far were counterfeiting the higher denomination currency. They now have to find new ways to do the same. We have been seeing its positive impact in J&K.
However, all policies have consequences. Tracing the paths of those consequences is seldom straightforward particularly when the impact is felt across a complex economy. In light of this, every economic policy ought to be preceded by some essential process elements, a sound theory and a rationale for why the underlying assumptions are valid. Together with evidence for those assumptions, cost-benefit analysis, including accounting for the systemic effects, unintended consequences and learnings from similar actions elsewhere. Such processes are not easy to do especially when high level secrecy needs to be maintained.
All policies have a stated objective of providing a public good. But every policy decision also involves trade-offs. There is invariably creation of a burden on some segments of society. A fact-based cost-benefit analysis is essential. Any policy ought to be able to pass a simple test: If the basic data on the economy in a pro forma assessment suggests that the policy runs a high risk of failure or has a major negative impact, stop and ask more questions before proceeding. Perhaps in hindsight, the government must be feeling they missed the bus.
The primary public good cited for India’s demonetization move was to take on the problem of corruption and illegal activity. Many commentators have commended the Indian prime minister for his “courage” in taking on such fundamental problems with bold action. This decisiveness was also popular and was rewarded politically by the strong performance of the Modi administration in crucial midterm regional elections.
However, in the case of India’s demonetization it is safe to assume that people have a strong incentive to not lose money. It is natural that they have found ways to deposit their invalidated cash in the banks. In Indian society not unlike in societies around the world there is access to money-laundering networks and creative schemes for getting around rules and regulations.
For an example of one such scheme people with large holdings of the old banknotes sold them at a discount to brokers who then distributed them across a network of other people to deposit smaller amounts at banks so that they would not trigger an audit.
India’s central bank, the RBI, recently reported that of the estimated 15.28 trillion rupees in currency taken out of circulation by demonetization almost 99 per cent had been returned to the banking system. The original argument for demonetization unraveled because of the strategy of leaving the holders of illegal cash stranded with useless banknotes appears to have mostly failed.
In India’s case, when it was becoming clear that the initial objective of leaving illegal cash hoardings stranded was failing the administration changed its narrative to a backup rationale. That demonetization was good for weaning the country off its dependence on cash and moving transactions to digital platforms, thereby leading to greater efficiencies, transparency, and growth of online commerce, thereby catapulting India more forcefully into the digital age.
I however have no doubt that despite initial hiccups, demonetization coupled with implementation of GST would bring many more long term gains( including much higher GDP than 7.6 per cent within a year from now) to the country than the short term pains felt during the last one year.
*The author is M.Sc.(Tech), MBA(IIMA, managing director of Vibha Natural Products Ltd., Mumbai
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