Mumbai, India – Never before has a word sparked as much controversy and discussion in India as has demonetization. Although more than 2 years have elapsed since the proverbial bolt from the blue, we continue to hear contradictory opinions on the subject. But what is the real analysis of this major economic decision? What are the facts and reasons that led to it? What did it actually do to the Indian economy? These are some of the questions this essay attempts to decipher objectively.
But before we go to “The Day “, 8th November 2016, when it was announced, it is imperative that we understand the prevailing economic atmosphere at the time, the facts and figures about the Indian economy that led to this seminal decision. To make it simple let me point out some data elements that are indicative of the “progress” of the Indian economy prior to demonetization in the table.
By 2014, black money in the economy had reached an all time high. This has multiple implications. Cash leaves no footprints and hence lacks transparency entirely. It can never be traced. The cash racket gets further impetus by and is easier to perpetuate because of higher denomination notes. The higher the denomination of the currency notes, easier it is to indulge in nefarious activities such as the financing of terrorism and illegal drug sales, not to mention the ease of untraceable bribery. Cash begets cash, driving a vicious cycle of the black market and as a corollary, the counterfeit currency market.
Considering the fact that the cash economy was flourishing and fueling the worst kind of economic fire by 2014, demonetization can be considered as the ultimate douser, a surgical strike of sorts. Terrorism came to a standstill. Fake currency and black money were reined in effectively. There was a drastic fall in malpractice in unorganized trading, real estate and the share market. Reserve Bank data revealed that the average HDN rise was 51 percent from 2004-2010 and 14 percent annually thereafter. Participatory Notes rose from 68000 Cr. in 2004 to 3.81 lakh crore in 2007. Two thirds of 500 & 1000 rupee notes that were issued never returned to the bank (~6 lakh Crores). This huge cash component started driving gold and land prices and participatory notes, stock prices. These are the infamous HAWALA transactions out of India.
You would wonder how such asset inflation led to so called “high growth”. Inflated asset prices got accounted for as part of income and large chunks of gains on stock all got added to GDP, with very little taxes, further escalating high consumption patterns, the annual values of which grew 18 percent till about 2010. This kind of asset inflation showed growth, but sans jobs, as clearly seen in table 1.
With the share of HDN growing exponentially, it is now amply clear that demonetization should have happened much before it actually did, but obviously not done by the previous government as it would have exploded the myth of their fake growth story. Had the Modi government not taken this phenomenal step, the black money market would have surpassed the GDP, reaching a point of no- return. It can well be said that the HDN out of the bank ambit found its way into land, gold and stocks, providing capital gains-led growth and consumption. Had the then government somehow routed the HDN through banks, by virtue of the fractional reserve model of banking, it would have multiplied at least 4 times. This would have served to not only reduce inflation, but by lowering interest rates, also funded small and medium scale industries in a big way.
Modi’s demonetization was an inevitable step towards the economic health of the nation. The deception of a fake growth story was unmasked. Beneficial programs such as Make in India, Skill Development, etc would have had to be aborted prematurely due to diminished banking flows. Demonetization reversed this trend. Additionally, there will be a revival of job growth in the future. Historically speaking, demonetization was certainly a huge risk in terms of political popularity. A courageous decision indeed; farsighted and without heed to short term discomfort.
Skeptics will still debate: was demonetization a monumental blunder? The other side of the coin is: did it undo monumental mismanagement of the past? The post-demonetization data suggests the latter. 18 lakh bank accounts (worth 2.86 lakhs crore) are being investigated as their history bellied these figures. An additional 5.6 lakh accounts are up for investigation. 3 lakh registered companies have been found to have suspicious transactions out of which 37000 companies have been identified, 2.09 lakh companies have been struck off, 163 companies have had their trading suspended and 1.06 lakh directors have been disqualified. Until recently, 400 benami transactions have been identified and 240 provisional attachments processed. Vigilance revealed that Indian vacationers spent $40 million and $200 million during Nov’15-Jan’16 and Nov’16-Jan’17 respectively and scrutiny is ongoing.
Significant improvement has been achieved with respect to taxes. After decades, the individual tax base rose by 20 percent. The Advance tax collections for 2017-18 rose by 42 percent and self-assessment tax (paid now for last year) by 34 percent. The tax to GDP ratio that was hovering around 7-9 percent, climbed to 32 percent. Demonetization worked as an effective tool to ensure that India is a better tax compliant country than before.
With demonetization, the total cash stock fell from Rs 17.1 lakh crore to Rs 15.1 lakh crore — a reduction of Rs 2 lakh crore (which otherwise would have touched Rs 22 lakh crore, an increase by Rs 4.9 lakh crore). Likewise, cash with the public fell by Rs 2.1 lakh crore (as against a rise by Rs 6.6 lakh crore), dramatically increasing bank deposits in the bargain, from Rs 97 lakh crore to Rs 114.2 lakh crore.
A whopping 221 percent increase in volume of bank transactions,118 percent increase in value and total savings in banks of Rs 4.5 lakh crore have all been hitherto unreached heights. Consequently, Housing loan rates dropped from about 9.8 percent to 7.6- 8.2 percent. The Personal loan portfolios rose from 4468 million to 3263 million in a year .The Housing loan portfolios grew to 9086 billion rupees from 8058 billion (growth of 19 percent in one year). With this the active EPF contributors went up from 3.7 crores to 4.5 crores. Some lesser known benefits have accrued – cashless payments at toll plazas were earlier 3 percent of total collection, are now 15 percent Similarly, such payments at petrol/diesel outlets have risen from 4500 crores to 12000 crores (20 percent rise). Debit card usage for 2015-16 was 117 Crore transactions (worth Rs 1.58 lakh Crores). This rose in 2016-17 to 240 Crore transactions (valued at 3.3 lakh Crores). Railway bookings online were 50 percent: now risen to 68 percent of total tickets booked.
In 2017-18, a massive 2 crore people have downloaded BHIM App. That and UPI payment gateways together average 140 Crore Rs a day .The data says that the Bhim App government transactions in Nov 2016 were barely 101 Crores, having surged to 7057 Crores by Oct’17. The usage of mobile-wallets like PayTm/ SBI buddy free-charge, is already touching 2000 Cr rupees per day. All this has improved traceability of transactions immensely. Credit card usage rose by 39 percent compared to previous year and by 77.4 percent compared to 2 years data (32.65 million credit cards to 26.39 million in one year).
Meanwhile, the compliance path became ever more vigilant. The Income Tax department sniffed out over 4,172 crores of undisclosed income, seized new notes worth 105 crores, carried out a total of 983 enquiry operations, issued 5,027 notices on charges of tax evasion, seized cash/jewelry worth over 549 crore, seized new currency (2000/- notes) worth 105 crores. About 477 cases have been handed over to agencies like the CBI and ED for further investigations for crimes like money laundering, disproportionate assets and corruption. They have so far scrutinized 18 lakhs accounts and are investigating cash deposits worth 2.89 lakh crore .The probe is leading to huge number of new suspected cases of black money.
Demonetization encouraged people to use more cashless transactions in day-to-day life which helped the banking sector to expand the business to rural areas quickly. Lower inflation, lower interest rates and lower budget deficits are likely to be the long term positive macroeconomic effects of this move, which has stimulated economic growth and benefited businesses in the region.
Other subtle benefits have emerged. Human trafficking activities declined significantly after demonetization; radical terrorist groups in India suffered a huge blow as their stashed away cash became worthless overnight. The Naxalites and Maoists surrendered in record numbers. Hawala transactions were also reported to have taken a hit, which was particularly helpful in attenuating crime.
The Indian economy which was cash rich and non tax compliant by default for decades has metamorphosed into an environment where E-commerce is a new industry that is nothing short of a revolution. E- commerce has numerous social benefits for a country like India where infrastructure is still in the making, complementing our basically low budget economic scenario, as the cost of running an e-commerce business is very low, doing away with substantial rents, simplifying business processes and requiring less man-hours.