The Indian economy is back to cash transactions, and at a greater scale than pre-demonetisation levels. Was there any justification for the exercise at all?

• Over two years since the announcement of demonetisation by the Modi government, currency in circulation has crossed levels seen before the exercise.
• This flies in the face of the government’s claim that demonetisation has boosted the digital economy in India
• While it has little to show in terms of positive impact, demonetisation had a devastating impact on the informal sector.
• To the Modi government’s credit, GST compliance may improve with time and increase formality in the Indian economy, but that does little to justify the demonetisation exercise.

On November 8, 2016, Prime Minister Narendra Modi announced demonetisation, as a grand exercise to eradicate black money from the Indian economy and bring in a digital payment revolution. Two years hence, the government is still struggling to explain the benefits of the announcement, which invalidated around 86% of India’s currency in circulation overnight.

This is especially true because report after report released since then has surmised that the negatives due to demonetisation have far outweighed the positives. The latest in this context is a report which indicates that the cash is back with a bang, within just over two years.

Data from HSBC Bank indicates that currency in circulation (CIC) reached a new peak of Rs 20.65 lakh crore on January 18, 2019 – way above the pre-demonetisation levels of Rs 17.97 lakh crore. This would mean that the government’s claim that demonetisation boosted the digital economy is also on a sticky wicket as people seem to be back to cash transactions. The RBI Annual report for 2017-18 also revealed earlier that 99.3% of the banned currency had returned to the banks.

So what did the exercise achieve after all?

A STRIKE ON THE INFORMAL SECTOR?

The Modi government stalled a parliamentary panel report on the Demonetisation exercise, feeding into Opposition rhetoric that they want to now distance themselves from it. But global economists have analysed the after-effects very closely. Former Chief Economic Advisor Arvind Panagriya has himself called demonetisation a draconian move.

Harvard professors Gabriel Chodorow-Reich and Gita Gopinath (now chief economist of the International Monetary Fund), wrote in a paper that demonetisation’s impact was equivalent to a tightening of the key policy rate by 2%, and it brought down economic activity by 3%. While it was not visible in national GDP figures, the problem is that these numbers did not capture the impact on India’s informal economy.

The implementation challenges brought tremendous discomfort to Indians, as new currency notes took their time to arrive. It deeply affected the lives of a lot of people who weren’t necessarily linked to black money. Over a 100 people died in the immediate aftermath of the announcement.

However, this was just the beginning. Instead of hitting the black economy, demonetisation struck the informal sector, which included farmers and small businesses, since they were highly dependent on cash transactions. A number of businesses shut down altogether or laid off workers.

Economists estimate that the exercise literally crippled the job sector in the country. A survey by Centre for Monitoring Indian Economy (CMIE) claimed in October 2018 that around 3.5 million jobs evaporated due to demonetization. It also had a deep impact on the labour force, as the number of people looking for jobs dropped by 15 million.

By the end of 2018, CMIE has estimated that 11 million jobs were lost, primarily due to the dual impact of Demonetisation and GST. A draft NSSO survey which was not released and led to the controversial resignation of two officials estimated that unemployment in 2017-18 was at a 45-year high of 6.1%, nearly thrice the figure of 2.2% in 2011-12.

GST WAS NECESSARY, NOT DEMONETISATION

To add to these grim statistics, the surge in cash indicates that the informal sector is back on its heels in the Indian economy. Pranjul Bhandari, Chief Economist, India, HSBC, commented in a report that the acceleration of CIC since late 2017 is happening due to a leakage in the banking system. GST has not been able to improve tax compliance so far, according to the report.

Another economist Soumya Kandi Ghosh has a different view, “It is a matter of debate whether currency in circulation implies more cash usage. This is because there has been a decline in velocity of money implying that fewer cash transactions are being made.”

Deposit growth has also been weak at 4.9% compared to 8.2% rise in credit during FY 2018-19 (upto January 2019). This makes it difficult for banks to cut interest rates.

As compared to 11.9% on the eve of demonetization, the CIC -GDP ratio is expected to reach 11.4% by March 2019, and is further projected to rise to 11.6% by March 2020. Bhandari expects the ratio to get better as GST compliance improves.

Critics tend to often speak about demonetisation and GST in the same vein as the Modi government’s greatest failures. If we DKODE the two, GST is an extremely critical reform in which teething problems were expected. But demonetisation was a poorly conceptualised and badly thought out exercise, which did not have happpened at all.

On the other hand, it has led to some serious and unintended consequences, which the Modi government would like to gloss over. But the opposition would surely not let them do so in the run up to the upcoming Lok Sabha elections.