Demonetisation's crippling losses have quite clearly outweighed its small gains

Taking stock of the controversial move.

While announcing that Rs 500 and Rs 1,000 notes would no longer be legal tender from November 9, the prime minister had listed three objectives for the so-called demonetisation exercise: to filter out black money and counterfeit cash and crush terror funding. These objectives were undeniably laudable, but two months on, what has the exercise given us?

Initially, government sources had indicated that about Rs 5 lakh crore of the Rs 15.40 lakh crore extinguished currency would not come back to the system, ostensibly because this was black or tax-evaded money. This would be counted as the Reserve Bank of India’s bonus, which could be used to refinance public sector banks burdened with non-performing assets.

But that was not to be. Recent reports indicate that Rs 14.97 lakh crore, or almost 97% of the currency invalidated by the Narendra Modi government, has been deposited in banks as of December 30.

This, however, does not mean the objectives stated by Prime Minister Modi have not been realised.

Some gains

There is a good deal of tax-evaded income and counterfeit currency (used to fund terrorist activity) in the system. This first filtration, the demonetisation exercise, would have filtered out counterfeit cash.

Tax-evaded incomes will be targeted next, as large bank deposits from the usual suspects and unexpected sources will be scanned diligently. How much this will fetch the exchequer is not clear, but we can safely assume it will be a tidy sum.

In 2015-’16, the RBI had filtered out Rs 29.64 crore of counterfeit notes in circulation. The often-cited estimate is that there is about Rs 20,000 crore in fake currency – both locally manufactured and pumped in from Pakistan – in the economy.

These notes, if in circulation, will sooner or later be intercepted at the final stages of their life, when they come to the RBI for their obsequies. But a good part of these would have also been stashed away and we will never know how much of it will end up in the Ganga (where invalid notes were discarded after demonetisation, going by some reports).

This brings us to tax evasion, also a serious concern in India. According to the National Institute for Public Finance and Policy, the finance ministry’s in-house think-tank, the parallel economy is equivalent to about 68% of our Gross Domestic Product. Even if one dismisses this high estimate, other agencies such as the International Monetary Fund estimate it to be equivalent to about 20%-25% of the GDP. That means we are looking at a parallel economy of about Rs 30 lakh crore, which implies that the government is losing at least Rs 10 lakh crore in tax every year.

That’s a big amount and the country will benefit hugely if it comes back into the system – but the demonetisation exercise will not fetch even a fraction of it, largely because most of the undeclared income is metamorphosed into property, gold and foreign holdings, leaving only about 4%-5% as cash within the country.

According to the International Monetary Fund’s estimate of the size of the parallel economy, this would amount to Rs 1 lakh- Rs 1.5 lakh crore and going by the National Institute for Public Finance and Policy’s numbers, this would be about Rs 3 lakh crore to Rs 4.5 lakh crore.

There are now murmurs that about Rs 4 lakh crore that has flown into banks post demonetisation is undisclosed income, which is closer to the national institute’s estimates. This would yield tax gains of over Rs 1 lakh crore and after imposing penalties on this, the government will gain about Rs 2.4 lakh crore from unaccounted-for income that made its way into banks.

But this is going to be a one-time gain. Experience has shown us that tax evasion is bound to continue and there are only so many demonetisation exercises that one can endure in a lifetime. Taking such a move frequently will only diminish the credibility of the rupee and RBI. No government should keep risking that.

Crippling losses

So, for this one-time gain of, at best Rs 2.4 lakh crore, what did we lose?

The loss due to the unprecedented drop in production and income to the economy this year is now widely accepted by economists to be around 2% of GDP. This is almost Rs 3 lakh crore. The cost of printing new currency is expected to be about Rs 50,000 crore.

Then, there are human costs. India has a work force of close to 450 million. Of these only 7%, or 31 million, are in the organised sector, of which 24 million are employed by state or state-owned enterprises.

Of the vast reservoir of people in the unorganised sector, about half are in farming and another 10% each are in construction, small-scale manufacturing and retail. These are mostly daily-wage workers. The average daily wage in India is Rs 272, which means workers should be able to access a good part of it so that their families can escape starvation. These workers are paid in cash and at least 22 crore daily workers have suffered loss of work post-demonetisation, owing to the liquidity crisis. What is the cost of this? We are yet to find out.

The drought of cash has also impeded sowing and harvesting for farmers. This, in turn, has hit the trade of perishables like fruits and vegetables. The motorbike industry, for long the bellwether of rural prosperity, has also been affected. Year-on-year sales at Hero MotoCorp, the market leader and the world’s largest two wheeler producer, slid by more than a third in December. According to the research group Nielsen, fast-moving consumer goods, usually a reliable growth sector, have been hit harder.

Data released by the Centre for Monitoring the Indian Economy shows a huge fall in investment proposals post demonetisation. In the October-December quarter, firms received investment proposals amounting to only Rs 1.25 lakh crore, compared with an average of Rs.2.36 lakh crore worth of new investments per quarter since the Modi government has been in power.

Moreover, large volumes of new currency notes have again been found with individuals and corporations. Bureaucratic and political corruption is likely to go nowhere. The only palpable gain seems that high-value counterfeit notes from Pakistan have been choked, but this too is likely to pick up in time. Before long, it will be business as usual.

With the losses having quite clearly outweighed the gains, the government’s topmost priority now should be remonetise the economy fully. Unless this is done, growth cannot be restored and employment cannot be generated.

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