Chief Economic Adviser Arvind Subramanian has defended his initial reluctance to speak about demonetisation with a Buddhist saying: “Speak only when you can improve upon the silence”.

Nearly three months after it was announced, Subramanian broke his silence on the radical move in the Economic Survey, devoting to it a whole chapter, “Demonetisation: To Deify or Demonise?”

The heading is provocative, but the Survey has neither deified nor demonised demonetisation.

There are two views in the Survey on demonetisation: a forecast for the immediate impact of the cash crunch on the rate of Gross Domestic Product growth, and, in the chapter on India’s evolving economic vision, a political analysis.

Economic Forecast

The economic forecast is that the demonetisation will shave off anything between 0.25% to 0.50% from the rate of GDP growth this year (financial year 2016-17). Subramanian has subsequently emphasised that the estimate was arrived at on the basis of not the most rigorous analysis – the Central Statistics Office said it had no way of estimating the hit that economy would take. The choice being between giving a less thorough or absolutely no indication, he chose the former.

Other than this estimate, the Survey offers no definitive picture of the potentially destructive potency of demonetisation. The Survey predicts minimum, reversible damage: “There isn’t something necessarily permanent about this. Cash went out. You couldn’t transact. Maybe you borrowed a lot more. Cash comes back. It should recover back again,” Subramanian had told this writer hours after presenting it.

His assessment is that lasting destruction, if any, would mainly be in the informal segment of the economy, which will escape measurement. (In this context, at an Indian Express event earlier this week, he stressed the need for high-frequency official data on India’s informal sector.)

But, just as he expects no major setbacks to the economy, Subramanian is not particularly gung-ho about the gains.

The Survey makes it clear that it will be the follow-up steps that will determine the extent to which demonetisation will succeed in effectively curbing black money generation.

“There are two ways of interpreting this,” Subramanian had explained to this writer. “One is to say that we went after black cash. The other is to interpret it as a regime shift. We have shown you we can do this on demonetisation we can do this anywhere.”

The action steps necessary range from reducing stamp duties on land and real estate to making tax administration much more non-discretionary.

Markers of success

Subramanian listed at least four markers of success of demonetisation. These include the cash to GDP and the cash to deposits ratio, which is about 12%-12.5% right now. If it climbs down sustainedly that will be an indicator for saying that an illiquid form of savings stands converted to financial savings.

A steady and substantial increase over time in the baseline level at present of the number of income tax payers would be the second indicator.

A third marker of success would be real estate prices. A substantial drop would indicate the flushing out of black money.

The fourth marker will be the impact on the indirect taxes. An increase in registrations of tax payers, which will be a little more complicated measure because at the moment you have registrations for central excise, Value Added Tax and there will be the Goods and Services Tax.

These are clear indicators, but will have to be tracked for years before reaching any meaningful conclusions.

In the interim, would demonetisation nudge the middle class to pay taxes? Seems unlikely. The Survey offers deep insights into why there are such few taxpayers in India. About 7 per 100 voters, it estimates. This is discussed in the chapter on the evolution of India’s economic vision where it discusses the country’s dismal record of redistributing the tax money collected from the rich to the poor.

The state, it contends, earns legitimacy to redistribute through a demonstrated record of effectiveness in delivering essential services. The middle class will be unwilling to finance redistribution, Subramanian argues, unless it perceives that it would derive some benefits from the move. The US and Europe typically provided essential services – physical security, health, education, infrastructure etcetera – first, undertaking redistribution later, he writes.

Demonetisation is in effect a tax on illicit activities and those legal ones that were not disclosed to the tax authorities, and, therefore, is a redistributive device for transferring illicit wealth from the rich to the rest, via the government, Subramanian reasons.

And so, the well-known problems of leakages and poor targeting, essentially weak state capacity for delivery, will limit the redistributive potential of the demonetisation. “If subsidies have been an inefficient way of redistributing toward the poor, demonetisation could be seen as an inefficient way of redistributing away from the rich”. This is the dim conclusion of the Survey’s political analysis of demonetisation that takes a long-term, hence more observed, view.

In understanding the economy in general and demonetisation in particular, its value exceeds that of the estimate for the loss of GDP.