Way back in 1720, during the historic bull market known as the South Sea Bubble, a scamster floated an Initial Public Offering for a company that was set up “for carrying out an undertaking of great advantage, but nobody to know what it is”. I was reminded about this epic offer document by the recent government obfuscations about the purpose of demonetisation – when the Indian government banned high-value Rs 1,000 and Rs 500 currency notes overnight on November 8, 2016.
On August 29, the Secretary, Department of Economic Affairs, said with a straight face that “demonetisation had achieved its objectives quite substantially”. Asked to elaborate, he said: “I don’t want to give a lecture on that.” A day later, Finance Minister Arun Jaitley blogged about the “larger purpose” of the exercise. These claims belong to the same league of chutzpah as that 18th century Initial Public Offering.
Meanwhile the BJP used its numerical majority to block the adoption of a report by a Parliamentary Standing Committee on Finance that condemned demonetisation in unequivocal terms. That report remarked that the exercise had led to losses of at least 1% of India’s gross domestic product, and caused unemployment.
The data, incomplete as it still is, suggests there have been no benefits and the losses are obvious. So, what was the purpose of demonetisation anyway?
The first justification was that it would drive black money out of the system. Respected economists said anything up to Rs 3 trillion or more would not be returned to banks, for fear of the taxman. That would mean a windfall in terms of reduced liabilities to the RBI, which could then pass on a huge special dividend to the government. Well, 99.3% of the notes have been returned, according to the RBI. Neighbours like Nepal, which still hold some demonetised currency, are demanding that India honour its commitments, causing some embarrassment. So, there could be even more currency returned.
The second justification was that this would somehow turn India into a cashless nation where everybody made digital transactions. That has not happened either. Cash held by the public and the cash to GDP ratio are both back to pre-demonetisation levels. The RBI Annual Report for 2017-’18 makes that quite clear. Households are now holding a larger percentage of their savings in cash, rather than parking it in banks, according to the RBI. Back in November 2016, I had wondered if demonetisation would affect faith in the banking system. This may indeed have happened if people are avoiding making bank deposits.
There would be ancillary benefits on the terror front, we were told. Stone pelting in Kashmir would stop. Terror funding would stop. Maoists would die of starvation. The (nearly negligible) number of fake notes in the system would be flushed out and the printing presses churning out fakes would stop functioning once the new notes went into circulation. Well, stone pelting continues in Kashmir, despite the heroic efforts of Major Leetul Gogoi. Maoist attacks continue. Terror incidents continue. There are also plenty of fake currency notes of the new Rs 2,000 and Rs 500 series in circulation.
We were also told that tax collections would rise as everybody would return black money to the banks and therefore would have to declare their income. It is doubtful if this has happened. Indirect taxes have seen a sea change due to the Goods and Services Tax regime, which kicked in on July 1, 2017, and it is hard to make an analysis of indirect taxes.
Net collections of direct taxes (post refunds) ran at 14% higher in 2016-’17 and at 17% higher in 2017-’18. Those are good numbers, and much better than the 8%-9% increase in direct taxes during the 2014-’16 financial years. But direct tax had grown at similar, or higher rates, in the 2009-’12 period. It is a stretch to say demonetisation is responsible.
Another justification was that more people would file tax returns. This happened last year but again, it is hard to say if it exceeded the normal since more people file returns every year due to simple demographics. Every adult needs a Permanent Account Number and every PAN holder files a return. (Many returns are zero-tax).
There are chances that returns filed this year may actually reduce. Last year, 68.4 million returns were filed by the last date of March 31, 2018. This year, the date for filing was extended to August 31, with a special dispensation for Kerala. Anybody filing after August pays a late fine of Rs 5,000 and receives no interest on refunds. Only 54 million returns had been filed by August 31. Nobody would like to pay a fine. So, there is some reason to believe that the number of returns filed will not exceed last year’s figure.
Damage to economy
The ill effects of demonetisation continue to be apparent. Some 100-odd citizens died while standing in queues to claim their own money. India went through at least two quarters of sub-par growth before the Goods and Services Tax shock hit the system. GDP growth dropped from 7.6% in the first quarter of 2016-’17 to 5.6% in the first quarter of 2017-’18.
The unorganised sector was hit hard and some of the ill-effects will not be picked up by official data. There are signals from the employment numbers of the Centre for Monitoring Indian Economy. They say that the workforce shrank, from 444 million in October 2016 to 417 million by July 2017, due to lower labour participation as people just gave up looking for work. Labour participation has now started expanding again but unemployment is up too. The Centre for Monitoring Indian Economy estimates that the current work force is at 428 million but the unemployment rate has risen to 6.4%, from 5.6% in July 2018.
We also have inklings of the damage to the informal sector from RBI statistics. Micro and Small Industrial Units connect to the informal sector, and stresses in the informal sector show up in these units. Non-Performing Assets from that segment have risen. Units with investments in plants and machinery of between Rs 25 lakhs to Rs 5 crore were covered in an RBI response to a Right to Information query. In March 2016, these units had Rs 9.52 trillion outstanding loans and Non-Performing Assets of Rs 74,000 crore – a Non-Performing Assets ratio of 7.8%. By March 2017, the numbers were Rs 9.8 trillion and Rs 82,000 crore Non-Performing Assets (a ratio of 8.3%). By March 2018, outstandings were Rs 10.5 trillion with Rs 98,500 crore of Non-Performing Assets (9.4%).
So what larger purpose did demonetisation serve? None that its defenders can articulate clearly. Looking back, it just seems like a madcap idea that the government is desperately trying to rationalise post-facto.
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