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November 8, 2016: Notes Demonetised in India

On this day, three years ago, the government of India announced the radical economic decision of demonetization that invalidated designated bank notes of denomination Rs 500 and Rs 1,000. The exercise continues to be the fulcrum of India's socio-political discourse, with its supporters flaunting it as an anti-black money weapon, and the critics claiming that none of its objectives were met. The notes came to naught, but the debate on whether demonetization was a 'demon or deity' is still raging

What shook India on this day in 2016?
On 8 November 2016, India’s Prime Minister Narendra Modi announced that high value currency notes (Rs. 500 and Rs. 1000) would be withdrawn from the financial system overnight. He said it was part of a crackdown on corruption and illegal cash holdings.

The Reserve Bank of India (RBI) Press Release declared, “Government of India vide their Notification no. 2652 dated November 8, 2016 have withdrawn the Legal Tender status of ₹ 500 and ₹ 1,000 denominations of banknotes of the Mahatma Gandhi Series issued by the Reserve Bank of India till November 8, 2016. This is necessitated to tackle counterfeiting Indian banknotes, to effectively nullify black money hoarded in cash and curb funding of terrorism with fake notes.”

In one legal stroke, 86% of the cash in the country was extinguished overnight and a billion people were impacted. The public was given time till 30 December to exchange or deposit their old currency notes with banks. The government and the RBI imposed limits on withdrawal from banks and automated teller machines (ATMs).

The "great Indian demonetization" of 2016 will rank among the most impactful economic policy decisions of any country in recent history. Initially, specific exemptions were allowed for a few days and use of the old high-value notes was allowed at government hospitals, petrol pumps, and buying rail and air tickets, and so on.
In the weeks and months after November 8, 2016, Indians cutting across all lines — rich and poor, urban and rural — formed serpentine queues to deposit money and get hold of some precious but rationed cash for much-needed daily use. In a country whose economy was dominated by cash transactions, demonetization was touted as a drastic attempt to change the behaviour of Indians, moving them away from the use of currency notes towards electronic modes of transferring money. It was also an attempt to check black money by imposing what economists called a ‘one-time shock’ that would neutralise it.

In his speech on 8 November, Modi said the primary motives for demonetization were threefold - to eradicate black money, remove counterfeit currency, and stop terror financing. He embarked on a three-day state visit to Japan the morning after the announcement. By the time he returned, all hell had broken loose. 

Withdrawal symptoms
With about 86% of currency in circulation no longer legal tender, people’s lives were thrown out of gear as they queued up for new currency notes and to deposit old ones. The government and the RBI were unprepared to deal with the consequences. A Right to Information (RTI) query revealed later that RBI had just one-fourth of the Rs 20.5 trillion (lakh crore) worth stock of old notes in new replacement notes.

There were serpentine queues of people to withdraw their own cash from bank ATMs. Millions of families were left stranded with no cash. Weddings were cancelled, small shops downed shutters and economic activity was disrupted. There was a crisis of liquidity. Stand-up comics were writing new parody scripts.
The government soon unveiled a series of measures to encourage digital payments. It offered discounts on petrol, railway tickets, toll payments and insurance policies; asked banks to waive fees on debit and credit cards; told banks to install an additional one million point of sales (PoS) terminals in three months, and even introduced a lucky draw for digital payment users.
The RBI issued over 60 circulars on the rules pertaining to cash/withdrawal and deposits in the following weeks. Confusion prevailed across different walks of life.

Why were the consequences disruptive?
Things did not go according to the script. Within a matter of two weeks, "demonetization" was being repositioned from being an attempt to flush out undeclared wealth to a magic wand to turn a poverty-stricken nation into a ‘cashless’ economy. The bravado was admirable to some and laughable to others. Much attention has been paid to how demonetization slowed the economy down, and various anecdotal reports or surveys about how it caused joblessness.

Negative impact

Demonetization broke the back of the primarily cash-reliant rural economy, adding distress to mounting debts. The agricultural sector, which has perennially been behind in reforms and investment, started struggling for survival due to cash shortages, plunging demand and collapsing prices. Prices of potatoes, onions and tomatoes were half of what they had been a year before in January-February. While this was good for the consumers, the farmers were left poorer. The outcome was widespread suffering and farmer unrest in the states of Madhya Pradesh, Maharashtra, Gujarat, Tamil Nadu and Rajasthan.

The downturn spilled over to other sectors. A survey by India Development Foundation found that production took a hit, accompanied by fall in employment, wages and job losses in the two months after demonetization. In Mumbai, more than 50% of the power loom units were shut down, impacting around 300,000 workers. Around 1.5 million jobs were lost in the first four months of this year.

Surveys done by the Punjab Haryana Delhi Chamber of Commerce and IndustryAll India Manufactures Association and State Bank of India showed that the impact was between 50% and 80% on small and unorganized sectors. The RBI’s Annual Report stated that industry slowed down.

The immediate economic impact of demonetization was almost certain to be negative. PM Modi stressed on the fact that any short-term negatives were the hardships that were undertaken while cash in the system was brought back in.

Last year, Congress leader P Chidambaram, currently in jail over corruption charges, said that the Indian economy had lost 1.5 percent of GDP in terms of growth. “That alone was a loss of Rs 2.25 lakh crore a year,” he tweeted. The former Finance Minister, a vocal critic of demonetization, said this after the RBI released data on demonetization, saying 99.3 percent of notes were back in the system. “Over 100 lives were lost. 15 crore daily wage earners lost their livelihood for several weeks. Thousands of SME units were shut down. Lakhs of jobs were destroyed," Chidambaram said.

On top of this, little black money has been brought to light. Of the $240 billion USD worth of the notes removed from circulation, the government estimated that as much as a third would not be deposited in banks, implying that black marketers would junk their undeclared cash than risk being found out. But this didn’t happen. Almost the entire amount made it to the banks. The Income Tax department now has a tedious process at hand in trying to identify the shady deposits and nab the currency hoarders.
The RBI report said that nearly Rs 13,000 crore was spent in the span of two years to remonetise the economy. This also impacted RBI’s profit.This in turn led to lower dividend paid by the central bank to the government. In 2015-2016, the RBI paid the government Rs 65,876 crore. The amount came down to half, Rs 30,659 crore, in 2016-2017.
All in all, demonetization accomplished too little – if anything at all - while causing too much collateral damage. Demonetization was flawed from the start according to some, due to the following reasons:

Demonetization could not have eliminated black money since it was already well-documented by various research studies that only about 6% of illicit wealth in India was held in cash. So, invalidating 90% of the stock of currency notes to catch 6% of illegal wealth was a clear case of using a hammer to kill a fly.
The rationale of a crackdown on counterfeit notes was also misleading since India's central bank's own estimate was that fewer than 0.02% of all currency notes in circulation were fake. Counterfeit currency notes are a universal and perennial problem, which is best addressed through periodic design changes, not through demonetization.

The third reason cited by Modi for the drastic measure was that India's share of high value currency was inordinately large which aided terrorist financing. This is again mistaken and misleading. India's stock of high-value currency was growing in line with the GDP and the share of such currency in India's GDP remained constant at around 9% for half a decade. Further, there is no evidence that rising stock of high value currency had increased terror incidents.

When does the exercise make sense?
"I bow to the people of India for steadfastly supporting the several measures taken by the Government to eradicate corruption and black money. 125 crore Indians fought a decisive battle and WON."  ~ Narendra Modi, 8 November 2017

The many benefits of the exercise, as claimed by the government, include the increased taxpayers base, unearthing of many modules of black money in circulation, choking of the funding of anti-national activities in many parts of India, restricting the total value of high currency notes in India by 1/3rd, surgical strikes on the shell companies in India and increase in digital transactions in India.
Demonetization was designed to flush the system of the accumulated and hidden black money that tax evaders, nefarious elements, anti-national elements, hoarders and black-marketers had accumulated under political patronage. The move forced tax evaders to deposit their money in regular banking channels. On one hand, this reduced the amount of black money available for nefarious activities, and on the other, it allowed India to track and investigate suspicious movements of funds in bank accounts that do not match with the tax profiles associated with those accounts.

The charge that demonetization has failed to ‘fix’ the country’s problem of black money is an exaggerated point that is not really as stark as it has been made out to be. Originally, the hope indeed was that a substantial fraction of the unaccounted-for stock of money would be ‘extinguished’ as people would be hesitant to deposit their ill-gotten funds in bank accounts. The initial idea of withdrawing Rs 500 and Rs 1,000 notes was to prevent the use of these as a store of illicit wealth. Soon after the move was announced, however, economists led by Jagdish Bhagwati pointed out that this may not pan out.

It did not. And that’s alright because the message has been deliveredThe fear of demonetization is perhaps more potent than demonetization itself. The government declared its intent to render the hoarded cash to ash. Many got away, but many understand that they may not escape demonetization 2.0 if it ever happens.

Operation Clean Money was launched to nab offenders and it quickly unearthed several suspect transactions, including 14,000 properties of more than Rs 1 crore each, where persons have not even filed Income Tax returns. Officials also detected over 3 lakh-registered companies that were involved in suspected dealings, and registrations of more than 1 lakh shell companies have been cancelled.

Demonetization reduced the amount of cash available with the citizens, which in turn increased the bank deposits somewhere between Rs 2.8-4.3 lakh crore. If we assume Rs 3 lakh as the average figure and apply an accepted 6 multiplier, then demonetization created new lending capacity of Rs 18 lakh crore, which is 36 times India’s Central government allocation to primary education. After the introduction of demonetization, interest rates were lowered by 2 per cent. Expensive loans and the increasing cost of money in the country had been crippling India’s entrepreneurs.

With the introduction of demonetization came the 7.6 crore new monthly digital transactions. Demonetization exploded the number of digital payments on UPI/BHIM apps from 1 lakh in October 2016 to 7.7 crore in October 2017.

Demonetization served as a catalyst for 3 lakh crore new financial savings. In the eight months after note ban was introduced, the country saw mutual fund inflows of Rs 1.69 lakh crore (up 1700 per cent) and the three months after demonetization saw Life Insurance Premiums rising by 46 per cent. With greater financialisation of savings, a virtuous cycle for formal job creation was expected to start (it didn’t).

Demonetization was an effective countermeasure against anti-national activities such as funding of terrorism and Naxalism. The call traffic of hawala agents dropped by 50 per cent and even the incidents of stone pelting in Kashmir declined sharply post demonetization. It also reduced the menace of Pakistan-printed high-value fake currency notes.

Real estate prices came down and cheaper homes were made available under the Prime Minister's Housing Scheme, fulfilling the dreams of many to own their own homes.

Demonetization was not the panacea for all ills that years of corruption-laden governance has afflicted India with. It was, however, a major tool that, in combination with the other measures taken by the government at curbing corruption, could not only create a cleaner and more transparent economy, but also strengthen the economic fundamentals promoting more inclusive growth. Theoretically speaking, it kind of made sense. With the benefit of hindsight and data, it doesn’t anymore.

Where did the exercise go wrong?
“To break the grip of corruption and black money, we have decided that the five hundred rupee and thousand rupee currency notes presently in use will no longer be legal tender from midnight tonight, that is 8th November 2016,” Modi said. “The five hundred and thousand rupee notes hoarded by anti-national and anti-social elements will become just worthless pieces of paper,” he added.

There were three main targets initially announced by the prime minister in his televised speech. 1) Curbing black money in the economy in the form of cash 2) terminating cash-based corruption and 3) killing fake currency. There were also goals added later such as curbing terrorist activities where cash exchange is dominant, pushing digital transactions, widening the tax base and so on. Indeed, it is on those parameters that we must judge the success or otherwise of the unprecedented exercise.

Note ban did not kill unaccounted cash: As mentioned before, black money in the form of cash was only about 6 percent of the total stock, while the remaining was either in the form of real estate investments, gold or other assets. Hence, the idea that the note ban would kill unaccounted cash was a dud from Day One. Even the RBI directors hadn't agreed with the government argument that the note ban will help curb black money in a significant manner. "While any incidence of counterfeiting is a concern, Rs 400 crore as a percentage of the total quantum of currency in circulation is not very significant," they said. In short, there is no material evidence to prove that the demonetization has significantly reduced black money in the system.

New Rs 2,000 note finds itself in black money seizures: What about counterfeit notes? Fake currency notes worth Rs 28.1 crore were seized in 2017, which rose 76 percent from the previous year's mark of Rs 15.9 crore, according to the Crime in India-2017 report put together by the National Crime Records Bureau (NCRB). According to this report, the new Rs 2,000 note, released after the November 2016 demonetization, accounted for Rs 14.98 crore of the currency seized in 2017. This is logical because Rs 2,000 notes are easy to carry and hoard for crooks in the business of counterfeit notes.

Corruption and terrorist activity: The note ban was expected to take care of cash exchange for terrorist activities. But according to reports, such cases increased in the years 2016, 2017, and 2018, as compared to 2015. While 728 people died in terrorist activities in 2015; the number of casualties rose to 905, 812, and 940 in such activities in 2016, 2017, and 2018, according to the South Asia Terrorism Portal (SATP) data.

Spike in digital money: Digital payments spiked during the demonetization and in the immediate months after that. Since then digital transactions have gone up substantially, but so is the use of cash too. Cash in circulation has gone back to pre-demonetization levels. Hence, the impact on both digital and cash is neutral.
ITR filings go up but not tax collection: One of the factors used by the government to show the demonetization as a success was the increase in tax to Gross Domestic Product (GDP) ratio. This claim had some merit to an extent. The number of people filing income tax returns (ITRs) has gone up, which is good but not the tax collection. But the tax-to-GDP ratio still remains nearly half of what advanced countries have. The botched up implementation of the GST (Goods and Services Tax) added further woes to revenue collection.

So, India gained nothing out of demonetization. And what did India lose due to this exercise? The informal economy took a severe hit in the post-demonetization period. The GDP slowed down by more than 2 percentage points (the economy was already on a shaky path, note ban added to the woes), unemployment among cash-intense contract labor industry jumped and many small businesses had to shut down. To sum up, the major objectives demonetization sought to achieve have been missed; the pain the economy suffered due to note ban was way bigger than the gains attributed to the exercise.

Who remained unaffected by demonetization?
If India’s political parties are to be believed, demonetization is either really good or really bad. There is no middle. As India prepared for the general elections in 2019, the second anniversary of the demonetization exercise in 2018 became an opportunity for the Opposition parties to score political points against Prime Minister Modi.

"We would like to ask the prime minister about who is responsible for all this. The prime minister should take moral responsibility for this. Had it been any other country, the prime minister would have resigned. Prime Minister Modi should also have resigned from his post on moral grounds, but expecting that from him would be too much,” Congress spokesperson Randeep Surjewala said on the eve of the second anniversary.
Two years after the disruption, the battle of perception was still on. The issue was being used by the Opposition to needle the BJP-ruled government after the move to wipe out “illegal money” failed to reach its desired objectives. Demonetization, to be fair to those opposing it, could also be seen through the political prism. Indeed, having been announced months before the Uttar Pradesh assembly elections, it was also seen by analysts as having a clear political goal as well: to cement PM Modi’s image as an anti-corruption crusader. For some, it was even a move to drain out opposition parties’ cash chest ahead of the key elections in UP.

Whatever be the motive, the elections in Uttar Pradesh saw the BJP sweep the state in a landslide victory. Since then, however, the BJP had tuned down references to demonetization as one of its key policy steps. Its mention was even missing during the PM’s Independence Day speech in 2018. The Congress, meanwhile, looked to increase its attacks on the government, and even labelled the move as a “Modi-made disaster” and a “Tughlaqi fairman”. Its hope was that the people of India would ‘punish’ Modi for unleashing the demonetization demon. The Congress in 2018 held a nationwide protest demanding an apology from Modi to the people for “ruining and wrecking” the economy.

And then Modi won again. And his 2019 win was even bigger than his massive win in 2014.

When Modi ran for the top job five years ago, he campaigned as the country’s best hope for economic reform. The government he ran against, led by the Congress party, had mismanaged the economy, fallen into paralysis, and faced one major corruption scandal after another. Modi convinced voters that he was the answer to their economic woes. He spouted slogans like “minimum government, maximum governance” and promised that the “government has no business to be in business.” On the strength of such promises, he led his Bharatiya Janata Party (BJP) to a sweeping general election victory in 2014.

The Modi government made some important economic reforms in its first term. Following nearly two decades of debate, New Delhi adopted a sweeping indirect tax known as the Goods and Services Tax (GST), which economists liken to India signing a free trade agreement with itself. The GST, at least in theory, creates uniformity across state lines. Moreover, the government has pushed through an ambitious bankruptcy code, which is meant to facilitate “creative destruction” by making it easier for loss-making firms to wind down their operations.

But coupled with a global economic slowdown, Modi’s policies only managed to produce underwhelming growth, encourage little investment, and, according to a recent study, lose jobs at a time when India desperately needs to create jobs for its young workforce. The Modi government also committed serious sins of commission. Chief among these was “demonetization” — the abrupt invalidation of high-denomination currency notes in an attempt to cleanse the economy of untaxed cash, known as “black money.” As estimated by a Harvard study, the move cut India’s GDP by two percent and cost 1.5 million jobs. Economists are still assessing the damage inflicted by this radical policy — a difficult task given the scarcity of reliable data from India’s vast informal economy.

However, the faltering economy did little to undermine Modi’s 2019 reelection bid. A military standoff with Pakistan buoyed nationalist fervor, and as a result the BJP actually increased its parliamentary tally — making it the first non-Congress government in India’s post-independence history to win reelection. Millions of Indians saw Modi as decisive, muscular, and incorruptible, embracing his campaign slogan of “Modi hai to mumkin hai” (With Modi, anything is possible). BJP voters seemed to believe him when he reminded them that he could not undo 65 years of lackluster economic performance in one five-year term.
Modi faces a mounting economic crisis in his second term. India now needs the promising untested reformer that it voted for in 2014 to prove his worth before 2024.

Note“Tughlaqi Firmaan” is a reference to the quirky policy decisions of Mohammad Bin Tughlaq of the Delhi Sulanate. He ascended the throne in 1325 AD and ruled till 1351 AD. Tuglaq during his reign experimented with bringing upon many reforms in policies within his empire, including shifting of the capital from Delhi to Daulatabad for better administration and then relocating to Delhi from Daulatabad.

How do people assess demonetization today?
Around one-third of people surveyed recently think economic slowdown was the biggest negative impact of demonetization, while 28 per cent said it had no negative effects at all, according to a report.

Around 32 per cent of respondents believe note ban caused loss of earnings for many unorganised sector workers, as per the survey conducted by online community platform LocalCircles. The survey, with a sample size of about 50,000 respondents from across India, came on the eve of the third anniversary of demonetization.
Regarding the top benefit of demonetization, 42 per cent said it brought a large number of evaders in the tax net, while 25 per cent felt the move had no benefits at all. Interestingly, around 21 per cent respondents said note ban has reduced black money in the economy and 12 per cent said it increased direct tax collections.
Meanwhile, cash is back

Three years since demonetization, the level of cash with the public has grown faster than the GDP growth of the country, even as digital payments — especially those on the Unified Payments Interface (UPI) platform — have seen robust growth.
RBI data show that the public held ₹20.49 lakh crore in cash as of September 2019, the latest data available, which is 13.3% more than the figure for the corresponding month of 2018. The data show that the cash held by the public made up 96% of the money in circulation, with most of the rest deposited in banks. In December 2016, one month after demonetization and the enforced deposits in banks, this percentage stood at 83%.

Former finance secretary Subhash Chandra Garg who took voluntary retirement from the Indian Administrative Service (IAS) on 31 October, in a recent blog post, mentioned that currency notes of Rs 2,000 are being “hoarded” and can be demonetised without causing any disruption. Well…like we said before, the fear of demonetization is more potent than demonetization itself.



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