So what was the real reason behind demonetisation? That question has cropped up once again now that the Reserve Bank of India (RBI) annual report shows that 99.3 per cent of all the high value currency notes that were demonetized was deposited back, and with various government spokespersons rushing to babble out fresh reasons to explain that it was not a complete and utter failure. The remaining 0.7 per cent cash that has not come back would probably have returned as well if the RBI had allowed them to be given back - it actually turned away many people who came to deposit the cash back by changing the rules, despite Prime Minister Narendra Modi's initial promise that everyone would be allowed to return money within the stipulated time and even the finance ministry advertisements that promised the same.
Obviously even the government knows that demonetisation was a big failure. The Prime Minister was careful not to mention it while touting the long list of achievements of his government during his Independence Day speech. The RBI report itself was released quietly, and initially only a few government spokespersons tried to defend it once the report was released. (They are still trying to do it, though few of their reasons sound convincing).
The problem is that two big objectives that the Prime Minister had touted in his late evening speech - about catching black money and weeding out fake notes - have been less than successful to say the least. The fact that the new currency notes were not all that counterfeit-proof is apparent from the RBI report which talks of the amount of new, fake currency seized already. Ditto for black money - yes some was probably caught and some probably came back to the government through higher tax paid on deposits, but the amount was nowhere near the windfall gains that the government hoped for. (S Gurumurthy, co-founder of Swadeshi Jagran Manch, a recently nominated board member of the RBI, and the person who apparently came up with the idea of demonetisation had said that as much as 20-40 per cent of the demonetized cash would not come back to the RBI, resulting in windfall gains to the government. It is obvious that his calculations were way off). Neither is the number of new tax assesses enough to justify the pain of demonetisation. There were plenty of other tools available to bring non tax payers into the tax net.
Later justifications about the real benefits of demonetisation - ranging from a cash less (or less cash) economy to hitting terror networks have also proven to be far-fetched. The RBI report shows that people are again keeping a lot of their savings in cash. Digital transactions have gone up - but hardly enough to justify a drastic measures as demonetisation which slowed the economy.
As most economists, who were not ideologically committed to defending everything the government did, had pointed out, the timing could not have been worse for the drastic step. In an environment when the economy had already started slowing down, it caused a plunge in the GDP growth - which far outweighed any little tax gains the government accrued for the enormous pain and suffering it caused. (Actually it can be argued that there was never a good time for a step like drastic demonetisation which slowed growth and caused misery to people without any commensurate returns).
In fact, I suspect the government had figured out that demonetisation was a disaster pretty early. Which was why there was a rush to justify its benefits, which seemed to keep changing by the day, as did the rules for deposit and exchange of notes. That was why a number of silly statements were also made. One otherwise sensible gentleman said that demonetisation would stop Kashmiri stone pelters on their tracks because terror financing was hit. Another eminent politician said prostitution had come down because of the sudden cash shortage hence it was a good thing. And there were many such other benefits that were used to justify the long queues, the lost productivity, and the misery of the informal economy and even the job losses.
I suspect the government also knows that the disruption caused by the initial chaos surrounding the introduction of the Goods & Services Tax (GST) - which is easily one of the most significant reforms carried out by this government - would have been borne better by the SME sector if they were not already reeling from the blow of demonetisation. (A RBI report shows that SMEs were hit by a double whammy - first demonetisation hit credit flow, and then GST hit their exports).
Even though growth is now recovering from the disruptions of the past two years, and this government has actually taken a number of significant economic reforms which will help in the long term - GST and the passing of the Insolvency and Bankruptcy Code (IBC) - being the two biggest, I think that this five year period of the Modi government will always be defined by the ill thought out and ill planned demonetisation of 2016 for a very long time. If the Prime Minister had not unleashed it on an unsuspecting populace, his economic growth record would have been far superior to what it is now.
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