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Demonetisation was a massive, draconian, monetary shock: Arvind Subramanian

In his soon-to-be-released book, "Of Counsel: The Challenges of the Modi-Jaitley Economy", Subramanian has reportedly devoted an entire chapter to demonetisation

twitter-logoBusinessToday.In | November 29, 2018 | Updated 12:46 IST
Demonetisation was a massive, draconian, monetary shock: Arvind Subramanian

The latest person speaking out against Prime Minister Narendra Modi's surprise note ban announcement is former Chief Economic Advisor (CEA) Arvind Subramanian. He has finally voiced an opinion about the move that saw nearly 86 per cent of the currency in circulation at the time being invalidated overnight, calling it "a massive, draconian, monetary shock", IANS reported.

In his soon-to-be-released book, "Of Counsel: The Challenges of the Modi-Jaitley Economy", Subramanian has reportedly devoted an entire chapter to demonetisation. "Demonetisation was a massive, draconian, monetary shock: In one fell swoop, 86 per cent of the currency in circulation was withdrawn. The real GDP growth was affected by the demonetisation. Growth had been slowing even before, but after demonetisation, the slide accelerated," he penned in the chapter titled The Two Puzzles of Demonetisation - Political and Economic.

"In the six quarters before demonetisation, growth averaged 8 per cent and in the seven quarters after, it averaged about 6.8 per cent (with a four quarter window, the relevant numbers are 8.1 per cent before and 6.2 per cent after)," he added. While he claims not to have a strongly-backed empirical view he points to the fact that the welfare costs, especially on the informal sector, were substantial.

In the book Subramanian provides an inside account of his rollercoaster journey as the CEA to the government of India from 2014 to 2018. "With an illustrious cast of characters, this part-memoir, part-analytical writings candidly reveal the numerous triumphs and challenges of policymaking at the zenith, while appraising India's economic potential through comprehensive research and original hypotheses," said book's publisher Penguin Random House India. It will reportedly hit the shelves on December 5.

Though it has long been speculated that he was not consulted on the crucial decision, the news agency claims that Subramanian has continued to remain tight-lipped on the topic in his book.

According to the former CEA, the real debate is not whether demonetisation slowed growth, but about the size of the impact - whether it's 2 percentage points or less - since several other factors had affected growth in this period, especially GST, oil prices and higher real interest rates. " when a shock like demonetisation occurs, that primarily affects the informal sector, relying on formal indicators to measure overall activity will overstate GDP. This hypothesis goes only a small way towards explaining the puzzle since any squeeze in informal sector incomes would depress demand in the formal sector, and this effect should have been sizable," he reportedly said.

Extending other explanations, Subramanian said people may have found ways around the note ban with the possibility that the production was sustained by extending informal credit. Demonetisation, to a certain extent, may have also prompted people to switch from using cash to digital payments.

"Or, there may be other, completely different explanations that have eluded my understanding of demonetisation, one of the unlikeliest economic experiments in modern Indian history," he added.

Subramanian also makes it clear that from a political angle, demonetisation was an unprecedented, unique move - no other country in recent history had opted for such a sudden move in normal times, limiting the exercise to extreme circumstances like war, hyperinflation, currency crises or political turmoil, as in the case of Venezuela in 2016.

According to him, the BJP's victory in Uttar Pradesh assembly elections, so shortly after demonetisation, was widely seen as a verdict on the note ban. This suggests that the poor were willing to overlook their own hardships [from the exercise], knowing that the rich and their ill-begotten wealth were experiencing even greater hardship, which he poses could be seen as one answer to the demonetisation puzzle.

However, according to him, the above view that the costs to the poor were "unavoidable collateral damage" in the pursuit of a larger goal is not entirely convincing. After all, the collateral damage was, in fact, avoidable. "Understanding the political economy of demonetisation may require us, therefore, to confront one overlooked possibility - that adversely impacting the many, far from being a bug, could perhaps have been a feature of the policy action. Not necessarily by design or in real time, but in retrospect, it appears that impacting the many adversely may have been intrinsic to the success of the policy," Subramanian reportedly summed up.

Subramanian, who was appointed as CEA on October 16, 2014, for a three-year term and was given an extension last year. However, although his official contract was till May 2019, he resigned in July citing "pressing family commitments". He is currently a visiting lecturer of public policy at Harvard University's Kennedy School of Government and a senior fellow at the Peterson Institute for International Economics.

(Edited by Sushmita Choudhury Agarwal)

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