Demonetisation: Success Or Failure?

A critical look at Demonetisation and its effects

A critical look at Demonetisation and its effects
Since demonetisation has impacted the lives of every living Indian like no other move has in independent India, it is one of the most talked about topics, not just by politicians who may have vested interests in its success or failure, but by just about everyone else. A majority of the general public have supported it in the belief that it is in the long term interest of the nation, even as many of them also believe it has been badly implemented. Some are wondering if the future benefits are worth the current pain.

We will very likely know whether demonetisation was a success (to a reasonable level of confidence) only after a couple of years…

Media has built up huge expectations (like money being put into the accounts of Jan-Dhan account holders, IT relief for the middle class, etc), but the PM’s speech on December 31 didn’t present a ‘balance sheet’ of demonetisation nor meet any of these expectations.

While opinions of the economists have been generally unfavourable to the Government, the opinions of industrialists, bureaucrats, and educated middle class have been more favourable. TRP-conscious media, seeking instant views from experts and politicians, have not been too helpful in assisting people make informed opinions.

Given that demonetisation is ‘fait accompli’, there’s no decision to be made by any of us anyway (except perhaps those living in the 5 states going to the polls). We’re all only speculating whether it is going to be a success or not.

We will very likely know whether demonetisation was a success (to a reasonable level of confidence) only after a couple of years once we have an idea of how the economy has behaved post-demonetisation in the medium term, and how well the weaker sections of people have managed during this period.

We would have a moderate idea of the success (or otherwise) of demonetisation from the budget speech in February 2018, by which time the submission of IT returns for the year 2016-17 would have been over and the IT department would have known exactly how much additional taxes this move fetched compared to the IT returns that the Government would have realised had there been no demonetisation, if we ignore the court-contested cases.

All other talk at present is speculation, or worse, wishful thinking (on both sides), even when they come from the mouths of top economic experts.

We could have some idea by February 1, 2017 from the budget speech in the coming year, by which time the Government would have made an approximate assessment of the likely costs vs benefits. This would still not have exactly reckoned how high-value depositors would account for the large amounts of old Rs 1000 and 500 cash they deposited in their accounts, and how court cases that arise as a result would play out.

All other talk at present is speculation, or worse, wishful thinking (on both sides), even when they come from the mouths of top economic experts. It may be worthwhile to know what Philip Tetlock said about how good experts are at predicting the future in their own realms.  Rarely correct. Here are a few examples:

“The next generation of interesting software will be done on the Macintosh, not the IBM PC” said Bill Gates in a Business Week article in 1984.

Gates said this in a BBC interview: “[E-mail] spam will be a thing of the past in two years’ time.”

“I think there is a world market for maybe five computers.” Thomas Watson, Chairman of IBM, in 1943.

“Computers in the future may weigh no more than 1.5 tons.” Popular Mechanics, forecasting the relentless march of science, 1949.

“Who the hell wants to hear actors talk?” H. M. Warner (1881-1958), founder of Warner Brothers, in 1927.

“We don’t like their sound, and guitar music is on the way out.” Decca Recording Co. rejecting the Beatles, in 1962.

“Rail travel at high speed is not possible, because passengers, unable to breathe, would die of asphyxia.” Dr. Dionysus Lardner, Professor of Natural Philosophy and Astronomy, University College London.

Here’s one on economists themselves:

“Paul Samuelson and other Keynesian economists predicted that unemployment would soar when American soldiers returned from World War II, unless the Federal government continued massive deficit spending and price controls. The government, instead, reduced spending and removed price controls, and the returning soldiers found employment in a booming economy.”

I’m very optimistic. Since I’m no expert in economics, I believe I stand a better chance of being right. So, let me add to the speculation and say why I believe the positives of demonetisation have been under-rated, listing some of the benefits.

  1. The biggest benefit of demonetisation is the strong possibility of the Government turning the screws on a very large number of tax-evaders and income-under-reporters, making them cough up huge amounts of taxes (which could be more than a Lakh of Crores every year). This includes traders, professionals, and industrialists. Their numbers is likely to be very large, of the order of millions.

The cumulative value of these additional tax collections over the years will be huge, dwarfing the cost of the demonetisation exercise, which critics keep harping on.

Even if some of the big ticket depositors try to use our weak legal system to escape penalties, the Government would have identified them as suspect using big data analytics (already initiated); armed with this information, the Government can keep investigating them for many years, for their past misdeeds and potential future misdeeds, in possible every way (like accumulating black money in other forms like real estate, gold, foreign bank accounts/ property holdings, and other wrong-doings like hawala, money laundering, etc).

If some of them have made payments into the accounts of mules to whitewash black money, they may still be detected, and criminally proceeded against. Even if the chances of getting caught are low, they are taking a huge risk, given the possible imprisonment terms it entails.

  1. Another big benefit of demonetisation is stoppage of fake currency and even genuine currency flow for terrorism, narcotics and other illegal activities. A mis-projection that detractors of demonetisation make is that the amount involved in these activities is a very small % of the total money demonetised. We should see the damage these activities cause to the economy and the society rather than the exact amount of money involved in these activities. Many terror attacks are known to have cost the terrorists less than a lac of rupees. Looked from this angle, the benefit from demonetisation to the society is very large. However, unless the Government finds a way to substantially reduce entry of fake currency into the market and future fund flow into these activities, the benefit could be temporary. I hope the Government will do something substantive in this direction.

  2. Yet another benefit is moving the nation in the direction of ‘less cash economy’. This will lead to many further benefits, the main one being maintenance of record of money flow and substantial prevention of corruption (esp at the lower levels) and new black money into the economy. This will further facilitate implementation of GST minimising leaks. The additional realisation to the Government from GST on account of this step alone is also likely to be substantial, over the years, like in the case of IT.

  3. Property prices coming down making low-costing housing more affordable will be another major benefit. The Government may reduce stamp duty, thus reducing the cost of housing further, without losing revenue as the recorded sale value of properties will increase.

  4. Since banks are flush with funds, the interest rates on private and business loans are likely to come down substantially, which will increase industrial and trading activity, bringing down the cost of many products & services, benefitting the aam aadmi.

  5. Lower interest rates will make Indian products & services more competitive, increasing our exports.

  6. In view of increased availability of funds, banks and NBFCs will be able to lend more to MSMEs which are employment generators, giving a boost to the economy.

  7. More accounted money in circulation through banks is likely to lead to higher velocity of flow of money and hence higher growth and more jobs.

  8. Some believe that an insignificant windfall gain in the form of non-return of the demonetised notes has meant the failure of demonetisation. On the contrary, if the black money holders had not deposited their demonetised notes, the Government would have had no clue who they are and how much of black money they had, and the loss to the black money holders would have been one time. Now, since the Government has encouraged them to deposit by making the deal sweeter (50% tax and 25% deposit for 4 years), even if only as an afterthought, the Government knows exactly who the black money suspects are now since they have deposited the demonetised notes into their accounts; the Government can now scrutinise their past misdeeds and monitor their future acts, as they are potential black money holders.

  9. Yet another major benefit will be the ability to crack criminal cases since cash drawal of large amounts by itself would become a give-away, in times when cash drawals is substantially reduced. Where they resort to use of electronic transfer, the money flow trail will be the give-away.

  10. Post-demonetisation, since there is a growing realisation of the advantages of everyone becoming a part of the formal economy, a lot more of people, including the poor will have bank accounts and learn to transfer money electronically. This will lead to their financial inclusion and empower them hugely.

  11. Many of us may not know that our official GDP figures themselves are incorrect; the GDP we know of is only the GDP of the formal economy, the unknown being the GDP of the informal economy whether taxable or not. Much of the current confusion between the growth figures quoted by the Government and the critics is due mainly to this. The Government can plan better when it integrates the informal economy also into the formal economy.

  12. With the lack of availability of black money in the system, there will be less demand for luxury goods and hence more investment will go to serve the people at the bottom of the pyramid, thus improving the quality of their lives.

  13. With the lack of availability of black money in the system, there will be less scope for demand for donations and capitation fees for admission to professional colleges. And regulatory authorities won’t permit exorbitant fees for professional education. So, the cost of higher education will come down.

Some of these benefits will be temporary; the Government should ensure that black money doesn’t build up again. Critics who question the Government on demonetisation now didn’t question RBI and the Government why they had allowed 86% of the currency to be in the top 2 denomination notes for so long.

The Government is already working on additional measures like making political funding transparent, unearthing black money abroad, confiscating benami property, etc, which can all make the system cleaner.

Some argue that much of the benefits could have been accomplished even without demonetisation, or with better planning. Both these arguments are fallacious. Any other method would have improved things only slowly and organically. Necessity has forced many of us to change to digital ways. If demonetisation were done with better planning, many of the black money holders could have sensed it and converted their cash into other assets.

The Government is already working on additional measures like making political funding transparent, unearthing black money abroad, confiscating benami property, etc, which can all make the system cleaner.

A valid criticism is the increased possibility of identity thefts and frauds in the new digital economy, esp affecting the poor illiterates. BHIM, a unique Aadhar Enabled, finger-print based, Payment System, just introduced by the Government, will minimise if not completely avoid identity thefts and frauds as it is not based on password, mobile, card, etc but our own unique fingerprints.

Some of these benefits are stand-alone, not just for the immediate future but also for the very long term, and are adequate to justify this bitter pill, but if the Government takes additional follow up measures, the benefits are likely to be very huge, making it a case study in economic textbooks worldwide.

These benefits can’t be dismissed even by the best of economic experts as insignificant, despite a period of pain to every citizen. Nor can they claim that the costs of demonetisation are higher than these benefits. So, all things considered, I believe the benefits of demonetisation far outweigh the costs, and hard proof will come by starting from the ensuing budget, progressively over the coming years.

Note:
1. The views expressed here are those of the author and do not necessarily represent or reflect the views of PGurus.

Ganesan Subramanian

An Engineer-entrepreneur and Africa Business Consultant, Ganesan has many suggestions for the Government and sees the need for the Govt to tap the ideas of its people to perform to its potential.

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