The problem with disruptive economic initiatives like demonetisation is that no one can really tell how much it has worked, and how much it hasn’t. This is because the disruption does not happen in a vacuum, where its impact can be isolated from the impact of other forces at work in the economy.
When PM Narendra Modi announced the withdrawal of high-value notes, several other disruptions were already underway: The Indian economy was already slowing down, with gross value added (GVA) falling in the first two quarters of 2016-17 from the peak of 8.7 per cent achieved in the last quarter of 2015-16. In the two quarters before demonetisation, GVA fell first to 7.6 per cent and then to 6.8 per cent.
If one were to assume the same rate of fall in the next two quarters where the impact of demonetisation was higher (October-December 2016, and January-March 2017), GVA should have grown at only 5.3 per cent in the second of those quarters. The actual rate of GVA growth in January-March 2017 was 5.6 per cent.
So, even though such linear mathematical logic does not work in a complex economy, the point is that the fall attributed to demonetisation could well have been a continuation of the same negative forces that were lowering growth in the previous quarters. We know what some of these forces were: Rising bad debt with banks, with non-performing assets crossing `7 lakh crore, weak growth in corporate profitability, and the Modi government’s attack on black money. All three were denting India Inc’s capacity to invest in growth.
However, this is too facile an explanation, and anecdotal and other evidence suggest that the informal sector, and farmers, were indeed impacted by the cash crunch. The only sensible conclusion is to accept that demonetisation impacted growth and incomes, especially in the informal sector. The doubt is over the extent of the impact. Some analysts like agricultural expert Harish Damodaran believe that the post-demonetisation cash shortage made the fall in vegetable prices—the cause of the Mandsaur farmer protests—worse than what might have been caused purely by oversupply after a bumper harvest. It is impossible to separate the demonetisation losses from those caused by other factors.
A better way to assess the success or failure of a measure like demonetisation is to assess it in terms of what were claimed to be its goals. We should also ask whether there could have been a more cost-effective way to achieve the same goals. If the cost of achieving those goals through demonetisation was higher than through normal means, then the gains are illusory.
One unstated goal was that a lot of the money won’t come back, and to the extent that happened, the Reserve Bank could have written off the liabilities and handed over a hefty dividend to the government. Figures as high as `2-3 lakh crore were mentioned in this context. But clearly this has not happened, and the RBI is yet to tell us how much money came back. So goal one has not been met.
The next stated goal was to curb tax evasion and expand the tax net. In his last Budget speech, Arun Jaitley gave us the following details: “During 8th November to 30th December 2016, deposits between `2 lakh and `80 lakh were made in about 1.09 crore accounts with an average deposit size of `5.03 lakh. Deposits of more than `80 lakh were made in 1.48 lakh accounts with average deposit size of `3.31 crore.”
These deposits add up to more than `10.38 lakh crore, or two-thirds of the demonetised notes outstanding. It is not clear if the bulk of the money came into corporate accounts, where they may be partially legitimate, or in individual accounts. If hope there is on the gains of demonetisation, it lies here.
The jury is out on this one, and the expansion of the base will be seen as a gain only if the expansion results in a sustained increase in tax revenues. Also, there is little doubt that expansion of the base can happen even without demonetisation.
A third gain from demonetisation is the rise in digital payments. Non-cash modes of payment are rising steadily even after cash came back to the system, and this is one major success of demonetisation. But once again, the question is the same: Was the big drop in GDP and loss out sales too high a cost to pay, when smaller expenditures incurred in promoting and incentivising digital payments could easily have been more cost-effective? Also, digital payments have seen a secular rise even before demonetisation, and it only needed a policy push to take off vertically.
The real big gains from demonetisation could flow over the longer term, but with more disruptions coming up, including the biggest one of them all, the Goods and Services Tax, we may never be able to tell which gains in the future can be attributed to demonetisation, and which to other factors.
In the ultimate analysis, it is fair to say that the costs of demonetisation are visible, but the gains are less visible or may even be non-existent in some cases.
But two gains cannot be denied—one tangible, one intangible. The flooding of banks with deposits has enabled them to bring down interest rates, enabling ordinary borrowers to lower the cost of their home and auto loans. It has cut the cost of government borrowings even without the RBI having to do anything. If, and when, India Inc is ready to resume capital investment, banks will not be short of resources. The consumption story is reviving, and capital spending will follow in due course.
Secondly, Modi has shown he can take politically bold decisions to turn the heat on black money holders. In future, no tax evader can presume that things can go on as usual. The biggest gain thus may be Modi’s demo of intent that sends a signal to tax evaders. He has put fear of god where it needed to be put.
R Jagannathan
Editorial Director, Swarajya
Email: thejaggi@swarajyamag.com