Tuesday, 5 September 2017


 -*Dr. S. Vijay Kumar
           Prime Minister Narender Modi’s in his election campaign in 2014 promised Rs. 15 lakh would be credited into the bank accounts of every citizen by brining black money from Swiss Bank. But, it became a joke. Before forgetting this joke, on November 8th 2016 Prime Minister Narendra Modi, in a surprise abolished Rs 500 and Rs 1,000 notes overnight in a bid to end black money in the country. They constituted 86 percent of India's currency in circulation at the time. The government replaced old Rs 500 notes with new ones, but no replacement for Rs 1000 notes has been made. Instead, a new Rs 2,000 note was introduced post note ban. Besides, new Rs 500 and Rs 2000 notes, the RBI has also printed new Rs 200 notes and released on 25 - 06- 2017. Now, let us try to analyze the results, whether the recent demobilization in our country is successful or a failure? 
Impact of  Demonetization - Facts and Analysis:
·  On 30 August 2017, the RBI annual report published that people had returned Rs 15.28 lakh crore of the Rs 15.44 lakh banned currency or 98.96 percent of the scrapped Rs 500 and Rs 1,000 notes to the banking system. After announcing the demonetization of currency notes, it was said the government estimated at least Rs 3 lakh crore would not return to the system. This would mean an equal amount black money would get extinguished and liability of the RBI would reduce. But, the results are quite disappointing, 99% of banned notes back in banking system ,thus the very purpose of  the demonetization  is being defeated giving a scope  that demonetization helped to convert black money in to white. The common citizen supported the demonetization move admirably, but the ground realities are different.
·     The Reserve Bank of India on 30 August, 2017 confirmed that 8.9 crore old Rs 1,000 notes out of 632.6 crore have not been returned post the note ban last November.
·   ‘Unusual’ cash deposits totaling Rs 1.6-1.7 lakh crore were made during the demonetization period.
·       Only 1%  i.e. Rs. 16,000 crore did not return to banks.
· Demonetization was a failure because the government succeeded in impounding or confiscating just 1 percent of the banned currency.  The real success is the mainstreaming of the unorganized and the subterranean economy
·        Money in circulation in 96% , 86% demonetized.
·        Estimated, Rs. 4, 500 black money.

·        According to RBI report the cost of printing of currency notes more than doubled to Rs 7,965 crore in 2016-17 from Rs 3,421 crore in the previous year on account of new currency printing. The net transfer of profits to the Union Government as a result have fallen drastically during this year by 53.5 per cent. "In the current case, there is a seigniorage loss (profit made by a government by issuing currency, especially the difference between the face value of coins and their production costs), as the face value of Rs 15.28 trillion of Rs 17.1 trillion has been printed," it said.

·        Demonetization and GST Bite - Data released by the Central Statistics Office (CSO) on 31/08/2017 showed the economy grew 5.7% in April-June 2017, the first quarter of the current fiscal year, slower than the previous quarter's 6.1% and much lower than the 7.9% growth registered in the first quarter of 2016-17. India's April-June growth of 5.7% is below China's 6.9% expansion during the same period and puts pressure on policymakers to unveil measures to revive the economy.

·     Detailing the impact of demonetization on currency composition, the RBI said that the value of banknotes in circulation declined by 20.2 percent over the year to Rs 13.1 lakh crore as of end-March 2017. The volume of banknotes, however, increased by 11.1 percent, mainly due to higher infusion of banknotes of lower denomination in circulation following the demonetization.
·     In value terms, the share of Rs 500 and above banknotes stood at 73.4 percent compared to 86.4 percent before demonetization.
·    The share of Rs 2,000 banknotes in the total value of banknotes in circulation was 50.2 percent at end-March 2017.

RBI’s Annual Accounts:
·    The RBI's balance sheet increased by 1.88 percent in the year ended June 30, 2017, showed the report.
·        RBI's income for the year decreased by 23.56 percent
·        RBI's expenditure for the year increased by 107.84 percent
·        RBI had a surplus of Rs 30,659 crore during the year

RBI Annual Report 2016-17: 
·   The increase on the asset side was due to increase in foreign investments and domestic investments by 2.70 percent and 7.45 percent, respectively, and capital contribution to the subsidiaries of the Reserve Bank. On the liability side, the increase was mainly due to increase in Deposits by 76.96 percent.

·    Factors that impacted the RBI’s balance sheet during the year included the need for more intervention due to a surge in liquidity post demonetization. As deposits came in and liquidity surged, the RBI sucked out this excess liquidity through tools such as reverse repo operations. The central bank pays an interest to banks on the amount that they park with it through such a window.
·        The RBI also incurred higher costs on printing currency.
·  Expenditure on currency printing rose to Rs 7,965 crore in 2016-17 compared to Rs 3,420 crore in 2015-16.
·   Nearly 60% of demonetization deposits have stayed with banks, RBI Deputy Governor S.S. Mundra told BloombergQuint in an interview last week.
·       Increase in Deposits: Aggregate deposits of scheduled commercial banks stood at Rs 106.5 lakh crore as of July 7, 2017, compared to Rs 96.2 lakh crore as of July 8, 2016, according to RBI data.
Doubts About Demonetization Announcement – Raghuram Rajan’s Clarification:  According to “First Post. Updated Date: Sep 04, 2017 11:55 am and Published on 5/09/2017. There are two questions about demonetization. One, if Raghuram Rajan didn’t approve of demonetization "at any point during his term", how did the government claim it got the Reserve Bank of India (RBI) on board some six months before the launch to start preparations for the massively disruptive exercise in the economy? Rajan left the RBI on 4 September 2016 and demonetization was announced just two months later, on 8 November 2016. Two, if the RBI, under Rajan, had duly warned the government that short-term costs of the move could outweigh the long-term benefits, particularly if not executed well, and there are alternative ways to achieve this objective, then why did the government still go ahead with the plan ignoring the advice from the monetary authority and custodian of currency, in an economy where growth hadn’t taken a firm hold yet? In hindsight, we all know that the government and RBI miserably failed to plan it properly. The immediate context of these two questions is the revelations by Rajan in his new book, title The immediate context of these two questions is the revelations by Rajan in his new book, titled I Do What I Do: On Reforms Rhetoric and Resolve and through his interviews to media in this context. In an interview to The Times of India, Rajan said although RBI was consulted, at no point during his term was it asked to take a decision on demonetization. He added that he had handed over a note to the government outlining the potential cost and benefits of demonetization as well as alternatives to achieve similar aims. He further said: "If the government, on weighing the pros and cons, still decided to go ahead with demonetization, the note outlined the preparation that would be needed and the time that the preparation would take. The RBI flagged what would happen if preparation was inadequate." The government then set up a committee to consider the issues, Rajan said, adding that "the deputy governor in charge of currency attended these meetings and at no point during my term was the RBI asked to make a decision on demonetization". By this, it is crystal clear that the former RBI Governor was reluctant to “Modi’s Demonetization with in short time that to without proper preparation.” Hence, he was compelled to resign and Modi’s favorite person Urjit Patel was brought as RBI Governor. Hence, demonetization is  a “hasty decision without  proper preparation at the cost of the nation.”

            All in all, the tangible costs of demonetization has far exceeded the gains, so far. The government had initially expected about Rs 3 lakh crore to Rs 4 lakh crore of currency would not come back to the system and this will be a windfall gain. But, it didn’t happen. The economy has paid a heavy price for this exercise, with GDP falling to 6.1 percent in the March quarter and further to 5.7 percent in the June quarter. There are reports of major job losses in informal sector. Even the right-wing labour unions have accused the Modi-government for destroying jobs with the ill-prepared demonetization move. There are claims and counter claims about the stated objectives of demonetization after 10 months. There were three main objectives to it in the beginning before the government began shifting the goal posts after each stage. These were fighting black money, cash-based corruption and terror funding. And later the objectives of digital-shift and cashless economy were added when Modi spoke about this in his Mann ki Baat programme. Subsequently, much stress was given to mainstreaming of money and expanding the tax base as the major victories of demonetization.
           There are not any solid evidences of demonetization achieving any of these objectives contrary to the government’s claims. There was a spike in digital transactions post demonetization when cash was not available in the system and now it has come back to the “trend growth line”, data suggests that tax payer base might have gone up on account of note ban and how many of these will actually contribute to higher tax revenue is debatable. Clearly, corruption and terror funding have not been impacted much due to note ban. As far as black money is concerned, the only way demonetization can be salvaged now is when taxman unearths substantial amount of illicit money from the money deposited in bank accounts post demonetization. But, here, Rajan cautions. “The government can investigate the deposits, and some of it may turn out to be black money but it does imply that a greater effort is required and could also mean - and this is something a number of commentators have pointed out - more harassment for the general public that has honestly deposited money that was lying for one reason or the other in various accounts. So that benefit - if it comes - let us see at what cost it comes.”

             If one looks at the record of India’s corrupt, under-equipped tax department, the rate of success If one looks at the record of India’s corrupt, under-equipped tax department, the rate of success in the battle against tax cheats aren’t very encouraging. The government and taxmen will have to work hard to change this record. But, as Rajan cautioned, giving a free hand to taxmen and pushing them for targets could also lead to harassment of even legitimate depositors. The government needs to be careful not to let this happen. The gains of demonetization on black money continue to be uncertain. But, the moot question here is this: If the RBI didn’t approve of demonetization until 5 September and warned about its likely damaging effects on economy, then why did the government go for this dangerous gambit? Was it worth the pain for common man and the economy? And more importantly, if the government hasn’t still learned any lesson from the demonetization episode (finance minister Arun Jaitley believes the exercise has achieved its objectives) and is confident that it didn’t hurt the political prospects (evident from UP polls), will it go for similar gambles yet again in the economy? Rajan’s revelations only raise more uncomfortable questions. In hindsight, it is quite clear now that Modi would have done well listening to Rajan on demonetization. Government's argument is that “black money doesn't become white just because it is deposited in bank accounts, it has to be analyzed.” Let us see how much black money will come out due to demonetization.

RBI doesn’t know how much black money was eliminated by demonetization:
The RBI has told a parliamentary panel that it has “no information” on how much black money has been extinguished as a result of demonetization of Rs 500/1,000 notes or about unaccounted cash legitimized through exchange of currency post note ban. Stating that an estimated Rs 15.28 lakh crore in junked notes has come back “subject to future corrections based on verification process.” Replying to queries from the panel, the RBI said the verification for authenticity and numerical accuracy are still on, while some of the specified bank notes (old Rs 500/1,000 notes) which were accepted by banks and post offices are still lying in currency chests. The central bank also informed the panel that the completion of the process of verification will take time in view of the large volume involved.

Beyond Savings Accounts & Into Mutual Funds: While the initial deposits came into current accounts and savings accounts (CASA), over time the funds have started to disperse across different products but appear to be staying within the financial sector. Paresh Sukthankar, deputy managing director at HDFC Bank, on Monday said that a substantial proportion of the demonetization deposits have proved to be sticky. He added that over the past few months, money has moved from low cost CASA accounts to fixed deposits and other financial instruments. Data suggests that mutual funds have been among the beneficiaries. Mutual fund assets stood at Rs 18.96 lakh crore as of June-end, compared to Rs 16.28 lakh crore at the end of October 2016 before demonetization was announced. That works out to an average increase of about Rs 33,500 crore each month over the eight month period. In contrast, the pace of monthly additions during the eight months between October 2015 and June 2016 stood at just over Rs 7,000 crore. To be sure, mutual fund inflows had picked up even before demonetization with systematic investment plans starting to come in vogue. Demonetization appears to have added to this trend. 

Demonetization lead to a shift towards financial assets?
Viral Acharya, deputy governor RBI said there has been a “non-linear shift” in Indian household savings towards the financial sector. Products such as mutual funds, structured investments and insurance have benefited from this shift, Acharya pointed out.

Insurance Inflows Get A Boost Too: Inflows into the insurance sector have picked up as well, although the pace of increase has been volatile for the sector. In November 2016, the month when demonetization was announced, first year premium collected nearly doubled, shows data available on the insurance regulator’s website. In the months since, the year-on-year growth rates have varied between 27 percent and (-)12 percent. In the months before demonetization, growth rates ranged from a high of 60 percent in September 2016 to a low of 3.6 percent in October. Between November 2016 and June 2017, first year premium of Rs 1.2 lakh crore has been collected by the life insurance industry, shows the data. Between November 2015 and June 2016, about Rs 1 lakh crore in first year premium had been collected. The stickiness of this money will be determined over a longer period of time when data on long term persistency becomes available. Acharya also mentioned a move into structured products, consolidated data for which is not available. However, there appears to be a fair amount of evidence to support Acharya’s claim of a move towards financial assets in the aftermath of demonetization. There “is merit in allowing the money to remain in the system as the money starts to earn,” said

RBI Deputy Governor S. S. Mundra.

Merits of Demonetization:
·        Politics aside, analysts claim that the economic benefits of demonetization will emerge over a time.
·       As a result of demonetization, government has been gradually making enrolment to its national electronic database 'Aadhaar' mandatory for tax returns, opening of bank accounts and any purchases above 50,000 rupees. It is estimated that over 99 percent of Indians aged 18 and above are now enrolled in the scheme. This means that the government can expect to see the benefits of taxation on previously hidden black money over the coming months and years.
·      India's finance ministry says it is probing 1.8 million bank accounts where cash inflows during the demonetization period "did not appear in line with its tax profile," meaning it can expect some belated tax payments.
·   "There are also long-term benefits from demonetization in terms of increasing income tax payments going forward and encouraging the use of digital payments over cash, a means of encouraging better tax compliance among businesses."
·     Most important positive impact of demonetization is to bring more people in to the banking system and under tax purview to generate more revenue to the Government.

·      Demonetization has initiated a kick start to cashless economy, where many people have started using internet channels for payment of money.

·    Many wealthy Indians turned to friends and relatives to help them funnel previously undeclared cash into the banking system, while others “advance paid” salaries for large numbers of workers.

·      A major step to various e-payment portals and the drive towards the  digitalization on the nation.

·   Un Organized Sector has been brought under Organized Sector via demonetization program which in turn leads to increase in economic growth.

·        Transactions through banking channels have led to moving informal business into formal business as payments are made via them.

·        Curbing the black money which has been one of the main agenda of demonetization will get the major push as the black money hoarded in the form of banned currency will no longer be in use.

·         Fake Indian Currency Notes (FICN) which were mainly used to fund the terrorists will be dismantled.

·       The people will get reward in the form of lower price of real estate as most of the black money are converted into assets in which real estate and gold tops the lists.

·        The introduction of new currency notes of Rs. 2000 and Rs. 500 Rs. 200 have come with fine security design to avoid the production of counterfeit notes.

·        The government added 9.1 million new taxpayers in 2016-17, an 80% increase over the typical yearly rise, highlighting the impact of India’s November, 2016 demonetization of high-value currencies.

·        Due to demonetization tax evaders and money hoarders came into light where a heavy duty was imposed on them and it is a major setback to them.

Demerits of Demonetization:
·        In the country where 90% of transaction takes place in cash in the market, where only 40% have bank account in that country government banned those notes which had 86%of share in the market which led to great hustle in the market.

·        The dividend paid by the Reserve Bank to the government for the financial year 2016-17 was Rs. 30.7 lakh crore, as against the expectation of Rs. 74.9 lakh crore. This was less than half the dividend of Rs. 65.9 lakh crore paid by the RBI in 2015-16. This decrease was due to demonetization.

·        The demonetization resulted in economic slowdown of 5.7% in April-June 2017, the first quarter of the current fiscal year, slower than the previous quarter's 6.1% and much lower than the 7.9% growth registered in the first quarter of 2016-17.
·        Cash-dependent small businesses, daily wagers and poorer have been badly affected.
·        The bank’s estimate follows media reports that complex money-laundering networks sprang up in the wake of the demonetization to help wealthy Indians deposit huge volumes of previously undeclared currency without exposing themselves to tax authorities. Such people allegedly sold the old notes, at a discount, to brokers who then dispatched low-income Indians to deposit or exchange them at banks.
·     Some wealthier Indians had burnt, or dumped, their illicit cash to avoid official scrutiny.
·        More more number of  people has converted their cash in to gold, agricultural lands, houses, fruit gardens, house plots and flats.
·        Demonetization had an adverse effect on farmers and villagers who did not have bank account and had mostly the demonetization of 500 and 1000 rupee notes after the sale of their crops.

·        Due to the demonetization many people lost their life either because of standing in long queues or denial by hospitals to give treatment in exchange of old currency notes which led to death of many people.

·     Small business faced the major loss and people also had to skip their work in order to withdraw money from ATMs by standing in serpentine queues.

·        There was poor coordination between the banks and the government.

·        The frequent changes of the policy by the RBI gave the idea about the lacking in systematic planning.

·        This off-guard step was greatly criticized by the oppositions where many rallies were taken out in protest of such changes.

·        Families which were having marriage ceremony were greatly affected as they had to withdraw cash of Rs 500 and Rs1000 and more over they were not allowed to with draw not more than 2 lakhs.

·        There was a loss of jobs due to demonetization, particularly in the unorganized and informal sector and in small enterprises. Labour union jobs were crashed.

·        The verdict is clear. It was a monetary policy blunder. It achieved next to nothing, and inflicted a large cost on the poor and the informal sector.

Reactions of Prominent Economists and Politicians to Demonetization:
·        Strongly reacting to the RBI data on demonetization, former finance minister P Chidambaram tweeted, “Rs 16000 crore out of demonetized notes of Rs 15,44,000 crore did not come back to RBI. That is 1%. Shame on RBI which ‘recommended’ demonetization. RBI ‘gained’ Rs 16000 crore, but ‘lost’ Rs 21000 crore in printing new notes! The economists deserve Nobel Prize99% notes legally exchanged! Was demonetization a scheme designed to convert black money into white?”

·        Dr. Manmohan Singh warned for the economy post note ban that “the GDP of the country can decline by about 2 percentage points as a result of what has been done”. It became reality.

·        Former Governor Raghuram Rajan, "My sense is the clever find ways around it. They find ways to divide up their hoard into many smaller pieces. You do find that people who haven't thought of a way to convert black to white throw it into the Hundi in some temples. I think there are ways around demonetization."

·        Y V Reddy, a former RBI Governor, "I believe our economic system is ripe for a change, and demonetization 2016 has triggered the possibility of a change not because of the questionable decision, but because of the nature of reactions of the masses to the enigmatic decision of Prime Minister Modi. I believe that an invisible, non-quantifiable message from the people's response to the crisis is actually an implicit mandate for the authorities as well as for the society as a whole.''

·                The Indian Supreme Court while hearing one among a slew of cases filed against the sudden demonetization decision in various courts, observed that it "appears to be carpet bombing and not surgical strike" which government repeatedly claims it to be.
·                Nobel laureate Indian economist Amartya Sen, severely criticized the demonetization move calling it a "despotic action" among other things.
·        Former Senior Vice-President and Chief Economist of the World BankKaushik Basu, called it a 'major mistake' and said that the 'damage' is likely to be much greater than any possible benefits.
·   Pronab Sen, former Chief Statistician and Planning Commission of India member, called it a "hollow move" since it did not really address any of the purported goals of tackling black money or fake currency.
·   Prabhat Patnaik, a former professor of economics at the Jawaharlal Nehru University, Delhi called the move 'witless' and 'anti-people'. He criticized the simple way in which black money was assumed as "a hoard of cash", saying that it would have little effect in eliminating "black activities" while "causing much hardship to common people."
·        Noted economist and journalist, T. N. Ninan wrote in the Business Standard that demonetization 'looks like a bad idea, badly executed on the basis of some half-baked notions.'
·     Deepak Parekh (Chairman of HDFC) had initially appreciated the decision to ban the Rs 500 and Rs 1000 notes, but later said that the move had derailed the economy, and expressed skepticism about its outcome. 
·        Industrialist Rajiv Bajaj criticized the demonetization, saying that not just the execution, but the concept of demonetization was wrong in itself.
·        Rahul Gandhi, leader of the opposition Congress party, tweeted: “A colossal failure which cost innocent lives and ruined the economy. Will the PM own up?”
·        Chief Ministers of several Indian states like Mamata BanerjeeArvind Kejriwal and Pinarayi Vijayan have criticized and led major protests against the decision in their states and in parliament. Initially, the move to demonetize and try to hinder black money was appreciated, but the manner in which it was carried out by causing hardships to common people was criticized.

     To conclude, though demonetization has failed in short term, but due to its impact several benefits like cashless transactions, brining informal business in to formal business via banks, bring more people in to the banking system and under tax purview, digitalization were achieved to a certain extent. In the long run we can expect even more benefits like increase in GDP growth rate, more revenue to the Government through increased tax payers, curbing black money and fake notes.


View: Is Demonetization a success or failure? By Narendra Nathan: The Economic Times, Up dated and Published on: 31/08/2017.

Look at the facts of demonetization, not politics written by Kaushik Basu, The Indian Express: Published on 11/05/2017.

RBI Annual Report: 99% Of Demonetized Currency Returned - BloombergQuint.
Raghuram Rajan’s Revelations on Demonetization: Narendra Modi shouldn’t have ignored his caution, First Post. Published on 5/09/2017.
Raghuram Rajan breaks silence, says neither he nor RBI under him wanted demonetization, Hindustan Times: Updated and Published on 5/09/2017.
Raghuram Rajan’s book out today: Sneak peek on what he writes about demonetization, social media and more, Hindustan Times: Updated and Published on 5/09/2017.
2016 Indian Bank Note Demonetization: Wikipedia