On fifth anniversary of Demonetisation, cash in circulation 57% more

Today marks the fifth anniversary of the day demonetisation was sprung on the nation at merely four hours’ notice. The Prime Minister announced at 8 pm on November 8, 2016, that all thousand-and five-hundred-rupee notes would cease to be legal tender from midnight. Effectively 86 percent of the currency was taken away, and the new replacement notes were not yet ready.

For several months Indians did not have access to their own funds. And the small numbers of notes issued initially were all in 2000-rupee denominations, which didn’t help since nobody had change (of the new 500 denomination). There were long lines of people outside bank branches and ATMs desperate to withdraw the small 4000-rupee limit allowed in the early days. There were cases of rioting, attacks on bank staff, and people also died, some of them waiting in lines to withdraw money.

Snatching away the belongings of people was a very harsh and cruel public policy measure. After fifty days, in late December the government also passed an ordinance (later made into law) that possession of old notes was illegal (on par with owning drugs).

There is telling irony and pathos, that recently, unaware of demonetisation which happened five years ago, a blind person, a destitute, who earned his keep by begging in the Krishnagiri district of Tamil Nadu, asked the collector to exchange his entire life savings of 65,000 rupees in old notes. Of course, his request was denied. There are probably lakhs of such savers who in the past five years discovered that their savings were equal to mud, and had no recourse.

And yet month after month, after that fateful November 8 announcement, public opinion surveys showed strong support for the Prime Minister’s intent. People around the country, especially the poor were convinced that some big fish were fried and were caught with their pants down. The PM’s message was that hoarding cash was black money, and the sudden almost “surgical attack” took the big fat cat black money hoarders by surprise.

If this thesis was correct then a substantial portion of the demonetised money should not have come back into the banking system. But it became clear within first 60 days itself, confirmed by the Reserve Bank of India much later in August 2017, that more than 99 percent of the cash had been turned in.

This return of demonetised currency into the banking system was not surprising at all. That’s because the government’s own data from several years of income tax raids and action by the Enforcement Directorate, had shown that nearly 93 percent of ill-gotten wealth was in the form of benami land, gold, real estate, stocks and foreign accounts. So only 7 percent of black money sits around as cash.

Even then demonetising high value notes is a good idea, mooted by the OECD, the European Central Bank and even the former Chief Economist of the International Monetary Fund, Ken Rogoff, among many others. But their version of discontinuing high value notes, was with an advance notice of twelve to eighteen months. And to certainly not introduce even higher value notes!

The highest value note in the United States is 100 dollars which is 0.16 percent in value of their per capita income. And most of the 100-dollar notes are actually circulating outside the U.S. not within.

For India, a 2000 rupee note represents 1.3 percent of the country’s per capita income. That’s more than 8 times the ratio of the U.S. Since it is 8 times higher in relative terms, than that of the US, by American standards our highest denomination should be 1/8th of 2000 which is around Rs. 350. So a maximum 500-rupee denomination should suffice. If the demonetisation was supposed to make a big dent on black money, it clearly failed.

Incidentally the cash in circulation prior to November 8, 2016, was 18 lakh crore, and five years later it is 28.3 lakh crore, a jump of 57.5 percent i.e. roughly a ten percent per year growth, higher than the real GDP growth. In these current times of high inflation, the cash with the public is extraordinarily high.

This is despite a steep rise in electronic payments and the widespread use of the Unified Payment Interface (UPI). The latter is clocking more than 4 billion transactions every month, and annually will clock 25 billion transactions as against 15 billion in China.

But it can be argued that India’s digital journey did not need a demonetisation “jhatka”. It would have happened anyway, as the current pace of adoption shows. More importantly the share of payments (by value) which are instant payments of the UPI kind are 15.6 percent as per a study by a US company called ACI Worldwide. Even the Reserve Bank of India’s annual report shows that retail non-cash, instant payment systems still have a lot of catching up to do. It is undoubted that the pace of adoption of digital payments is super-fast, but no credit for this should be given to demonetisation.

The objectives of demonetisation were never spelt out clearly, and the narrative kept changing in the course of the following year. First it was an attack on black money, counterfeit currency, terrorist financing. Next it was mopping up extra income tax and bringing more people into the tax net. Next it was to make India move rapidly to cashless transactions. And then again, it was to enable the ecosystem of fintech companies and innovation in the financial system.

None of this has borne out. However, one can use the “post hoc, ergo propter hoc” fallacy to justify that demonetisation goals (whatever they were) have been met. Not only does “correlation does not mean causation”, but also, just because X follows Y, it does not mean that Y causes X to happen. All this may sound too nuanced, and it will need this year’s economics Nobel winners to tease out the causality between demonetisation and subsequent effects.

Undeniably the following propositions still hold.

Firstly, people suffered hardship. Secondly the informal sector economy was badly hit. Thirdly the popularity of the Prime Minister, who took ownership of the decision remained undiminished. (This could be attributed to his power of projecting a “reality distortion field” as often referred to by the legendary business leader and innovator Steve Jobs). It is the power of his charisma.

Fourth, cash is back in circulation with a vengeance, despite a steep increase in digital payments. Fifth, until the pandemic year GDP growth declined continuously and investment to the GDP ratio stagnated. Lastly, the informal economy as a share of the total economy has shrunk, although the factors are many. The analysis of shrinkage of the informal economy is left for another column.

(Dr.Ajit Ranade is an economist and Senior Fellow, Takshashila) Institution. Views are personal) (Syndicate: The Billion Press)