Optionless RBI cuts Growth Estimate

I have always maintained that demonetisation, in the manner in which it has been done, is a bad move and it would needlessly hurt the economy. The prediction seems to be coming true. Nevertheless, given the situation that we are in at the moment, I am in full agreement with the announcements of the RBI on the monetary policy review held today. The RBI has made the right decisions under the circumstances, and deserves to be commended for taking difficult decisions in the face of pressure from various quarters. It has downgraded the growth outlook (gross value added) for 2016-17 from 7.6 to 7.1, which was obvious with the economy expected to contract after the demonetisation move. I would have, though, downgraded the growth rate further, but RBI has at least acknowledged the trajectory.

By allowing the repo rate to stay at 6.25%, the RBI is sitting on the fence and keeping its options open until such time that it has a better sense of the directions that the economy will take. It has kept the January inflation rate target at 5%, which indicates its view that inflation may initially dip but will soon start going up as remonetisation progresses and supply constraints start to bite.

big question: was DEMONETISATION NECESSARY AT ALL?

More importantly, by saying that ₹11.5 lakh crore has already come back into the banking system, when compared to the ₹15.4 lakh crore demonetised, the apex bank has hinted that there would no “big dividend” to the government. This is an extremely important stance since the budget-making process is in full swing and estimates of such a “dividend” will be an important component of revenue projections.

Be that as it may, this again raises the question on whether demonetisation was necessary at all. I don’t believe it is the RBI Governor Urjit Patel’s domain to talk about issues such as terror funding. Nevertheless, let us consider the different aspects he spoke about that the demonetisation helped in dealing with—fake currencies, terror funding and black money.

The only study that is available on counterfeit currency or fake Indian currency notes is by the Indian Statistical Institute, Kolkata. It said that ₹400 crore worth of fake currency was in circulation in the country at any given point of time. So, to extinguish ₹400 crore, the government demonetised ₹15.4 lakh crore! If this was the main reason, then an aircraft gun was used to kill a mosquito.

Further, there does not seem to be a direct link between terrorists and fake currencies either. According to reports, none of the terrorists killed or caught carried fake currencies with them. In fact, the money found on them was always real currencies. The entry of fake currency into our economy is at different points then that need to be investigated and plugged.

black cash estimations off the mark

Then, the argument is on containing black money. Black money in cash form hardly makes up about 15 to 20% of all currency with the public. The gap between the ₹15.4 lakh crore worth currencies that were demonetised and the final amount that is deposited or returned to the banks may be considered as an estimate of the black money, but the indication is that this gap may well be far below the initial estimates. The really important outcome would be on how many people more will now come under the tax net, which depends largely upon how effectively the tax authorities use the data that is now available in the banking sector. So far, the focus appears to be on income tax violations, but it should be remembered that black money generation happens in a big way in excise tax evasion as well. I do not know whether the excise authorities are at all seized of the matter and capable of doing something about it.

Finally, to get back to the RBI, as the custodian of all matters monetary and the regulator of banks, I believe it is incumbent upon it to lay out a clear game plan for the transition to the new currency regime. The uncertainty and speculations that are rife need to be put to rest immediately, but the RBI has not stepped up to the plate yet.

Dr Pronab Sen was the first Chief Statistician of India. He is currently the Country Director for International Growth Centre

As told to Sebastian PT