It was on the evening of November 8, 2016, that Prime Minister Narendra Modi announced the withdrawal of the existing ₹500 and ₹1,000 notes, rendering them illegal. People holding such notes could get deposit them in their bank accounts and exchange them for newly issued ₹500 and ₹2,000 notes. The ₹500 and ₹1,000 notes had then formed 85 per cent of currency in circulation.
The logic behind the move was that the black/unaccounted money hoarded in the demonetised currency denominations would not return to the banking system and hence will be permanently “extinguished.” It seemed like a simple solution to rid the country of the black money issue.
But this “surgical strike” against black money was undertaken under the mistaken notion that black money in the country was hoarded in currency notes, in pillow covers or gunny bags, at the homes of the corrupt. This was hardly the case as black money was always either invested in property or other assets under “benami” holdings or moved to offshore bank accounts.
But the Modi government reportedly under the advise of a little known Pune-based think-tank went ahead with this move. It was of course done with utmost secrecy with even the then Finance Minister and the RBI being kept in the dark.
Misguided ideals
That this ill-advised move would severely impact a cash-dependent economy like India was known right from the beginning and several economists and commentators even said so. But among the urban middle-classes there was a palpable sense of excitement — at last something radical was being done to root out corruption and black money. The move had a surprisingly high level of public approval.
Interestingly, Shankar Acharya, Chief Economic Advisor from 1993-2001, who was part of the earliest study on black economy in the early eighties, had specifically advised against demonetisation and voluntary disclosure schemes.
The economic devastation demonetisation wrought was painfully brought out soon enough. It wreaked havoc on an economy where a large chunk of workers were employed in the informal sector of which agriculture was a huge component.
But despite the all-round misery, and newspapers were full of them, there were no protests against the policy move. In fact Sanjaya Baru, renowned author, columnist and commentator, in a public discussion a few weeks later remarked that how years from now, more than economists, sociologists would study why demonetisation elicited no protests and dissent from the common folk.
Demonetisation’s objectives were to root out black money, curb illicit activities, counterfeit currency and curb terror funding. But once it became obvious that all the money, or most of it, came back to the banks, the goalposts kept changing. Promoting a digital economy, with less reliance on cash became a later objective. Then making the economy more "formal" and increasing the tax base were added to this growing list of objectives.
Though digital transactions have increased in these last five years, recently released RBI data shows that the reliance on cash remains as high as it did five years ago.
Almost all the money in demonetised denominations returning to the banking system could imply two things — that the money was not unaccounted or "black" in the first place or the corrupt found ways to launder their black money and push it back into the banking system. In fact the government then had said that it closely scrutinise all the money returning to banks and take action against the corrupt.
But as mentioned by former Chief Statistician Pronab Sen in a recent newspaper interview, even after five years there has hardly been any action on this front. This despite the banks having kept meticulous records of all the money in demonetised denominations coming back to the system.
More formal economy?
There have been recent studies on how the Indian economy has become more "formal", which was one among the objectives of demonetisation. By this we mean that greater number of economic activities (businesses, trading etc) are coming under the regulatory ambit.
The State Bank of India’s recent EcoWrap report states that the informal sector in recent times have shrunk to 20 per cent of the GDP, which it says may itself be an overestimation.
But with almost 90 per cent of the Indian workforce employed in the informal sector, what does the shrinking of the informal sector mean? Does it imply that now a large part of the workforce too has moved to the formal sector enjoying written contracts, social security and health benefits? Even anecdotal evidence suggests that that is not the case. The vast number of “self-employed” persons in India is evidence to this.
An SBI analyst was quoted in an article in the Scroll website saying that the EcoWrap study looked at “formalisation” solely from a banking perspective and the objective of the study was to initiate a debate on this issue. So this is an area where more research needs to be done.
An economy which was beginning to revive in the second half of 2016 was delivered a sledgehammer blow by demonetisation. Some economists argue that the economy hasn’t recovered, with Covid making the economic situation worse.
But the irony is that this disastrous policy move had virtually no political costs — the BJP’s electoral successes, both at the national and State level, are testimony to that.
This episode also showed how public perception can be completely divorced from ground level reality.