Tuesday, February 28, 2017

Demonetization - my perspective

No government and no Prime Minister has persistently focused on bringing back or eliminating black money. Even if we all make fun at the campaign promise the PM made regarding the money he will deposit in everyone's bank accounts got from Swiss banks we cannot dispute so many measures taken to attack the black money. Starting with appointment of Special Investigation team (SIT) to probe the black money on Day 1 of the government and secondly, the PM announced several Income tax declaration window with penalties (even though this didn't yield much results). It also signed tax treaties with Singapore, Mauritius, Cyprus (double taxation avoidance) to prevent round tripping. Round tripping is a phenomenon under which money that goes out of India comes back through foreign investment and evades taxes. Also, to consider is the fact that political party funding is a major source of black money and the government's announcement that any amount above Rs.2000 has to come through cheque or digital means (as announced in 2017 Budget) are serious attempts to tackle black money.

With no measure done till date giving any fruitful results the PM announced something on Nov 8th 2016 that will forever be a watershed moment in Indian political history. 8th Nov 2016 8 pm the PM announced Rs.500 and 1000 cease to exist as a legal tender starting that midnight creating ripples and shock waves not just in the country, but also across the borders. Counterfeit currency is widely printed in Pakistan and is circulated and it completely rendered useless.

Hard facts: 86% of total money in circulation is Rs.500 and Rs.1000 and there are 201,861 ATM's across the country.

Nov 8th v/s Nov 17th Date of Demonetization:


RBI had planned for Demonetization in advance starting Feb 2016 when the government seriously thought of the idea and expressed it to the RBI. If RBI had planned in open by announcing the game plan then the whole exercise would have been known to the public. So, it secretly began taking several steps like printing the new currency of Rs.2000. As part of this exercise RBI also found that several ATMs didn't dispense Rs.100 notes and instead Rs.500 and Rs.1000. So, it passed a circular on Nov 2nd that 10% of select ATMs (20,000 ATMs) should take out the cartridges dispensing higher denomination with that of Rs. 100 (Click here ). RBI called this move as calibration and not "recalibration" because re calibration involves removing some cartridges from the ATM and replacing them with something new. Let's imagine for a second if these selected ATM's were re calibrated then people would have sensed something fishy. RBI itself gave a deadline of 17th Nov 2016.  Had 17th Nov 2016 passed the ATM's would have had Rs.100 in circulation which went badly missing since the demonetization exercise was announced on Nov 8th. Why did the PM chose to go public on Nov 8th instead of Nov 17th? Was this intentional or accidental? A politically smart person like the PM would have definitely done this intentionally. There must have been strong reason for this announcement without waiting till Nov 17th. No one will probably ever know.

Even if one discounts the above fact of Nov 17th RBI cannot escape the reality that it fell short even in its planned execution of printing and distributing Rs.2000. It also failed in taking stern action against banks who made ATM's dysfunctional.

How much black money exists:

No one can estimate this. Black money means unaccounted money. When money is not accounted how can you account it? Economists can only give estimates and these are just estimates. Economist Amartya Sen says 6% is the total black money. There is no concrete evidence of this claim.

Read this special report drafted by our current President Dr. Pranab Mukherjee (who was then Finance Minister in 2012 UPA government headed by Congress). This report says no one can estimate the amount of black money that exists and one can only arrive at estimates.  Indian economists estimates $1.2 trillion is stashed abroad in Swiss banks, whereas Swiss Govt says it is only $2 billion. This document clearly is an evidence that amount of black money cannot be accounted leave alone the cash component.


So, any success is being estimated by these numbers. However, calculating the success or failure of the move is inaccurate with incomplete and non-deterministic data.

Immediate Effects of Demonetization

1) Depletion of cash and fall in property and commodity prices ( a mini Deflation)

Once demonetization was announced, the effects were more pronounced on all sections of life. With cash being mode of majority of transactions it brought life to stand still. Auto wallas, taxi wallahs, small businesses, street vendors, housewives, aged people, middle class, poor - every category was hit. India had never been exposed to this extreme demonetization. The last such move was taken by former PM Moraji Desai in 1977. However, high denomination currency in circulation at that time was very less so the effects were not steep. The current government probably underestimated the usage of cash or did not adequately ensure RBI is ready to circulate with newer currency and smaller denomination currency. If either of them was executed as planned there wouldn't have been this level of agony and pain. True, an exercise of this sort cannot be planned with perfection. However, the imperfections and inefficiency of RBI to deal with the situation will go in history as a sad moment of improper execution of a good intended policy decision. Lines before ATM's everywhere hit all cities and towns. Some banks were closed, several ATM's were out of order and long lines made headlines every day.  The country experienced deflation. Prices of commodities and real estate fell. Real estate prices fell by about 40% in several cities including the capital New Delhi. The most severe impact was on people who had saved the money for immediate expenses, medical emergencies and savings for long term and ordinary labors whose wages and spending was purely in terms of cash.

2) Swell in gold purchases:
It is a well known fact that several jewelers had kept their stores open and people flocked to convert their money to gold. The prices of gold and silver surged.

3) Fall in GDP :
The real GDP fall is yet to be witnessed. However, GDP based on estimates will fall to less than 6.5%. Before demonetization we were growing at 7.5% and we were the fastest growing economy. Former PM Manmohan Singh's prediction that it will fall 2% points may or may not happen and only time will tell.

4) Impact on Kashmir and Naxal belts:
Kashmir was so much used to people saving money in banks that the impact was not grave. It is widely known that Kashmir is prone to terrorist attacks. So, amidst this fear several people deposited cash in banks. The lines were fewer and it got worse only when ATM's and banks began to delay or shut down.  The reduced incidents of violence as claimed by the PM may not be entirely true. Two months before this announcement the violence had come down as the army cracked down on militants.

In Naxal belts like Bastar (Chattisgarh) and southern parts of Orissa there was news that said Rs.7,000 crores was stored in dumps by Naxals and they forced farmers and other poor people to store this money in banks so that they could take it later. This task reduced Naxalism drastically because cash Naxals had couldn't be used to buy any weapons or carry out attacks.

5) Spike in cashless transactions:

The most positive impact on Demonetization is the increased pace of cashless transactions. Several companies that allow e-payments saw spikes never witnessed before. As examples

Ola - 1500% increase in recharge
Paytm - 435% increase in traffic
Razorpay - 200% increase in traffic
MobiKwik - 15 times its normal traffic

The RuPay cards that were launched with Jan Dhan account saw 316% spike in transactions. Seizing the moment government introduced few more encouraging steps such as waiving of transaction fees for transaction amounts up to Rs.2000, discounts for using card payments in fuel purchases, toll plazas, insurance policy purchases. Railways initiated cashless mechanisms at several railway stations.

The PM also launched BHIM - that has over 1 million downloads. The app makes it simple to make payments between your bank and any other party extremely easy. It is impossible to think of suddenly developing this app within days of demonetization announcement. This app must have been developed over several months in advance. More on BHIM can be read here.

6) RBI flip flops confusing everyone:

Here's the link that lists complete list of flip flops made by RBI that made the entire exercise look very weak.

Here's  a youtube video that also describes the same.


7) Money laundering thrives:

In several cities money laundering brokers thrived. People were looking to convert their accumulated cash of old currency into new ones. Brokers were available to convert this at 50% commission in some cases. Obviously, this couldn't be possible without a nexus between these brokers and bank officials.

Why is that RBI couldn't keep a watch on several bank managers and employees who openly polluted the system when money hoarders began to bribe them and park the cash in fictitious bank accounts. The government cracked down on several of such incidents (Source 1Source 2). 50 Banks were raided to find new currency without any account (Source). 5.7 Crore Rupees in new currency was found in Bangalore. (Source). The central government did a good job on announcing these raids, but the pace of such incidents outpaced the manpower of tax officials. Therefore, no matter how many raids were done that came into the media highlight- the undeniable fact is that several people still continue to have this high value currency earned through unaccounted means in several fictitious accounts. As these raids continue we may never even know all the people who were involved in this.

How do you evaluate this was success for failure?

The government estimates 15.44 lakh crore high denomination currency existed on Nov 8th.

Based on this article the amount of money deposited in the banks was close to 13 lakh crore. This means nearly 80% reached the banking system.  Some say the government didn't expect this and that is why it is a failure. However, the PM clearly said to India Today as below (Source):

We were, in fact, clear from the beginning that high-value notes should return to the financial system. Why else would we give the banking system so much time and options for the return of the notes? Why else would we allow acceptance of such notes through a host of avenues, ranging from petrol pumps to government dues till 15 December? Hence, a large part of the notes not returning to the banking system was never an expectation or agenda of the government.

What this means is that Government clearly did expect all money not to come back into the system. 

Impact of such a policy has never been measured. This continues to baffle several economists who are not able to judge the effects accurately. The situation is exceptional because of two main factors - large population and dominance of cash in the market. No country with both these factors has ever applied such a policy. Some economists argue this was totally unnecessary when the country was doing so good in terms of GDP. Some argue that the PM has taken the end upon himself and won't see the end of the tunnel. Some argue that this was needed since cash transactions had to be curtailed.  There are quite a few economists who agree that real black money is not cash, but gold and property that people pile up to cover black money and evade taxes. This is true. The main question is how does one precisely get a count of how much black money exists, how much exists as cash and how much as property.  

How much is the cost of printing the money and the rate of printing:

India has 4 currency printing press locations - Nashik, Dewas, Salboni and Mysuru. Nashik and Dewas are owned by central govt through Security Printing and Minting Corp of India. The latter two are owned by RBI's subsidiary Bharitya Reserve Bank Note Mudram Pvt. Ltd. The presses at Salboni and Mysuru can print 16 billion notes in two shifts/year. In two shifts 26.66 billion notes will be printed and in three shifts 4 presses will produce 40 billion notes. Going by this order to meet the current number of 14 lakh crore few months are needed and not 50 days as promised by the PM. It is now end of February and the entire country is now more or less out of cash crunch. The cash crunch certainly did not end in 50 days as promised by the Prime Minister.

Expected Long term impact of demonetizaton

While no one can predict the long term impact of such a move the surge in bank deposits clearly indicate capital flow to the government in way that lending will get cheaper in the long run fueling growth. Adding to this move the introduction of GST will only widen the tax base since no business can escape being part of GST - be it small, medium or large.  The increase in indirect tax collection will change the face of the economy.

Indians have shown remarkable patience and resilience even though it affected them in every way. The PM's personal popularity has increased and the way he presented his case changed people's perception about him despite all inconveniences. There is also a section of the society that will probably never forgive him. The PM politically may not reap enough benefits, but if he consistently pushes for cashless economy it will have long term positive effects on the economy. BJP must keep in mind that overselling demonetization can only boomerang on its political fortunes.

Drastic policy changes often will not win elections. Without winning elections no government can deliver its promises. This is exactly the point where the PM faces his biggest risk. The PM has to change his narrative else he will risk losing significant gains he has made in the past two years. The real black money also lies with political party funding and it needs to be tackled. For people who believe corruption will be eliminated they are absolutely wrong because this can be changed only through perception and bringing in transparency in the local municipal bodies where maximum interaction between citizens and the government takes place.

1 comment:

Unknown said...

Great study Anjan. we need lot of time and patience even to read and understand.
never knew many facts you have written here, until i read.
thank you
Devika