Is demonetization an effective tool? A detailed analysis.
I would like to address this Issue of demonetization in 2 parts:
- Demonetization Itself: The merit of this activity/the actual purpose it can serve.
In simplest terms, demonetization means withdrawal of a particular form of currency from circulation. In Indian context, this was done for Rs.500 and Rs.1000 notes. The PM announced that this was done to stop circulation of black money and as a measure that would effectively address counterfeit-currency, terrorist-funding, corruption etc.
This move intended to provide huge setback to people hoarding large sums of money as that would become non-usable, unless exchanged. Later, the hoarders were given an option to make declarations of their money by paying a penalty. Similarly, the counterfeit-currency will become defunct. The terrorist-activities will receive a huge jolt as they finance all their activities with the higher denomination notes.
Let’s do a detailed evaluation on what demonetization will achieve and what it will not.
As per RBI, the total money in circulation is around 16.5-lac crores, money of all denominations put together. Out of this total money in circulation, the rs.500 and rs.1000 notes constitute aprx. 86%, which comes to around 14.5-lac crores. The same report reveals the counterfeit-currency to be around 400crores.
- At the stroke of midnight hour on 9th Nov2016, all rs.500 and rs1000 notes were made invalid. Was this a masterstroke? No matter how noble the intention, Economic prudence can never allow that 86% of the money to be removed out of circulation. This alone has a potential to create mayhem in the country. There was no immediate replacement of notes thus further worsening the situation. A crippled economy will never allow any benefits from demonetization, as expected earlier.
- Counterfeit currency
Yes, this activity does serve the purpose of one time wiping-off of all counterfeit currency.
However, 400crores out of 16.5lac crores is a miniscule % to have any merit to carry such a large-scale activity.
Moreover, several cases of duplication of new currency came into limelight and a real question mark was put on the process of wiping-off counterfeit currency when a young make-in-India awardee from Chandigarh was caught with fake new-2000rs notes. Such an immediate wipe-off of this benefit was certainly not expected.
It has reached an advanced stage and is absolutely not cash-dependent, leave alone Rupee-dependent. There are several instances of money being wired for terrorism purposes and if we genuinely think that terrorism will stop by such a move- we deserve to be terrorized!
- The Black Money
We get it completely wrong if we think that majority black money is hoarded in 500rs and 1000rs denomination and is never circulated. Infact, most of this money is in circulation.
I will take example of an actual person whom I know. The 2crores of non-declared, non-taxed money in their household has the following components:
Real Estate (1 Flat + 4 small plots)- aprx 1.2crores
Gold- aprx 50 lacs
Shares- aprx 15lacs
Car purchase in Jan this year- 16lacs
Cash they have at home (at any point of time)- 7-8lacs aprx.
The cash-component comes to 3.6% in this case and I guess this is no different for most individuals who have non-taxed income. The most optimistic estimates point to black money having a cash component of max 3-4%. If this is indeed the case, it is anybody’s guess that this demonetization move will stop short of just scratching the surface with nothing substantial achieved.
Now we know, the cash component of black money that we are trying to unearth is not very high. The hoarders have found a way around this too. Several cases of bribing of bank officials have come out and they represent just the tip of iceberg; a significant amount is getting legalized through this route. There are agents available to convert black money at 20-25% commission, either by giving lesser-value real estate or by simply arranging gold deals. Several relatives have come to their rescue and the risk is getting distributed. If not relatives, people are available to get this done at a cost. Paying off salaries of employees for the entire next year, paying off car loans etc are several other ways adopted to legalize the black money. Jugaad-Nation- This is such an apt title we deserve!
I am also reminded of the fact that was hammered on us literally in every speech made during the election time- that the biggest chunk of black money is stashed in foreign banks. How will this demonetization move address that?
A large sum of money belonging to the poor and un-informed people will become invalid. It is their hard-earned savings which they are unable to convert either because they don’t have access or right information about the whole process. The demonetization move got announced on TV with almost a daily change in rules and it might just turn out to be a case of Chinese whispers for these people.
Will not the introduction of Rs.2000 note lead to further multiplication of hoarding activity?
Will it not wife-off any benefits that were expected from rs.500 and rs.1000 notes discontinuation?
The latest reports point to a deposit of close to 12-lac crores of invalid 500rs and 1000rs notes, thus validating 82% plus notes in circulation. This is just short of the 14.5-lac crores, the total circulation of 500rs and 1000rs. There are still 25days to go and this deposit of 12-lac crore will further increase, thus wiping off any benefits that were expected from demonetization.
- Banking system
Demonetization intends that people who are hoarding black money come out in open and make declarations. If however, they do not make such declarations or get their hoarded money exchanged, that undeclared/un-exchanged amount becomes the profit of the RBI and in turn of the government. This can be used for re-structuring and development.
Banking system is up for revival and it is almost certain that demonetization will lead to banks having far more funds than earlier. Interest rates are expected to come down and give some relief to middle class. The Higher class, as usual will be the biggest beneficiary. These benefits will however not trickle down to the Poor/unprivileged people for the simple reason that they do not have access to banking. The Jandhan accounts are still far from operational reality and hence these people have to depend on local systems of banking, loosely termed as Informal Economy
The Informal economy is collapsing for the simple reason that it thrives on cash transactions. More than 90% of the labor force in India is dependent on this; receiving the biggest jolt of their lives. The demand has come down and the small/micro enterprises have slowed down on their production. Since the labor force works on a daily-cycle, a loss of 1-month of their pay has crippled the Informal economy like never before.
- The PM tells his core group to spread that demonetization (& hence less use of cash) will have following benefits to common people- Adverse impact on taking/giving bribes, ransom, dowry & capitation fee.
I find this argument most strange of all. Bribe is a form of corruption. Corruption is a state of mind and black money or rather any other money form, is just a tool for doing corruption. If not the earlier 500 and 1000notes, corruption will happen with help of new notes, gold or just thru a barter. Bribe will find its own medium to stay alive.
I cannot think of a family refusing dowry just because 500rs and 1000rs notes are not there. Same is true for ransom money or capitation fee.
Bribe/Ransom/Dowry/Capitation are the evils of our society which will find an expression in some form or the other. Demonetization, as a tool is not even remotely effective in curbing them.
Demonetization as a tool to curb black money, corruption, counterfeit currency, terrorist activities etc. is ineffective.
- The actual manner of Implementation of demonetization in India and its Impact
Having addressed the Strategic part on ‘Can demonetization actually lead to a positive impact’, it is very critical we spare few minute on the actual Implementation part.
I will quote my CEO to start with. You may be equipped with best of knowledge and previous best practices that may lead you to devise the best Strategy one can probably have. But the GOD still lies in the way you implement it, the detailing part. No matter how noble your intention -a faulty and not-so-well-thought-of implementation will be a big dis-service to the organization and ultimately to the Nation.
- 86% of circulated money was discontinued and this alone has the potential of creating a crippled economy. The plot further worsens when we overlook our logistical capabilities and are unable to provide replacement notes in time. This was a case of a monumental planning failure and now the most conservative estimates point to a 3-5months period by when the notes circulation will become normal.
- The simple fact of new notes not being compatible with the ATMs points towards a sheer lack of visualization of post-demonetization process. The daily changes in withdrawal rules is another pointer towards lack of planning.
- The salaried got salaries on time. Just that they don’t have access to it. This has led to the biggest violation in a democracy– “People not being allowed to withdraw their own money in the manner they want”. This is nothing short of a Financial Emergency in the country!
- I wonder when people say that the pain is short-term and invoke patriotism to make the gullible people accept it as a part of their lives. Truth is actually very simple, all this could have got avoided if authorities had planned it well.
A cost-benefit analysis makes a perfect sense. It is a pertinent question to ask if the benefits exceed the cost of this demonetization initiative. CMIE points towards an estimated cost of 1.28-lac crores to economy for the 50-day time period till the end of depositing period of old currency. An Irreversible loss for sure!
- This 1.28-lac crores includes an amount of aprx. 61000crores, a cost on enterprise sector- farmers, transporters, stockists, manufacturers, retail etc. They are a cash-based economy and cannot cope up with non-availability of cash
- It puts a cost of 17000 crores towards the Government and the RBI for implementing the demonetization process in India- printing new currency notes, cost of transporting the new notes to all bank branches & post offices, recalibrating ATMs, human resources cost etc.
- The cost of people standing in the queue, Xeroxing of Id cards, number of work-hours put in by bank officials at expense of something else etc. is put to around 20,000 crores, claims CMIE.
Net, the cost of demonetization implementation in India was very high. Obviously, this was not built-in by our strategists.
Demonetization is a one-time event; after creating the initial wipe-off, it will cease to have any impact. Cashless economy, Tax reforms, GST etc. can help us achieve a long-term economic growth
Cashless economy It is an ideal thing to have but we should not be naïve enough to believe that it will become a reality anytime soon. The total population of the country using net banking/credit cards/debit cards is less than 10% and the best estimates indicate movement to cashless economy of max. 25-30% in next 5years. However, going cashless comes with a transaction cost and the government policies have to address it adequately. The more we move in this direction, the better it is for us.
The Government revealed a very shocking fact that out of a total population of 123crores, while 2.8crores filed the IT returns, only 1.25crores paid the Income Tax, an abysmal 1% of India’s population. Since such a small number of people pay IT (Direct Tax), the Indirect taxes keep on increasing continuously and this is really a punishing for the poor of the country.
A simple step to widen the tax base can be to strengthen the consumerism data- anybody buying a Car or say a white good costing beyond a certain amount. Then there is a huge chunk which files IT returns but does not pay Income Tax, almost 1crore such people. This can be immediately addressed. A strong political will is needed to widen our Tax base- to increase the number of people who pay IT. This will not only reduce the burden on the fewer people who pay IT but will also reduce the ever- increasing unfair Indirect Taxes.
- Removing 86% cash from circulation is a very fatal step and doing it without planning was most damaging to the economy
- This is an anti-poor move as these people would be at left to fight the system and would eventually incur the maximum loss
- The cost of demonetization implementation in India far exceeds the benefits that might accrue out of it.
- Widening of tax-base and a movement towards cashless transactions will be a positive step forward.