On November 8, 2016, most Americans, and many across the world were glued to the U.S. news – Donald Trump had just won the presidential election. But in India, 1.3 billion people had their attention shifted to their wallets as 86 percent of the cash in circulation was demonetised overnight.
It is perhaps, the single most devastating economic move in recent times. To understand what was happening during this period, one had to keep their ears glued for Reserve Bank of India announcements. These were not always reliable. Both the government and Reserve Bank of India kept everyone on their toes by changing goalposts and policies on the fly.
The first promise was to tackle ‘black money’ – untaxed income that formed the bulk of India’s economy. It was believed that this took the form of cash and that a digital payment/ banking revolution would clean the system up for the taxman. The second promise was that terrorists and insurgencies would face a cash crunch. The third, simply, was that it was necessary to boost tax revenues.
Much has been written on the tremendous inconvenience that demonetisation cost the Indian public. The question that’s on everyone’s mind right now is simply this: Was it worth it?
Frame by frame
Three financial quarters have passed us by since demonetisation took place. The dust was still settling as elections were won, economic surveys released and a Union Budget delivered to Parliament. Many economists, much-maligned for their negative critique of demonetisation, awaited the latest set of numbers that could prove or disprove whether the move was a fiscal disaster.
Initially, the numbers were contradictory. Despite a very visual shutdown of the economy, India maintained a seven percent growth rate in Q3 of 2017 (October – December). Even standing still, it was the world’s fastest growing economy.
Q4 (January to March) saw the first signs of a slowdown. GDP growth was 6.1 percent. Sectors like industry had seen growth half from the previous quarter. Agricultural growth dropped from 6.9 to 5.2 percent. But it was still surprising that there was growth. One explanation was that manufacturers kept making goods, but only shipped them to dealers – without any sales. Since GDP can be measured by output as well, this did not reflect poorly on Q3’s growth. The same situation struck farmers – spurred by a strong monsoon, they grew more crops. When there was no cash, they let their payments be deferred.
From a strong start to 2017, the numbers grew worse. Banks started lending less, with credit growth severely stunted from previous year figures. The country’s largest lender, the State Bank of India, warned that this situation could continue.
What about black money? When the RBI finally finished counting the demonetised notes on August 31, 2017, they found that they’d received 99 percent of the cash in circulation back. It throws shade on the idea that black money was somehow destroyed by the move. But it could also be that a great deal of illegal money was turned ‘white’ by depositing it in banks. The outcome will depend on how the Government’s taxmen (and the Financial Intelligence Unit) can differentiate black from white.
The latest announcement is that GDP growth has crumbled. At 5.7 percent in Q1, 2017, it shunts India far from its position as the world’s fastest growing economy. Worse, this is the sixth consecutive quarter of falling growth.
The prime minister’s logic for the timing of demonetisation – during a period of fast growth – was that you perform surgery on a healthy body. Whatever the state of the economy then, the surgery seems only to have made the patient sicker.
Manufacturing had little time to rebound before the rollout of the Goods and Services Tax (GST) took place. Now the sector is slowing again as industries retool to comply with new regulations. Unemployment remains at 3.4 percent which is lower than historical averages, but still a depressing tale when accompanied by weak job growth figures.
The phase of point-and-blame is over now. Days after demonetisation, Dr Manmohan Singh (India’s previous Prime Minister), predicted a two percent drop in GDP. We are now at that stage.
It is unclear what exactly the Government tried to achieve with demonetisation. NPR interviewed the man who pitched the idea to Narendra Modi (four years earlier, in 2013) – Anil Bokil. For him, the enemy was corruption – the mafioso who drained India’s wealth from its rightful place in tax coffers. His analogies are unclear – and whether the note ban achieved this is in question. In March, Transparency International declared India the most corrupt nation in Asia.
There is an urgent need for job creation, greater access to credit and digital payments. The government has shown its disdain for the cash economy before, and if demonetisation achieved anything, it was to show the stark difference between those who had digital payments and those who did not. If there is to be another round of demonetisation, as some fear will happen to higher denominations of currency, the government needs a better digital payments infrastructure in place.
Perhaps, most importantly, it’s time the government started listening to its economists. Anil Bokil was an engineering student. Narendra Modi is a politician. And the opinions of both the present and former RBI governors seems to have mattered little during policy conceptualisation. From Raghuram Rajan (last Governor of the RBI) to Arvind Panagariya (Chairman of the chief decision-making think-tank NITI Ayog, is on his way out) to the infamous ‘hard work is more powerful than Harvard’ statement, Modi has shown a disdain for measured expert advice.
It’s ironic then, that Panagariya’s next move is to teach at Columbia University. But perhaps his final piece of advice could be worth heeding – improve the country’s Ease of Doing Business ranking. India’s best hope remains its people. Doing business in the last year has been a herculean task with the combined burden of demonetisation (affecting everything from payment of salaries to supply chains) to achieving GST-compliance.
Too many ‘shock therapies’ will rob India of its appeal as an investment destination. India will have to sprint to regain its ‘fastest-growing economy’ tag. If Modi wants to achieve his promise of minimum government and maximum governance, now is his last chance to start. Because everything else that has happened under this administration suggests the opposite.
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