The following is an extract from the recent book Demonetisation and Black Money by economist C. Rammanohar Reddy, former editor of Economic and Political Weekly (EPW).
What Next?
In mid-February 2017, three months after Prime Minister Narendra Modi’s announcement on demonetisation, there were no immediate gains to be seen from the decision. True, the benefits, if any, of something as major as Demonetisation 2016 cannot be reaped immediately, they are to be had only in the long term. There was one immediate outcome and this was the colossal amount of hardship experienced by the citizens of India. That most of the affected people did not openly express their unhappiness at having to bear this hardship does not reduce its severity.
While many economists forecast that the Indian economy had experienced significant damage from which recovery would be slow, some said that the economy would quickly bounce back from the downturn in growth. As of mid-February, there was no evidence of that as yet, but even if that happened, why cause a dislocation in the first place?
All the disruption and distress, to what purpose? When assessed in terms of the objectives of Demonetisation 2016, the outcome was unclear.
The government is yet (mid-February 2017) to present an estimate of how much of counterfeit currency that had been in circulation had been neutralised by demonetisation. It would also be time before the efficacy of the new security features in defeating counterfeiting could be assessed. In any case, as has been argued in this book, dealing with counterfeit currency did not require the suddenness and consequent harshness of a design and implementation as contained in Demonetisation 2016.
Originally, the main objective was to destroy black money held as cash in the form of Rs 500 and Rs 1,000 notes. But it is in the unearthing of black money that the outcome of Demonetisation 2016 has been very clearly limited. Demonetisation has not, as promised, turned ‘worthless’ the black money held in high denomination notes. The numbers released until early December 2016 indicated that most of the currency had already entered the banking system. Very little seemed to have been held back by holders of black money scared to enter the banking system.
The success of Demonetisation 2016 in unearthing black money that was circulating in the form of the demonetised high denomination notes now depends, in the first instance, on the new amnesty scheme, the PMGKY, receiving a large amount of disclosures. If the PMGKY does not yield declarations running into lakhs of crores (trillions) of rupees, yet another avenue will have to be explored. That would be the income tax authorities identifying holders of black money who did not take advantage of the PMGKY. Will the government, keen to show it has been successful with the demonetisation exercise, ask the income tax authorities to go after all those who made large deposits in banks between 10 November and 30 December 2016? This raises the spectre of harassment. Indeed the biggest concern, irrespective of the assurances of the government, is that we are now entering an era of tax harassment as government agencies set about trying to prove that Demonetisation 2016 was a major success in unearthing black money and improving tax compliance.
One of the central arguments in this book is that whichever way one looks at it, Demonetisation 2016 was not a good idea. One, very little of black money is held in the form of cash, so demonetisation was not going to destroy much of the unaccounted wealth. Two, even if the government did want to track down unaccounted cash, demonetisation itself was not the best way to go about it since it hurt the entire population while trying to ensnare a small number of holders of illicit cash. An alternative would have been to collect, analyse and follow up on information on large cash withdrawals from banks and thereby identify possible flows of unaccounted cash. Three, if, in spite of all the risks and limited chances of success, the government still wanted to go ahead with demonetisation, then the manner in which Demonetisation 2016 was designed and implemented was neither the only option nor the best one. There were other less destructive options available.
In public discussion, ‘formalisation of the informal’ emerged as a new rationale for Demonetisation 2016 after the event. Demonetisation and then digitalisation of monetary transactions would compel, it was argued, the informal sector to be henceforth more tax compliant. It was also argued that the introduction of the Goods and Services Tax (GST) would only strengthen this process. It is indeed well-known that in large sections of the informal sector—real estate, retail and wholesale trade, and professional services—payment of taxes is often not the norm. Demonetisation and digitalisation may drag these economic agents into the formal sector and lead to greater tax compliance. However, the fundamental problem with the ‘formalisation of the informal’ argument is that the much larger informal sector that ekes out its livelihood on the margins does not avoid paying taxes, it just earns too little to fall into the tax bracket. Formalisation of production by the tiny enterprises in industry, road-side service establishments, and by small- and medium-sized farmers would not lead to a gain to society. It would, in fact, put an additional burden on these producers who are already struggling by earning low incomes.
Some weeks after demonetisation was announced and when it became clear that a large amount of the high denomination notes had already entered the banking system, digitalisation emerged as the main agenda from Demonetisation 2016. It remains the most important item on the agenda. The focus now is on how to accelerate the adoption of electronic payments at all levels—from households upwards. There remain many infrastructural and economic constraints to accelerating digitalisation. That, however, is not the issue with the emergence of digitalisation as an action programme after Demonetisation 2016. The main issue is, did the economy have to be put through the demonetisation wringer in order to drive it towards digitalisation?
Digitalisation of payments is a process that has been underway in India for a decade and more. It has made considerable progress in transactions between companies in the organised sector and among those comfortable with electronic/on-line forms of payment. The larger population is, however, right now outside the scope of digital payments. Even with the Jan Dhan financial inclusion programme and the telecom revolution, major constraints in infrastructure and also issues relating to a lack of familiarity and unaffordability tell us that digitalisation cannot be hurried without running the risk of exclusion. Yet, the one major agenda that the government has been driving since Demonetisation 2016 has been digitalisation.
For some, it is not any concrete gain that matters, but the long-term ‘psychological shock’ that Demonetisation 2016 will inflict on the behaviour of people. The holders of black money will have experienced such a major shock that they will, it is said, decide that tax compliance is a better strategy than running the risk of losing everything in the future. But the immediate outcome seemed very much the opposite. That almost the entire stock of demonetised currency had entered the banking system showed the ease with which such individuals and organisations could get the better of the system. It also reflects the confidence they have of subsequently managing the system, in case there are to be investigations in the future.
The more likely psychological shock was a harmful one. Some commentators pointed out that the upheaval caused by the removal of 86 per cent of the currency in circulation had unnerved ordinary people, the honest citizens. The trust they had reposed in the currency issued by the central bank and the government had been shaken. This is an unhealthy development in a modern economy.
Yet, the promise initially was of something else. Soon after demonetisation had been announced, in the intense debate that followed it was pointed out by many that this action by itself would do little to destroy black money and do even less to end the future generation of black money. The government in response said that demonetisation was neither the first nor the last measure to be taken to destroy black money. More steps were to follow in what was promised would be a larger war.
There was little of that kind to be seen in the next three months, save the limited measures on political party finance announced in the Union Budget for 2017–18. It appeared as if the promised action was not to follow.
