Slaying an Old Demon

THE IMMEDIATE AFTERMATH of the Modi government’s shock November 8, 2016, decision to demonetise bank notes of `500 and `1,000 was marked by an intriguing duality. On the one hand, there were long queues at banks and ATMs as thousands of people sought to change or withdraw cash, and at the same time an element of glee was clearly discernible. Employees at various offices, cabbies, helps and casual workers seemed to derive vicarious pleasure from the seth running around trying to dispose of cash either through brokers who sprung up overnight or—as a last resort—stuffing notes into bank accounts, a process that could lead to a fresh tax assessment. Many small and medium local businesses gave workers advance salaries up to six months or even a year in order to account for cash they held.

The merits of demonetisation will be, despite the recent Supreme Court order upholding the government’s decision, discussed for years to come. But it was apparent soon after its announcement that “demon” was a political success. This was further established in the months ahead when elections to the Uttar Pradesh (UP) Assembly and Municipal Corporation of Delhi (MCD) were held. Despite reports of rural distress caused by demonetisation, with some farm unions ferrying the media to western UP where farmers were ostensibly dumping vegetables and milk on the road, the Bharatiya Janata Party (BJP) and its allies swept the Samajwadi Party (SP) out of office, winning 325 of 403 seats. In the Delhi municipal elections where any urban anger would surely have manifested itself, BJP bucked predictions and won a third successive term by big margins. In fact, demon failed to turn the masses against BJP as many saw it in class terms. Projecting the decision in terms of a class war was perhaps not the initial objective, but ironically enough, it did no harm to Narendra Modi’s ‘pro-poor’ image. Modi summed it up by noting, “The poor are sleeping soundly and the rich are buying sleeping pills.”

The inability of the demon-hurt-the-poor charge to stick meant criticism of the measure lost its sting. The popular verdict having been given and demon failing to impact results even in other state elections in Punjab, Goa, Uttarakhand and Manipur (BJP formed governments in three of these states) meant it was left to economists, policy wonks and legal minds to slug it out. Unsurprisingly, as has been the case since Prime Minister Modi assumed office, the verdict was sharply divided. BJP’s ideological opponents insisted that none of demon’s stated objectives was realised. Black money that was supposed to be extinguished returned to bank accounts, growth of cash revived after a lull, many businesses were devastated and demon was a colourable exercise of power that subjected people to intense hardship. As more measured analyses showed, the effects of demon could not be presented in such stark terms.

Demonetisation did not collapse the economy. India’s official GDP projections did not vary much from those made by international agencies like the World Bank and IMF. It was a big nudge to change social and economic behaviour. The poor realised the merits of keeping cash in banks and the rich figured out that illegal cash was a big risk

Share this on

The economy slowed, but did not stall. India is a continental-sized economy and different parts were affected in varying measures. It is true that a large part of the scrapped `15.44 lakh core currency found its way to bank accounts and this was not part of the government’s calculations. But, as the Centre submitted to the Supreme Court, “self-assessment tax in the year 2015-16 was Rs 55,000 crore and Rs 68,000 crore in the year 2016-2017, it has jumped to Rs 1,00,000 crore in the year 2017-18… as a direct benefit of demonetization, the volume of Unified Payments Interface (UPI) transactions shot up from 1.06 crore in 2016-2017 to 90.5 crore in 2017-18 and further to about 5,000 crore in 2021-22. Value of UPI transactions grew 1,210 times in 2021-22 as compared to 2016-17… real GDP growth in 2017-18 was higher than the average annual growth of 6.6% in the decade (2010-11 to 2019-20).”

It is indeed a fact that some sectors of the economy took a hit though the trough did not last long. A comparison of Q3 of 2015-16 and 2016-17 revealed that mining and quarrying declined from 13.3 per cent to 7.5 per cent, manufacturing from 12.8 to 8.3 per cent, construction from 3.2 to 2.7 per cent, financial and real estate from 10.4 to 3.1 per cent. But a comparison between Q2 and Q3 of 2016-17 also shows that some sectors improved in the October-December timeframe even if the rate of growth slowed. Then, a Q3-on-Q3 comparison for 2015-16 and 2016-17 shows that agriculture, forestry and fishing rose from minus (-) 2.2 per cent to 6 per cent, electricity and utilities from 4.1 to 6.8 per cent, and so did public administration from 7.5 to 11.9 per cent. Trade, transport and hotels declined but were higher than Q2 of 2016-17. The percentage change in gross value added at basic price in Q3 of 2015-16 and 2016-17 saw a dip from 7 to 6.6 per cent. It is fairly evident that demon did not collapse the economy and its effects were uneven. Also, though the National Statistical Office (NSO) was accused of massaging data, India’s official GDP projections did not vary much from those made by international multilateral agencies like the World Bank, the International Monetary Fund (IMF) and the Asian Development Bank (ADB).

The majority 4:1 ruling of the Supreme Court has upheld the legality of the demon exercise, concluding that it is in conformity with the Reserve Bank of India (RBI) Act. It has dismissed arguments that RBI did not exercise its mind and acted on the Centre’s prompt. In doing so, it clarified an important constitutional and governance issue relating to RBI’s functioning when it held that the central bank and the government did not act in silos. RBI does have its mandate but the fact that the Centre asked it to consider demonetisation and its board agreed does not violate the law. As the US Federal Reserve’s rules note, it is an independent government agency but one that is accountable to the public and to Congress. Central banks everywhere are not insensitive to the concerns of governments. In fact, in times of crisis, such as the 2008-09 financial crisis, they must act in concert. The Covid and Ukraine challenges present similar situations. In more normal times, while RBI acts to control inflation, it does not lose sight of the growth argument. The informal consultations between the RBI governor and the government are continuous. As minutes of RBI’s Monetary Policy Committee (MPC) show, there is a thorough discussion among all members. The problem arises when the government turns overbearing (UPA’s Finance Minister P Chidambaram and then RBI Governor D Subbarao were at loggerheads) or when governors fashion themselves as public intellectuals pronouncing on all manner of government policy as Raghuram Rajan did (although his differences with the government did not prevent him from exploring a possible extension).

In the end, demon was a big nudge to change social and economic behaviour. The poor realised the merits of keeping cash in banks rather than in trunks and the rich figured out that illegal cash was a big risk. As far as “cash is back” arguments go, they often do not compare the rate of growth of currency and the phenomenal rise in digital payments. Without doubt, demon significantly spurred the formalisation of the Indian economy.

About The Author

Rajeev Deshpande

•