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Mainstream, VOL LV No 38 New Delhi September 9, 2017

Reassessing Demonetisation: ‘RBI says 99 per cent is back’

Interview with Prof Arun Kumar

Saturday 9 September 2017


According to the RBI, 99 per cent of the demonetised currency has come back to the banks. What, in your opinion, is the significance of this statement? 

What the RBI has announced now was known to it as early as on January 13, 2017. Our article in Economic and Political Weekly has shown that by that date 98.8 per cent of the demonetised notes had come back to the RBI. What has now been announced is only a confirmation of that. So the question arises: why did the RBI not reveal this fact earlier? It was making excuses that it was recounting, reconciling the cash that had been deposited. These were merely excuses because they (the authorities) were highly embarrassed that most of the money had come back which they had not expected. They estimated that Rs.3 to 4 lakh crores would not come back and then they would claim the success of the scheme of demonetisation.

Now, knowing that all the money has come back, they have changed the goal-post and they are at the moment saying that all the money coming back is good for the system because the black money has also returned and it may be caught by the IT Department as it was deposited in the banks.

However, the question arises: which of the two is the correct situation? The money being deposited in the banks does not mean that it is black. It has to be proven by the IT Department that what has been deposited is black or white, and only after that can any action be taken by the government.

But this is a long and time-consuming process. Notices have to be issued and examined; and appeals will be made against any adverse orders of the Income Tax officers and in the end it is seen that the IT Department loses in most of such cases.

The government is also saying that we will go for large data analyses to catch the black money generators. But we know that in July 2016, the Chairperson of the Central Board of Direct Taxes said that the department has data on 90 lakh high-value transactions between 2009 and 2015 and this would be used to catch the black money generators. But till date nothing has come out of that. So what is the guarantee that the new data they have now will help them in catching the people who are guilty?

 Similarly, the government is claiming that new taxpayers have emerged as a result of demonetisation. But it is not very clear as to how many people have been identified because the Finance Minister had given the number as 91 lakhs while the PM gave the number as 56 lakhs. And, Part II of the Economic Survey, which has now been released, has given the figure as 5.4 lakhs.

However, be that as it may, more taxpayers filing their IT returns has not meant a propor-tionate rise in the tax collection.

So, the data for 2012-13 reveals that out of 52 million taxpayers, only 17 million were effective taxpayers. The rest of them paid little or no tax.

The Economic Survey Part II says about Rs 10,000 crores of income has been declared by the 5.4 lakh new taxpayers. The tax collection on this amount would be a maximum of Rs.3500 crores which is negligible compared to the direct tax collection now of about Rs 8 lakh crores. Therefore, the tax base too has hardly expanded.

Demonetisation was based on the assumption that ‘black means cash’. But unfortunately that is not the case because cash is also used for the white economy. Businesses need cash for making transactions and households need cash for day-to-day requirements. For example, a petrol pump which on a daily basis transacts Rs 20 lakhs would have deposited in 50 days Rs 10 crores and this cannot be called black. Similarly, hospitals, travel agencies, other businesses, etc., could have legitimate large transactions daily. So, the deposit of large amount of old notes cannot be called black. It needs to be established that it is from black income.

All this shows the utter failure of the scheme of demonetisation to tackle the black economy.

The government had expected to tackle the issue of counterfeit currency through demonetisation but according to the RBI’s report, they have detected about Rs 40 crores of fake currency. This is a very meagre amount compared to the Rs 15.44 lakh crores of demonetised money. In this sense this objective has also not been achieved. In any case, reports indicate that new fake currency has come into the system. So was this elaborate exercise at all necessary?

This exercise, which was ill-planned, was done without preparation and caused severe hardship to the common man and damaged the country no end. Clearly, the objectives stated right at the outset by the PM in his speech to the nation on November 8, 2016, have not been achieved.

What has been the overall impact of demonetisation on the economy? 

This scheme, which could not achieve its primary objective of tackling the black economy, damaged the white economy substantially. The economy, which the government had then claimed to be the fastest growing economy in the world, received a big shock.

The Indian economy consists of a large unorganised sector which operates largely with cash. It consists of small units which usually do not have bank accounts or access to electronic transfer of funds. So, a cash shortage meant that they could not do transactions and their business came to a halt. They could not pay wages or buy raw material, etc. Reports from various surveys conducted during that period show that they were impacted by this cash shortage to the extent of 60 to 80 per cent.

The unorganised sector in India employs 93 per cent of the workforce and produces 45 per cent of the output. So the impact of demoneti-sation affected the employees and many of them had to go back from the cities to the villages. It is a result of this migration that demand under the MGNREGS went up by a factor of three and four in December. If we take out agriculture from the unorganised sector, then the remaining part would be 31 per cent of the GDP and if this fraction of the economy contracted by 60 per cent, then the rate of growth for that period would be negative. The impact of demonetisation on the unorganised sector was also felt by the organised sector and its rate of growth also declined but not by so much because it had access to banks, electronic transfers etc. and it supplies to the well-off who were not hit so badly.

When demand declines and production falls, then capacity utilisation of the industry goes down. The data from the RBI shows that capacity utilisation was already low in October 2016 and it fell further after demonetisation. The impact of the low capacity utilisation is on investment. Already in October 2016 investment was sluggish and fell further after demoneti-sation. The data from the CMIE shows that investment fell from Rs 2.5 lakh crores in the December quarter in earlier years to Rs 1.36 lakh crores in 2016.

When investment falls, long-term growth comes down and that is what we are witnessing in the Indian economy: a short-term problem of money shortage has become a long-term problem of declining growth.

So, the people who say that the effect of demonetisation is over, are not correct. The effect of demonetisation is continuing in the Indian economy and has been aggravated by the intro-duction of GST in the economy in July 2017.

The argument for slowdown is also supported by the declining credit off-take from the banks. This happens when the rate of growth of the economy falls and investment is sluggish. Already in October 2016 credit off-take from banks was at a historic low of the last fifty years. That fell further after demonetisation to a historic low of sixty years. And further in July 2017 credit off-take has turned negative, something which has not happened before. This again indicates an economic slowdown.

Farmers too have been adversely impacted by these developments because of the decline in demand in the economy. So, prices of perishables, like vegetables, fell sharply after demonetisation. Since they needed cash to carry on Rabi production, they had to sell the other crops also at lower prices or buy the inputs at higher prices. Thus, the incomes of farmers fell and they faced difficulties in returning the bank loans and getting fresh loans for the next crop.

All this has led to large-scale protests by farmers and also the continuation of suicides by distressed farmers.

The banks in India faced a huge crisis due to demonetisation. They had no time for their routine operations and their NPAs increased further. This has meant a decline in their capacity to lend funds for productive purposes. Because of excess liquidity they lowered the interest rates but that has not led to any increase in credit off-take or increased investment.

How do you view the future?

Given the decline in demand in the economy, especially in the unorganised sector, the portents for the future are bleak. Without a revival in the investment growth, there can be no pick-up. So how to generate demand in the economy is a matter of serious concern. The government would have to step in with major investments and further infrastructure expenditure and expenditure on education, health and social welfare, especially in rural areas. This would also boost employment generation which has become essential because the youth are facing the problem of unemployment in a big way and they are protesting.

In conclusion, we can say that tackling black money is important for India but it cannot be done by demonetisation. It did not achieve its stated goals but on the contrary has considerably damaged the economy and it would take some time for the country to recover from this shock. It impacted those who never generated any black money but those who did, escaped. Its political and social implications would play themselves out in the future. Finally, it is an authoritarian move while what is needed is strengthening of democracy by building accountability of our businesses and politics. This is hard work but there is no silver bullet.

 Prof Arun Kumar is the Malcolm Adiseshiah Chair Professor, Institute of Social Sciences, New Delhi. He is a retired Professor of Economics, Jawaharlal Nehru University, New Delhi.

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