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Demonetisation: The chronicle of a failure foretold -C Rammanohar Reddy
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Because the exercise was doomed to fail in its primary objective of rooting out black money, the government kept changing its aims.

We have travelled a long way from November 8, 2016, when Prime Minister Narendra Modi told us that the black money held in Rs 500 and Rs 1,000 currency notes would become “worthless pieces of paper”. Now, we are told by the finance ministry that the government expected all demonetised cash to come back to the banking system.

Demonetisation was doomed to fail in its main objective of rooting out black money. It was, therefore, necessary to keep inventing new narratives. When it became impossible to hide the fact that 98.6% of the demonetised currency had returned to banks, the original aim of destroying black money had to be turned on its head.

We now have an expanded formal set of objectives. The real aims, we were told earlier this week by Finance Minister Arun Jaitley, were to reduce the role of cash in the economy, expand the tax base, push digitalisation and increase formalisation of the economy – and in all these respects, demonetisation has had a positive effect.

But today we know enough to say the immediate effect of demonetisation on the economy was, in a word, disastrous. Economic activity was severely affected for three to four months, with its impact being felt most by those who could not afford a shock. The urban informal sector, the rural non-farm sector and agricultural markets were all put through the wringer. People at the bottom of the ladder could not find work and many of those who had employment were not paid wages on time. All this has been reflected in revised numbers on GDP growth in 2016-’17; future revisions will show a bigger decline in the months after demonetisation. The Economic Survey Volume II estimated a 30% jump in demand under the Mahatma Gandhi National Rural Employment Guarantee Scheme in six of the poorest states during November 2016-January 2017, an indication of rural distress.

If we turn to medium and long-term impacts of demonetisation, the balance is far from weighing in favour of the positive.

Ill-gotten gains

One, it is said that most of the demonetised currency coming into banks is a positive development because all this cash is now part of the legal economy. Data analytics can be used to identify the suspicious deposits.

This is not just an after-the-event justification, it is an argument made in hope.

Those who deposited their undeclared income in banks were able to launder their black money into white. Some of them have presumably declared these deposits as income for 2016-’17 and have paid tax on them. They have chosen this route rather than come clean under the second amnesty scheme of 2016-’17 because they are supremely confident that they can, as in the past, buy their way out of trouble.

Two questions then. Why should we presume that these players will keep their funds in the banking system and not pull them out later? Why should we presume that their ability to continue generating black money has been diminished in any way?

The finance ministry has gleaned information on large deposits made in banks. The Reserve Bank of India also says there was a six-fold increase in 2016-’17 in the number of “suspicious transactions” in banks. Since end January 2017, the Income Tax Department has been investigating these deposits. We are told that as of May 2016, Rs 17,526 crore in undisclosed income was detected under Operation Clean Money. This is under 4% of the very large deposits, totalling Rs 4.89 lakh crore, made in 1.5 lakh accounts in November-December 2016, if we assume that all these deposits were from unaccounted incomes. The danger of now putting the burden of making a success of demonetisation on the Income Tax Department is that if it is unable to come up with definite results on a large number of money launderers, the pressure to deliver may lead to harassment.

Two, growth in tax revenue and increase in the number of taxpayers is claimed to be another success of demonetisation. When those who did not declare their income previously now launder their money and pay taxes, there will of course be a bump in tax revenue collection. Whether this bump would be permanent, and to what extent, depends on continued full disclosure of income. This also holds true for increase in the number of taxpayers since November 2016; all of them must remain in the tax net even after they have completed their money laundering operations.

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