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Surprised That Damage From Demonetisation Was Not More, Says Ken Rogoff

Expecting that a part of the currency would not come back to the banking system was not ‘realistic’, said Ken Rogoff

Kenneth S Rogoff speaks during a television interview (Source: Bloomberg)
Kenneth S Rogoff speaks during a television interview (Source: Bloomberg)

India’s decision to withdraw 86 percent of its currency in circulation a year ago could have potentially led to a significant contraction in economic activity, particularly in the informal sector. As it turned out, Indians averted the impact of demonetisation in creative ways and the damage was not as much as was feared, said Harvard economist Kenneth Rogoff in an interview with BloombergQuint.

“...You would expect economic activity, particularly in the informal economy to contract a lot. But the Indian people seem to have been incredibly creative,” said Rogoff. “It is really a surprise that the damage was not much more,” Rogoff added.

The Indian economy grew at 6.7 percent on a gross value added basis in the October-December 2016 quarter. This was only marginally lower than the previous quarter, suggesting that the initial impact of demonetisation was limited. The next couple quarters, however, changed that view as GVA growth slipped to 5.6 percent.

Rogoff, author of The Curse Of Cash, said India’s experience was similar to that of the U.S. Back in the 1930s, when the U.S. economy was in the midst of the Great Depression, Franklin Roosevelt decided to shut banks for over a week. Then, too, Americans had found creative ways to keep business going, Rogoff said.

It reminds me of when a similar event happened in the U.S., at the time of the Great Depression. Roosevelt, the new president, closed the banks when he was elected. People didn’t have access to cash or to their checking accounts. Back then, Americans too, were very creative in continuing to do their business. The Indian change was more dramatic in some ways and it is really a surprise that the damage was not much more.
Kenneth Rogoff, Economist, Harvard University
Surprised That  Damage From Demonetisation Was Not More, Says Ken Rogoff

Rogoff added that while demonetisation may not change habits overnight, it could shake up the system and direct Indians away from the use of cash. Digital transactions have risen in the months after demonetisation and flow of funds into financial assets has increased. Currency in circulation also remains below levels seen ahead of demonetisation.

According to Rogoff, a clearer view on the economic impact of demonetisation would emerge only over the next few years. “I think it would be at least 3 years before we have any idea of how this has gone. But no people don’t change their habits overnight. This has shaken up the system. It has had a psychological impact. But no, it’s not going to that rapidly accelerate things,” he said.

In the meantime, demonetisation may proven to be a bigger political success than imagined, Rogoff added.

A year later, it has been a bigger political success that I might have imagined. If the Prime Minister continues to capitalise on that to try to root out corruption, to try to make the Indian economy more efficient, it could end up being judged a success.
Kenneth Rogoff, Economist, Harvard University

99 Percent Of Cash Came Back

One of the perceived objectives of demonetisation was to hit the stock of black money. As such, it was expected that at least some part of the Rs 15.4 lakh crore in currency scrapped, would not return to the banking system.

Data released in the RBI Annual Report in August, however, showed that nearly 99 percent of the currency had returned. Rogoff said this was inevitable. “I think that was very hard to avoid,” he said.

I think when you are doing something so dramatic, which affects the economy so much and there is collateral damage going on everywhere. In the end the government is not able to tediously check everyone bringing cash back. That part of it is just not realistic.
Kenneth Rogoff, Economist, Harvard University

While almost all of the cash returned to the system, the Income Tax department is continuing to scrutinize accounts where large deposits were seen. On Monday, wire agency PTI reported that over 20,000 tax returns have been picked by the tax department for detailed scrutiny against alleged irregularities in deposits during demonetisation.

The RBI estimates that the quantum of unusual deposits received during that period may have been to the tune of Rs 1.7 lakh crore. Rogoff said that while such steps could “discourage this kind of future activity”, the real test is in being able to restrict the use of cash for large purchases.

The real test is to restrict the use of cash in the future; make it more difficult to buy a house or an apartment (with cash) and to make it more difficult to avoid taxes. I think this is a step in shaking things up and making people aware that the government is committed to reducing the use of cash. But I think, the idea that you would be able to seize the black money is too optimistic.
Kenneth Rogoff, Economist, Harvard University

What’s The Verdict?

When asked how he would describe India’s demonetisation experiment, Rogoff, who in his book advocates a slow withdrawal of high value notes in developed nations, said that the cash exchange program should be seen as part of a larger set of changes.

“I would describe it as part of a larger set of changes to try and modernise the Indian economy, to try to reduce the size of the informal sector, and to try and create a greater federal India,” said Rogoff.

In an interview to Bloomberg News in December 216, Rogoff had commented: “If you’re a developing economy, don’t try this at home.” Since then, Rogoff says that he has received feedback from political leaders of emerging nations that the linkage between corruption and use of cash in these countries should not be underestimated.

In my book, I recommend this as a policy for developed countries first. Although I have had push back from a number of political leaders in emerging markets who tell me the corruption problem in emerging markets is much greater than in advanced countries. Finding ways to fight corruption is absolutely at the top of the list and you shouldn’t underestimate the importance of reducing cash usage in emerging markets.
Kenneth Rogoff, Economist, Harvard University