Demonetisation: The Big Event That Turned Out To Be A Non-Event

Depending on which side of the demonetisation debate you were on, you either thought it was a brilliant idea or a dreadful one. Everyone was impacted. Rich or poor. Rural or urban. Everyone had a point of view. Good or bad.

As time has passed, passions have cooled and data has (finally) been released, it appears that demonetisation turned out to be, well, a bit of a non-event. It had some negative impact, it had some positive impact, but, in final analysis, it didn’t shake the earth.

Here’s why.

Data released by the Reserve Bank of India (RBI) in its annual report shows that Rs 15.28 lakh crore in demonetised notes had returned to the system as of June 30, 2017. This is nearly 99 percent of the Rs 15.45 lakh crore in currency that had been scrapped because of the withdrawal of legal tender status for Rs 500 and Rs 1000 notes.

What Demonetisation Failed To Do

If the government’s hope in announcing demonetisation was to hit the black economy, then the data released by the RBI shows that objective was not met. While announcing the decision to withdraw Rs 500 and Rs 1000 notes, Prime Minister Narendra Modi said this was being done to “break the grip of corruption and black money.”

The objective to hit black money could have been fulfilled if a significant amount of money had not come back into the system. Essentially that would have suggested that those who were sitting on unaccounted cash had been forced to forego this wealth. If a large amount (even 25 percent of the currency withdrawn) had not come back, the government could have argued that some part of the ‘stock’ (the part held in cash) of black money had been eliminated.

If this had been followed by the implementation of the Goods and Services Tax (GST), the government could have further argued that it is slowing the ‘flow’ of black money by bringing more transactions into the tax net.

As things stand, the stock of black money remains untouched. The flow, and whether it slows, is dependent on the successful implementation of the new indirect tax system.

What Demonetisation Did Do

What demonetisation did do, predictably, was deal a blow to the economy. With 86 percent of the currency gone, the economy was bound to take a hit. But the hit may have been less than expected and may pass soon.

GDP data for the fourth quarter of 2016-17 showed that growth had slowed to 6.1 percent from over 7 percent in the previous quarter. With the slowdown emerging from sectors like real estate and finance, that this decline in economic momentum was linked to demonetisation seemed an inescapable conclusion.

But the impact was not as bad as some had feared and dire predictions of growth stalling did not come true.

On Thursday, the government will release GDP data for the first quarter of the current fiscal. Most economists expect growth to revive to near about 6.6 percent. If economic activity shows a rebound and settles back at levels seen before demonetisation, then the storm would have passed with some damage but without crippling the economy.

What Demonetisation Might Have Done

Not all questions have been answered with the release of the information that 99 percent of the currency withdrawn came back to the system. There is still the question of what happens to those deposits.

In a press conference called after the release of the data, Finance Minister Arun Jaitley argued that tax authorities are mapping suspiciously large deposits. Earlier this month, the RBI had said that Rs 1.7 lakh crore in unusual deposits have been detected. It is possible that at a later stage some of these deposits will get taxed and government may be able to claim a fiscal benefit from demonetisation. But it will be a small benefit. Nowhere near the estimates of the windfall gain that some had predicted at the time of demonetisation.

It is also true that there has been an increase in flows into financial assets in the months after demonetisation. There has been a “distinct increase” of inflows into formal channels of savings such as equity and debt-oriented mutual funds and life insurance policies, said the RBI in its ‘Mint Street Memos’ earlier this month. Equally, there has been some increase in electronic transactions. And currency in circulation is now at 10 percent of GDP compared to 12 percent earlier.

But has demonetisation move the needle in any of these respects? Has the usage of cash in the economy slowed dramatically? And has the preference of Indians for physical asset investments been shaken for good? No one can argue that.

Was RBI The Big Loser?

While the economy may get away with saying that demonetisation was not-too-hot and not-too-cold, the country’s central bank will have no such luxury.

Questions about whether the RBI central board could have prevented this seemingly unnecessary event from unfolding still remain. Equally, it is still relevant to ask whether the RBI was ill-prepared and if it had done a thorough cost-benefit analysis before proceeding with demonetisation.

The RBI would do well to ponder whether demonetisation (and its handling of demonetisation) hurt the so-far stellar perception of the Indian central bank more than it did the economy.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.