Four years on

Even with hindsight, hard to say demonetisation was a success

It has been four years now since Prime Minister Narendra Modi went on national television to declare that currency notes of the Rs 500 and Rs 1,000 denominations would cease to be legal tender overnight. In these years, demonetisation has ceased to be a major subject of discussion. However, it is fair to say that demonetisation remains a controversial policy intervention and its benefits, if any, are even with hindsight hard to discern. This did not stop Mr Modi from tweeting in support of the move on Monday. The prime minister gave three broad areas in which demonetisation had been a success: In the reduction of black money; in increasing tax compliance; and boosting transparency. Some other officials, including the chief economic adviser, have also defended the policy recently.

From the government’s point of view, demonetisation needs to be seen as part of a series of steps intended to increase formalisation in the economy and to step up digitisation, especially of payments. Many of these, including the growth of the JAM (Jan Dhan, Aadhaar, and mobile) trinity and the increasing effectiveness of the United Payments Interface, or UPI, are indeed unquestionable positives from the point of view of increasing convenience and transparency. Yet their very success, and demonetisation’s place in the sequence of policy actions, make it hard to separate the effects of the note ban from those of these other policies. Was demonetisation an essential part of a formalisation and digitisation package? Can it be evaluated separately from the other policies? These questions remain unanswered in the government’s account. The data on this issue does not seem to support the government’s claim unequivocally. While the immediate payment system, or IMPS, has seen faster growth after demonetisation than prior to it, mobile transactions as a percentage of all transactions have largely returned to its pre-demonetisation growth trend. Currency in circulation as a percentage of gross domestic product was 12.1 in 2015-16, the last full financial year prior to demonetisation, when the ratio fell sharply. But by 2018-19, according to the Reserve Bank of India, it was back up to 11.2 per cent. Economists’ warnings that it is hard for acts such as demonetisation to change consumer behaviour in a sustainable manner seem to have been borne out.

When it comes to Mr Modi’s arguments on tax evasion, transparency, and black money, it is even harder to effectively declare success. Certainly, tax buoyancy increased in the years immediately after demonetisation. But it did so only when compared to those years immediately prior to demonetisation. It merely returned to the levels seen in 2012-13, and remained far below its pre-financial crisis thresholds. In terms of increasing the tax net, according to the finance ministry in Parliament, only 58 million income-tax returns were filed by individual taxpayers for the financial year 2018-19 till February 2020. And only 14.6 million individual taxpayers filed returns declaring income above Rs 5 lakh. This is in spite of not just demonetisation but multiple other attempts to plug tax leakage, including tax deduction at source on large cash withdrawals, the growth of Aadhaar, and so on. Finally, black money might have taken a one-time hit —but it is a flow as much as a stock. Given the amount of cash returned to banks, the size of the one-time hit is not clear, either.

The arguments on the negative side are clear. Informal enterprises in particular had diminished capacity after demonetisation and were further hurt by goods and services tax and then by the lockdown. Employment generation has also been hurt, according to various surveys. Even with hindsight, it is hard to claim that the possible positives of demonetisation outweigh the obvious negatives.