While the immediate impact of demonetisation was seen in the long queues outside ATMs and felt through acute cash shortage, its anniversary is an appropriate vantage point to assess the less visible and generalised effect on the economy of what was easily the most disruptive measure post-Independence.
The difficulty in making a cost-benefit analysis is that the move was not purely economic, given the fact that the currency issuer Reserve Bank of India (RBI) had no role in the decision, as testified by former Governor Raghuram Rajan.
So demonetisation comes across more as a measure of political economy with the declared objective of curbing black money and countering counterfeiting and terror finance, and which appeared to have paid political dividend to Prime Minister Narendra Modi in the Uttar Pradesh elections this year.
Starting with the official figures, at the end of May, the Central Statistics Office announced that GDP during the fourth quarter, ending March this year, fell sharply to 6.1 per cent from seven per cent in the previous quarter, while growth for the year as a whole was also expected to decline correspondingly. India’s GDP during the past fiscal grew at 7.1 per cent, at a rate lower than the 8 per cent achieved in 2015-16.
In terms of gross value added (GVA), which excludes taxes but includes subsidies, the growth came in even lower at 5.6 percent over the GVA for 2015-16.
Chief Statistician T.C.A. Anant sought to downplay the impact of the note ban, saying he “would caution against reading a single number that comes out after an event as being reflective of consequences of the event”. At the time of releasing the previous quarter’s GDP, he had said that this was based on figures on industrial production and only on the advance filings of corporates.
The numbers, therefore, had not factored in the informal economy, which accounts for an estimated 45-50 per cent of output in the Indian economy and employs around 85 per cent of the country’s workforce. More importantly, this sector transacts entirely in cash and was the hardest hit by demonetisation, which withdrew 86 per cent of currency from circulation.
Former Chief Statistician Pronab Sen had said in March that once the informal sector numbers came in, the growth rate could go below 6.5 per cent, which turned out to be close to the actual figure.
At the same time, both the RBI and the International Monetary Fund (IMF) lowered India’s growth estimates for 2016-17 by up to 1 percent, citing the impact of demonetisation.
This was not too far from former Prime Minister Manmohan Singh’s prediction that the economy would be hit by around two per cent because of the note ban.
Rating agency ICRA said in a note earlier this year that “since the early estimates of quarterly GVA rely heavily on available data from the formal sector, which is expected to have weathered the note ban better than the informal sector, the third quarter (October-December) projected GVA growth of 6.6 per cent may not fully capture the impact of the note ban”.
In October, the IMF said in its latest World Economic Outlook that India’s economic growth for 2017 and 2018 will be slower than earlier projections. The report cited “lingering impact” of demonetisation and the goods and services tax (GST) for the expected slowdown during the current and the next year. The IMF projected India to grow at 6.7 per cent in 2017 and 7.4 per cent in 2018, which are 0.5 and 0.3 percentage points less than the projections earlier this year, respectively.
The World Bank too forecast that India’s GDP may slow from 8.6 per cent in 2015 to 7.0 per cent in 2017 because of disruptions by demonetisation and the GST.
Former RBI Governor Raghuram Rajan, who, on being asked by Modi for his informal opinion, had said the costs of such a measure would outweigh any long-term benefits, while there were less costly alternatives to achieve the stated goals of demonetisation.
“On the short-term costs of such a measure, monetary economists would say that you’d see an immediate impact on activity. People who used currency, things would shut down for them… there would be an unrecoverable effect on economic activity,” Rajan said here at the launch of his book “I Do What I Do”.
Citing the cost analysis by metrics of demonetisation done by JP Morgan, Rajan said the GDP took a hit of around 1.5 per cent, which translates to a sum of Rs 200,000 crore.
“On the benefit side you have Rs 10,000 crore coming in, but you need a lot more taxes than that to really benefit,” he said.
Coming back to the beginning, this is what Nobel winning economist Amartya Sen had to say of demonetisation: “It is a despotic action that has struck at the root of the economy based on trust. It undermines notes, it undermines bank accounts, it undermines the entire economy of trust. That is the essence in which it is despotic.”
With demonetisation also designed to enlarge the tax base, an ex-IRS official’s perspective on Modi’s likely motive is provided by former Director of Revenue Intelligence B.V. Kumar, who writes in his book, “Underground Economy”: “One reason could be that Modi has completed half his term and not a single initiative during his term has shown results which can be termed as ‘spectacular’ and ‘vote spinners’.”
Demonetisation, after one year, does not look as rosy as it was painted out to be by the image spinners in the government.