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Demonetization: Success or Failure?

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I have been perplexed by the consensus among some eminent economists and common people alike about the “failure” of demonetization. It has been denounced as everything from a monumental failure to an unmitigated disaster. I will try to present a contrarian view to this opinion and articulate my thoughts.

The criticism of the move broadly rests on two rather rickety pillars. They are:

  1. Dip in GDP growth, especially in the Apr – Jun and Jul – Sep ’17 quarters
  2. The suffering caused to the common people due to acute cash shortages

Both the above criticisms seem to be flawed. Let me explain why –

1. Dip in GDP growth rate – By all accounts, most of the cash was back in the system by Feb/March 2017. So the fact that the slowdown started post April defies logic. There was a very minor slowdown in the Oct – Dec ’16 and Jan – Mar ’17 quarters, which was the actual duration of the cash crunch. It is likely that the subsequent dip was owing to other extraneous factors like GST, but not DeMo.

2. Suffering caused to people – There is no denying the fact that people endured significant hardship during the period. However, I do think that some economists and armchair experts overestimated the extent of trouble faced by people. This is borne out by the numerous electoral victories won by the ruling party in subsequent elections, right from panchayats to the largest state in India. Case in point: their vote share jumped from 15% to 45% in UP, which is inconceivable if people were reeling and resentful of this move. I, for one, would never vote for a government which caused me hardship, or to lose my job. The job loss numbers seem to be exaggerated too.

Now let me come to some of the benefits of the move, which are not highlighted enough.

1. Creation of an audit trail – The primary criticism of DeMo has been all the cash returning to banks in the stipulated period. While this is a legitimate criticism, it overlooks one important detail. Cash returned to the system has created a trail for every single penny circulating in the economy, which is now being used for data mining and analytics, for further investigation. Every single rupee is now accounted for. One interesting stat – 33% of cash (almost 5 lakh crore rupees) has been deposited by less than 0.1% of the population. Clearly, there is something askew. A lot of it could be ill gotten wealth deposited through shell companies.

2. Dramatic rise in bank deposits – RBI data has shown a net increase of 25% in deposits with banks post DeMo, which has not been withdrawn by depositors to this day. This has provided banks with excess liquidity, which they have used to purchase recapitalization bonds issued by the govt, among other things. The proceeds are being used by the govt to shore up the depleted capital levels of public sector banks. This has met with a lot of approval, exemplified by the sovereign rating upgrade by Moody’s, India’s first in 14 years. This wouldn’t have been possible if not for DeMo.

3. Reduction in total money supply – The economy has seen a remarkable drop in total currency in circulation, which indicates 2 things – excessive liquidity being sucked out of the system, and a move towards digital and non-cash modes of payment. This is likely to lead to reduced inflation in the longer term.

4. Shift from investment in physical to financial asset classes – There has been a marked shift from physical assets like gold and real estate to financial assets like capital markets and mutual funds. This could reduce the prices of physical assets like real estate due to drop in excess demand. Coupled with other measures like Benami and RERA this could make homes more affordable for the middle class, not to mention the reduction in money laundering in that sector.

5. Formalization of economy – There is a spike in digitalization and formalization of the economy, which bodes well for the future, being one of the stated aims of the move.

There could be some other advantages like reduction in terror financing and counterfeit currency which could become manifest in the future, but these have not been included for lack of evidence at present.

Needless to say, the implementation could have been better. But given the fact that this was an unprecedented exercise and there were no best practices or lessons to draw from, I believe it was executed rather well, without a single incident of violence reported across the country.

Any (civilized) comments, feedback and criticism are welcome.

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