Whatever else supporters and critics of the Indian government’s demonetisation exercise may disagree on, everyone will agree that the decision by Prime Minister Narendra Modi, on 8 November 2016, to remove from legal tender high denomination notes (HDNs) accounting for about 86% of the currency stock in value terms was a bold and unprecedented move. Indeed, it is arguably one of the great economic experiments in modern history and will be studied for years to come.
Given the disputes about the measure’s wisdom and success, however, it is time to take stock of what was said in the aftermath of 8 November and what has actually transpired since then.
With no compelling precedent for such a move in a growing and stable economy, not one suffering hyperinflation – it was no surprise that most commentators failed to grasp its implications and many got it plain wrong.
Take just three frequently repeated assertions.
First, many well-known economists argued that there would be a precipitous drop in GDP growth, the reasoning evidently being that the temporary liquidity crunch caused by demonetisation followed by slow “remonetisation” would severely affect cash-dependent sectors of the economy, leading presumably to a drop in aggregate demand and hence in GDP growth.
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Second, it was suggested that, if the intention was to detect and destroy “black money”, most of this money would escape the trap as large black money holders would find small, and presumably poorer, depositors as “mules” to deposit money on their behalf and eventually exchange these deposits for new notes. It was argued that we would largely see small deposits below the announced legal threshold for scrutiny – with little black money detected and confiscated through this exercise.
Third, it was argued that demonetisation would prove a political disaster for the Modi government, with the populace angered at having to wait in long queues to redeem their old notes into new notes and with ATMs short of cash in the month or so following 8 November.
But the doomsayers were to be proven wrong.
First, GDP growth in the third quarter, October-December 2016, the period during which demonetisation occurred, has shown only a modest dip (from projections made in advance of 8 November) of roughly one half of a percentage point. This is hardly the economic disaster that the critics had imagined.
Indeed, we were perhaps among a small minority of economists who had argued explicitly that, contrary to this emerging consensus, demonetisation could, paradoxically, be expansionary rather than contractionary, or, in any case, that the contractionary impact could be much less than commonly believed. Additionally, the take-up of digital payments, the emergence of informal credit arrangements between sellers and consumers, and the fast pace of remonetisation all together assured that the economy did not contract as much as was widely feared.
Second, data presented to Parliament on 1 February during the Union Budget speech by finance minister Arun Jaitley suggests that very many large deposits were made in the aftermath of 8 November. In particular, deposits exceeding Rs 80 lakh were made into 1.48 lakh accounts, with an average deposit of Rs 3.31 crore (thus accounting for around 5 trillion rupees or about a third of the currency in circulation). Smaller, but still quite significant and potentially taxable, deposits in the Rs 2 lakh – 80 lakh range accounted for another 5 trillion rupees.
Taken together these deposits accounted for about two thirds of the currency in circulation. Notwithstanding the multiple instances of malpractice and corruption at retail banks that have been exposed, these figures belie the narrative of clever money launderers circumventing potential taxation altogether through “benami” deposits.
Third, BJP’s success in recent state elections, most notably its thundering rout of all of the other parties in Uttar Pradesh, demolished the notion that there was a political price to be paid for the pain allegedly caused by the “despotic” demonetisation. Nothing succeeds like success; and the prime minister was clearly vindicated politically in the eyes of many voters, and, belatedly, the witless commenting class – some of whom had even resorted to ad hominem attacks against us in the absence of serious counter-arguments.
Finally, it was argued by Harvard economist, Kenneth Rogoff (an MIT student of Bhagwati), that demonetisation could have been pursued gradually – with the slow elimination of HDNs, planned over a seven-year period.
If the elimination of HDNs was a goal in itself, this may perhaps have been the ideal approach, but surely this was not the case in India where corruption, tax evasion and the accumulation of black wealth were instead the primary targets. Rogoff’s concern that the Indian system lacked the logistical capability to implement demonetisation has also proven unfounded: RBI succeeded in remonetising the entire system in less than a couple of months, for which Governor Urjit Patel and his team deserve enormous credit.
Macbeth’s great soliloquy (Act V, Scene 5) ends with these immortal lines: “It is a tale/ Told by an idiot, full of sound and fury/ Signifying nothing.” The same may be said of much of the commentary on demonetisation.