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Demonetization – a failure?

August 31, 2017 | Expert Insights

The annual report from the Reserve Bank of India has revealed that 99% of notes that were demonetized in November 2016 had been returned to the banks. Indian Prime Minister Narendra Modi on November 8, 2016 announced the demonetization of Rs 500 and Rs 1000 bank notes. In an unscheduled address to the nation, he said that this move would help the government fight black money. The government stated that this could curb counterfeiting of cash and the use of illicit money.

Background

Indian Prime Minister Narendra Modi on November 8, 2016 announced the demonetization of Rs 500 and Rs 1000 bank notes. In an unscheduled address to the nation, he said that this move would help the government fight black money. The government stated that this could curb counterfeiting of cash and the use of illicit money. The government did not want those funds to be utilized in sponsoring illegal activities and terrorism.

However, the sudden nature of the announcement resulted in widespread chaos in the country. Millions had to deal with sudden cash shortages and ATMs did not have notes for weeks. There was also a significant hit to the nation’s economy. During this period, reports began to emerge of deaths related to the move. People had to stand in queues for hours outside banks in a bid to exchange their notes. Some collapsed and died during this period.

Madan Sabnavis, chief economist of Care Ratings spoke to Hindustan Times noting, “The economy was expected to outperform in the fiscal gone by with favorable monsoon and wage increase post-implementation of the 7th Pay Commission, which was expected to spur consumption in the second half of the fiscal. However, demonetization had temporarily slowed down economic activities in the third quarter due to cash crunch.”

Analysis

India’s central banking system, the Reserve Bank of India published its annual report in August 2017. In page 195, the RBI revealed how much money was returned back to the banks as a result of this move. According to the RBI, India received Rs 15.28 lakh crores in banned Rs 500 and Rs 1,000 currency notes. Out of the 6,700 million notes that were circulating in the system as of November 8th 2017, nearly 99% of the notes have come back. Around 89 million notes of Rs 1,000 currency notes were not returned. This data has been calculated based on the number of notes that were returned by June 30th, 2017.

The one percent of the cash that was not returned amounts to Rs 16,000 crores. The RBI had spent Rs 21,000 crores in printing new notes to meet the demand after demonetization. In essence, the banking system has lost money due to the move.

India’s Finance Minister, Arun Jaitley defended the efficacy of the demonetization by noting, “Some don't understand the objectives of demonetization... The effect has been extremely positive in terms of expanding the tax base and more digitization. The fallout of demonetization is on predicted lines ... the fact that money got deposited in banks doesn't make it legitimate money.” 

If the government had hoped that demonetization would lead people to destroy their black money – then that seems to not have taken place. According to experts, those in possession of black money have found a way-around the system. They might have given their illegal notes to those who didn’t have black money, to deposit in banks. The report had also revealed that 573,891 fake Rs 500 and Rs 1,000 notes were detected between April 2017 and March 2017. This means that the total number of counterfeited notes as compared to the original notes is negligible. The total of number of Rs 500 and Rs 1,000 currency notes withdrawn stands at 24.02 billion. Hence, the number of counterfeited notes is just above 0%.

In June 2017, it was revealed that India’s economic growth had slowed to 6.1% in the fourth quarter ending March 2017 as compared with 7.1% in the previous quarter. The growth rate has further slowed down during the April-June period to 5.7%. This is a three-year low.  

Assessment 

Our assessment is that the nation’s economy and a number of its vital sectors had been hit significantly due to demonetization.  The economy is still recovering from the initial shock to the system. However, there have been some welcome trends that followed the move – cash was brought back into the banking system and therefore the cost of loans has come down. Additionally, it can be argued that more people had to accept and move towards digital wallets, which is an important agenda set out by the government. Having said so, the government may have failed to meet the initial set of objectives that it had itself set for demonetization to achieve.