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Demonetisation: The Whiff Of Money

On 8 November, came the tsunami; since then, growth has been on a southward sojourn. Is demonetisation to be blamed, asks Raghu Mohan

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It’s hard to draw up a balance-sheet on demonetisation, especially when nothing comparable — wherein 86 per cent of the currency in circulation is pulled out at one go — has been done anywhere on this planet.

All kinds of reasons have been extended to justify it — to clean up the moral fabric of society; better tax compliance; an assault on black money; to tackle counterfeit notes and terrorism; to encourage lesser use of cash and boost digital payments. Of course, there’s no denying that these are all laudable goals. But what exactly have we achieved?

Was the timing of it right? That’s assuming it was a rational move in the first place. Growth in GDP had soared to an all-time high of 9.13 per cent in the fourth quarter of 2015-16, but had started to wane by the third quarter of 2016-17.

On 8 November, came the tsunami; since then, growth has been on a southward sojourn. Is demonetisation to be blamed? Ranen Banerjee, Partner- Public Finance, Economics and Urban at PwC (India) feels “It may or may not be”.

His point is that maybe the informal sector faced the brunt and economic activities were severely constrained as widely reported. But then, it’s also known that GDP captures the informal sector data in a roundabout way and the post-demonetisation effect on the informal sector may not be fully captured in the GDP data itself.

“Therefore, the slowdown may not be owing to demonetisation as GDP could just be following the falling streak of the prior three quarters,” says Banerjee. It’s safe to assume that demonetisation may have hastened the fall in GDP; and the GST aggravated it — perhaps.

It was put forth that demonetisation would lead to a sharp fall in lending rates due to an uptick in banks’ current and savings accounts (and an across-the-board spurt in inter-bank liquidity); boost credit offtake; and this, in turn, would aid India Inc.’s investment buoyancy.

It didn’t pan out the way it was imagined for structural reasons. For, despite repeated repo rate cuts by Mint Road even in the pre-demonetised world, banks didn’t pass it on in equal measure due to the deadweight of dud-loans on their books.

Let’s also get this clear — the benefits of lower rates are not passed on in a secular way even at the best of times; at no point is it so as it depends on the sector-risk outlook of banks. Banks may announce rate cuts, but as to whether they lend at the lower rates is a different matter. The premise of    demonetisation was that it would in some magical way help to clear up the woods.

What about the decline in the currency with the public? It’s pointed out by Abheek Barua, Chief Economist at HDFC Bank, that to assume it implies a structural drop in cash usage is perhaps misleading, as it “involves a flawed linkage”.

There was a sudden spike in currency in circulation in early 2016 — between January and October 2016, it went up at a monthly average rate of 15 per cent year-on-year (YoY) compared to an average growth of 11 per cent in 2015 and 10 per cent in 2014.

Some, including the then RBI governor Raghuram Rajan, attributed it to state elections in Assam, Kerala, Tamil Nadu, West Bengal, and Puducherry; others to the environment of low real interest rates which made savings less attractive.

“Whatever the reason, the 2016 level of currency-with-public was an aberration from the normal trend and consequently a comparison with that number gives a wrong picture,” notes Baruah. A big positive was that digital payments saw an uptick post-demonetisation (albeit from a low base), but have since come off. Many outlets are back to “cash”.

Things would have been radically different had digital payments been incentivised as in South Korea, where merchants got a tax-break. What has also been lost in the din is that banks are now reviewing their entire digital strategy — web, mobile, point-of-sale machines (PoS) and automated teller machine deployments; all this even as the branch itself undergoes a change due to technology.

Take PoS machines — the surge in their number post-demonetisation (to 28.4 lakh as of July 2017 from 13.8 lakh in March 2016) has resulted in an increase in plastic transactions. But this has come at a price — the State Bank of India estimates the annual loss to the banking industry at around Rs 3,800 crore — the difference between OFF-us (if the issuing bank and the acquiring bank are different) and ON-us swipes (if they are the same).

Then you have the threat from fintechs, small payment banks and other tech-disruptions down the line. Given the pressure on their balance sheets and the state of the economy, it is likely that many banks just don’t have the bandwidth to get their head around all these myriad issues.

So, what did demonetisation achieve? Well as we said at the start — it’s hard to draw up a balance sheet on it.

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