Demonetisation: Ineffective, Inadequate And Premature

The demonetization of Rs 500 and Rs 1000 notes by the NDA government has three claims: it will end the circulation of "counterfeit notes" from Pakistan; it will stop the use of "black money"; and it will create a "cashless economy". Let us examine each claim separately.

First, while counterfeit currency is in circulation, there is no accurate estimate of its quantum. Over-the-top claims of counterfeit currency amounting to tens of thousands of crores of rupees are wrong. In 2015-16, the share of Fake Indian Currency Notes (FICN), "detected" by banks and police, in the total notes in circulation was 0.002 per cent for Rs 1000 notes and 0.009 per cent for Rs 500 notes. A study, conducted by the Indian Statistical Institute (ISI) Kolkata, estimated that only about Rs 400 crore worth FICN was in circulation at any given point.

Thus, the claim that demonetization would significantly hit terror financing appears overstretched.

Secondly, demonetization is wrongly premised on the assumption that "black money" is hoarded in cash. The government's white paper on black money in 2012 defined black money as "assets or resources that have neither been reported to the public authorities at the time of their generation nor disclosed at any point of time during their possession". Thus, black money originates from (a) manipulating account books through multiple means, and (b) through various transactions outside the account books. The former includes manipulation of sales, receipts, expenses, production, value of capital, closing stock and so on. The latter includes transactions without bills, use of parallel account books and unaccounted assets, and investments in shares through dummy entities.

Demonetization is a one-time measure that addresses only those cases where proceeds from the above illegalities are hoarded in cash. There are no estimates of the quantum of illegal cash hoardings in India. However, according to tax authorities, the most important form of holding illegal earnings is not cash, but physical assets like land/bullion and financial assets like shares. Another part is seamlessly invested as capital in productive activities; it "disappears" soon after generation. Yet another part is shifted out of India, through the hawala route; it is either stored as offshore deposits/assets or ploughed back to India through the "Mauritius route".

Thus, only a small section, which stores cash in large amounts either for future use or as revolving cash in business/trade transactions, is adversely affected by demonetization. Hence, no significant unearthing of illegal cash may be expected from demonetization, even if it might halt or slow down illegal cash-based operations for a while.

Thirdly, much of economic transactions in India are cash-based due to the presence of agriculture as a major source of livelihood, prevalence of a large informal sector and the poor penetration of rural banking infrastructure. The persistence of cash is, then, a structural feature of the Indian economy. Opening bank accounts for every household (as under the Jan Dhan Yojana) alters nothing vis-à-vis this structural basis of the cash-nexus. For example, even after the opening of crores of bank accounts, a large share of bank accounts is dormant; even after appointing lakhs of banking correspondents in villages, about half of them are "untraceable" and many others are rendered "unviable".

A cashless economy, in other words, is not created by diktat. It requires, as a pre-requisite, a structural transformation of the rural economy into a modern and productive sphere.

As an ideal state, moving into a cashless economy is not necessarily a bad idea. Developed countries have, over time, eliminated notes of larger denomination and moved to card/bank-based transactions. Such a shift indeed aids in controlling corruption and crime. The problem in India is that any hasty move towards a cashless economy would be premature and self-defeating. How many shops have credit/debit card machines, or even mobile-based transaction facilities? How many people have credit/debit cards? How many people have, or know about, Internet banking? Even after the progress made in opening new bank accounts in recent years, crores of households remain without bank accounts. These are indications of total lack of readiness. In such a context, any drastic push towards a cashless economy would be harsh on the unbanked households and those poorly connected to the banking system.

R. Ramakumar is NABARD Chair Professor and Dean of the School of Development Studies at the Tata Institute of Social Sciences, Mumbai.