Demonetisation-All Disruption And Distress, To What Purpose?

While the honest citizen found herself without work or waiting in queues at banks to draw small amounts of her savings, the holders of black money were not worried. They were able to find ways, to circumvent demonetisation, launder their black money and deposit it in banks. Faced with this circumvention, the government appeared to lose its professed determination to attack black money.

While proponents and opponents have argued on specific aspects of the policy, a holistic view has been absent from the debate. C. Rammanohar Reddy, in his book, 'Demonetisation and the black money', takes a closer look at the 8th November 2016 decision saga. What was the rationale for Demonetisation 2016? Can it stamp out black money as promised? Were there other options, which would have avoided causing immense grief to countless Indians? What next after demonetisation?

We reproduce few extracts from the book:

What Next?
In mid-February 2017, three months after Prime Minister Narendra Modi's announcement on demonetisation, there were no immediate gains to be seen from the decision. True, the benefits, if any, of something as major as Demonetisation 2016 cannot be reaped immediately, they are to be had only in the long term. There was one immediate outcome and this was the colossal amount of hardship experienced by the citizens of India. That most of the affected people did not openly express their unhappiness at having to bear this hardship does not reduce its severity.

While many economists forecast that the Indian economy had experienced significant damage from which recovery would be slow, some said that the economy would quickly bounce back from the downturn in growth. As of mid-February, there was no evidence of that as yet, but even if that happened, why cause a dislocation in the first place?

All the disruption and distress, to what purpose? When assessed in terms of the objectives of Demonetisation 2016, the outcome was unclear.

The government is yet (mid-February 2017) to present an estimate of how much of counterfeit currency that had been in circulation had been neutralised by demonetisation. It would also be time before the efficacy of the new security features in defeating counterfeiting could be assessed. In any case, as has been argued in this book, dealing with counterfeit currency did not require the suddenness and consequent harshness of a design and implementation as contained in Demonetisation 2016.

Originally, the main objective was to destroy black money held as cash in the form of Rs 500 and Rs 1,000 notes. But it is in the unearthing of black money that the outcome of Demonetisation 2016 has been very clearly limited. Demonetisation has not, as promised, turned 'worthless' the black money held in high denomination notes. The numbers released until early December 2016 indicated that most of the currency had already entered the banking system. Very little seemed to have been held back by holders of black money scared to enter the banking system.

The success of Demonetisation 2016 in unearthing black money that was circulating in the form of the demonetised high denomination notes now depends, in the first instance, on the new amnesty scheme, the PMGKY, receiving a large amount of disclosures. If the PMGKY does not yield declarations running into lakhs of crores (trillions) of rupees, yet another avenue will have to be explored. That would be the income tax authorities identifying holders of black money who did not take advantage of the PMGKY. Will the government, keen to show it has been successful with the demonetisation exercise, ask the income tax authorities to go after all those who made large deposits in banks between 10 November and 30 December 2016? This raises the spectre of harassment. Indeed the biggest concern, irrespective of the assurances of the government, is that we are now entering an era of tax harassment as government agencies set about trying to prove that Demonetisation 2016 was a major success in unearthing black money and improving tax compliance.

One of the central arguments in this book is that whichever way one looks at it, Demonetisation 2016 was not a good idea. One, very little of black money is held in the form of cash, so demonetisation was not going to destroy much of the unaccounted wealth. Two, even if the government did want to track down unaccounted cash, demonetisation itself was not the best way to go about it since it hurt the entire population while trying to ensnare a small number of holders of illicit cash. An alternative would have been to collect, analyse and follow up on information on large cash withdrawals from banks and thereby identify possible flows of unaccounted cash. Three, if, in spite of all the risks and limited chances of success, the government still wanted to go ahead with demonetisation, then the manner in which Demonetisation 2016 was designed and implemented was neither the only option nor the best one. There were other less destructive options available.

Some weeks after demonetisation was announced and when it became clear that a large amount of the high denomination notes had already entered the banking system, digitalisation emerged as the main agenda from Demonetisation 2016. It remains the most important item on the agenda. The focus now is on how to accelerate the adoption of electronic payments at all levels-from households upwards. There remain many infrastructural and economic constraints to accelerating digitalisation. That, however, is not the issue with the emergence of digitalisation as an action programme after Demonetisation 2016. The main issue is, did the economy have to be put through the demonetisation wringer in order to drive it towards digitalisation?

For some, it is not any concrete gain that matters, but the long-term 'psychological shock' that Demonetisation 2016 will inflict on the behaviour of people. The holders of black money will have experienced such a major shock that they will, it is said, decide that tax compliance is a better strategy than running the risk of losing everything in the future.

The more likely psychological shock was a harmful one. Some commentators pointed out that the upheaval caused by the removal of 86 per cent of the currency in circulation had unnerved ordinary people, the honest citizens. The trust they had reposed in the currency issued by the central bank and the government had been shaken. This is an unhealthy development in a modern economy.

Yet, the promise initially was of something else. Soon after demonetisation had been announced, in the intense debate that followed it was pointed out by many that this action by itself would do little to destroy black money and do even less to end the future generation of black money. The government in response said that demonetisation was neither the first nor the last measure to be taken to destroy black money. More steps were to follow in what was promised would be a larger war.

There was little of that kind to be seen in the next three months, save the limited measures on political party finance announced in the Union Budget for 2017-18. It appeared as if the promised action was not to follow.