Has DeMo Failed? Why Critics Rushing To Judgment Should Wait A Bit More 

R Jagannathan

May 16, 2017, 10:38 AM | Updated 10:38 AM IST

A bank staff member counts Indian 500 rupee notes to give to customers. (INDRANIL MUKHERJEE/AFP/Getty Images)
A bank staff member counts Indian 500 rupee notes to give to customers. (INDRANIL MUKHERJEE/AFP/Getty Images)
  • Demonetisation did lower the economic tempo of India, but there are long-term gains to balance against that.
  • It is still too early to say it gave us zilch.
  • What you believe on demonetisation – good or bad – seems to depend a lot on which side of the political divide you are on. It was always clear that invalidation of 86 per cent of the currency outstanding on 8 November would impact growth negatively, but it should have been equally obvious that after the speed-breaker, the economy would swing back to normal rapidly and pick up speed.

    This is exactly what may be happening. In March, a month after the crisis period of cash stringency got over, the new Index of Industrial Production (IIP) reported a rise in output by 2.7 per cent against 1.9 per cent in February. Exports in April, the first month of the New Year, also picked up smartly to 20 per cent. The fact that imports rose by a hefty 49 per cent may be bad news for the trade deficit, but it underscores a robust revival in domestic demand and economic activity.

    We may be about to see a V-shaped recovery from this quarter. One cannot also rule out the possibility that demonetisation, which crimped demand at home for a while, may have spurred manufacturers to export more to make up for revenue losses back home.

    For a full assessment of the pluses and minuses of demonetisation (DeMo), we may need to wait a bit more, but critics are rushing to write off DeMo’s impact a bit too soon. Kaushik Basu, former chief economic adviser to the Finance Ministry and former chief economist of the World Bank, is one of them. Basu, who oversaw a rapid deterioration of the Indian economy under UPA-2, says that demonetisation has essentially delivered nothing. In an article in The Indian Express, he wrote that “the benefits of demonetisation have been close to zero and the brunt of its pain has been shouldered by the poor and the lower middle class.”

    This is a rather sweeping judgment from someone who should know better. Let us grant that gross domestic product (GDP) has been impacted adversely, and that the pain has indeed been borne by the poor and the lower middle classes and small businesses, but can one decide so easily that the benefits of demonetisation are nil?

    Sometimes, the real impact – positive or negative – tends to be evident only after a lag. This would apply particularly to a move like demonetisation, as cash has multiple linkages to the real economy, and when some sector is adversely impacted, some others emerge as viable alternatives and see a rise. In a real economy, people are constantly responding to positive stimuli or shocks.

    While the negatives of demonetisation are clear, some positives are also beginning to emerge that one cannot discount.

    First, there has been a major expansion of the taxpayer base due to demonetisation as people with lots of concealed cash incomes deposited money in banks. A Mint newspaper report notes that 9.1 million new taxpayers have been added due to demonetisation, as against an annual average of five million. Thus 4.1 million more people are now in the tax net, and this gain will be permanent. Once the goods and services tax (GST) comes into being many more will be added. A larger taxpayer base means sustained long-term increases in tax revenues, even if the money does not come upfront.

    Second, there has been a fall in interest rates. With banks being flooded with cash, they have been able to bring down deposit rates, and lending rates, too, even though the Reserve Bank of India (RBI) has announced a pause in the rate cutting trend due to fears of inflation. Government borrowings are now cheaper for the same reason. Even today (16 May), two major banks, HDFC Bank and ICICI Bank, cut loan rates for home loans to 8.35 per cent – to remain on a par with the State Bank of India’s rate.

    Third, contrary to some news reports, the shift to digital and non-cash modes of payment endures. The latest RBI data on non-cash payments shows that figures for April are higher than the highest levels achieved during the peak months of demonetisation (November 2016 to February 2017) for all payment modes barring debit and credit cards. Whether it is real-time gross settlements (RTGS), the national electronic funds transfer (NEFT), the immediate payments system (IMPS), pre-paid instruments and e-wallets or the unified payments interface (UPI) and mobile money transfers, all payment systems have reported higher transaction values.

    Total non-cash payments in April, at Rs 10,960,200 crore, were 13 per cent higher than the average for November-February, and 5.3 per cent higher than the peak month for digital payments during the acute months of demonetisation. We must exclude March as this month is always an outlier for all economic data.

    Fourth, real estate seems to be a surprise package, reporting a 21 per cent increase in sales in the top eight cities of India, thanks both to price cuts by builders and lower interest rates, including the interest subvention scheme announced by the government for affordable housing. The real estate industry is clearly getting the message that high margins on small sales are not as good as slim margins on larger volumes. Faster growth in real estate means jobs will recover faster, for construction has one of the largest growth multipliers.

    The last, and one of the most intangible reasons for suspending harsh judgments on demonetisation is this simple one: when you opt for a surprise and untested initiative, you can never know what losses or gains it will bring. In the case of any measure, this is true. You can cut taxes and expect revenues to rise, but this may or may not happen. You can offer huge rebates and sales may still not pick up. Ditto for demo. What we now have is a real learning opportunity on what happens when so much cash is withdrawn, and how soon people and companies adapt to this shock. The answer is that Indians are very quick to adapt to a shock. That is a huge learning, not to speak of the micro learnings on how demonetisation impacted so many people and sectors.

    We should also wait for the January-March GDP data due this month-end, and possibly for the first quarter data of 2017-18 too, for if the economy is recovering very fast, the losses in the previous two quarters may well be partly made up.

    Demonetisation did lower the economic tempo of India, but there are long-term gains to balance against that. It is still too early to say it gave us zilch.

    (A part of this article was first published in DB Post)

    Jagannathan is Editorial Director, Swarajya. He tweets at @TheJaggi.

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