The DeMo Balance-Sheet: More Losses Than Gains; Five Lessons To Learn From It

The DeMo balance-sheet on two-year anniversary. (GettyImages)
  • The moral of DeMo is this: there is no silver bullet for eliminating black money. It is a long painstaking journey.

On the second anniversary of Narendra Modi’s disruptive demonetisation (DeMo) gambit, the only thing we can say for sure is that we still cannot easily assess its impact in full – both the merits and demerits. Reason: the economic impact of DeMo should have lasted about three quarters, but we can’t say it did not last longer because the second disruption – and an even bigger one – was upon us in the form of the goods and services tax (GST) from July 2017.

From a short-term viewpoint, excluding the immediate positive political impact in favour of Bharatiya Janata Party (BJP), which won the Uttar Pradesh assembly elections with an overwhelming majority, the costs of DeMo resulting from the way the government chose to execute it (knocking out 86 per cent of the currency in circulation overnight) outweighed the benefits.

The real short-term gain the government was probably hoping for was that 10-20 per cent of the illegal cash hoards would not get deposited in the banking system. This would have enabled the Reserve Bank of India (RBI) to extinguish these liabilities and give the government a hefty dividend. It would have resulted in a political and economic bonanza for the National Democratic Alliance (NDA) government, especially if Rs 1.5-3 lakh crore was available as the spoils of smoking out black money in this fashion.


But our cash hoarders proved smarter, and decided to either use backdoor methods to exchange their old Rs 500 and Rs 1,000 notes for new ones, or route it through dormant Jan Dhan accounts, or take their chances with the taxman. This is why all the black money came back into the system.

Put simply, the costs were the following: a further 0.5-1 per cent slowdown in growth, losses of millions of jobs, and a negative impact on high cash-using sectors like agriculture, the informal sector, real estate and construction, etc.

The gains were two-fold, basically limited to digitisation (which has been a roaring success), and higher tax collection (which has been rising), but we cannot presume that the tax buoyancy noted over the last one or two years is going to sustain.


Consider digitisation: there is little doubt that post-demonetisation, India took to non-cash means of transacting in a big way, and GST will have pushed that trend further. While RTGS (real-time gross settlement), an online method used largely by bulk users like companies and banks), grew at a sedate pace of 14 per cent between 2015-16 (before DeMo) and 2017-18 (the fiscal year that came well after the DeMo impact started subsiding), retail payments through the non-cash route skyrocketed.

What RTGS tells us is that the big users in the formal sector did not need the push of DeMo to shift to digital modes of payment. They were already doing so. On the other hand, retail payments shifted substantially to electronic modes: national electronic fund transfers (NEFT) grew 106 per cent, IMPS (immediate payment system) 402 per cent, UPI (unified payments interface) 1,500 per cent (in just one year, unlike the others, where the comparison is for two years), prepaid instruments (e-wallets) 190 per cent, and credit and debit cards (136 per cent).

In other words, retail payments have shifted significantly to digital mode after DeMo and GST. This is success.


As for tax compliance, there are certainly some indications that this is improving, with returns filed in fiscal 2017-18 rising 71 per cent to 5.42 crore. While direct tax receipts have not grown commensurately, they still hit record levels of over Rs 10 lakh crore in 2017-18, up 18 per cent over the year before. At the very least it can be said that more people are at least trying to comply with the law. You could call it tax terrorism or coercion, but it is difficult to believe that people change their ways purely through saintly motivations. The stick is needed sometimes. So, tax compliance can also be regarded as at least a half-success after DeMo, though we should wait a while to see if this trend continues. It should, since GST is a further prod towards formalisation and higher tax compliance.

But the question is whether these gains were worth the huge losses in GDP (which continued for three quarters) and income losses suffered by the informal sector. With the Centre for Monitoring Indian Economy reporting job losses of 1.5 million in the four months after DeMo, one has to accept that the overall losses outweigh the gains from this drastic measure to ferret out black money.

While the political opposition will chime in with its “we-told-you-so”, there are lessons to be learnt all around.


First, reducing dependence on cash should be done steadily, and not in one dramatic move. So, if the government wants to discourage cash transactions, it should withdraw higher-value notes as they come back to banking channels and reissue only smaller notes. Once the big-notes stock with the public falls, holders can be asked to deposit the remaining cash any time over the next six months and obtain matching credits in their accounts. The time is ripe to do so with the new Rs 2,000 note, and later with the Rs 500 note, once digitisation spreads across the country, even to rural areas. The key lesson is that two different objectives – reducing black money and reducing cash in the system – need not be combined.

Second, the fight against black money is a long-term fight, and not a one-time blast. It can be won only if all avenues for illegal money-making start closing one by one, and this includes reducing discretionary powers of ministers and bureaucrats, using technology for transparent dealings with the public, and making electoral funding fully digital. The anonymous electoral bonds issued to curtail black money funding of elections is neither here nor there; we need deeper electoral reforms, including state funding of candidates, while all political party donations should be made only by cheque or through digital modes, where there is no anonymity in payments.

Third, formalisation – kickstarted by DeMo and accelerated by GST – is good, but the short-term impact of greater formalisation will be a jobs slowdown, for formalisation means higher wage costs, where social security payments will be higher for companies. This cannot but impact short-term employment prospects, and the weak jobs growth trend right now is a case in point. Governments which want to push formalisation have to grit their teeth for the short-term political impact, which is surely negative. This is the price Narendra Modi is paying for DeMo and formalisation. Future governments know what not to do.


Fourth, the fight against black money can be won over time by making income taxes really low, preferably through a shift to flat rates or by having two low rates. This way, the incentive to cheat is reduced. If we had just two tax rates – say 10 per cent and 20 per cent – few people would consider it worth their while to evade taxes. At these rates, taxation would be painless, as the example of tax deduction at source (TDS) shows. In 2017-18, over two crore people paid taxes but did not file returns. This means that the 10-20 per cent rate is the right range in which people don’t mind paying taxes. A new tax system where more people collect 15 per cent TDS, and where the remission of taxes deducted is made easy for deductors (including individuals paying their domestic help), would boost tax collections and also ensure less evasion. The key to less evasion is to make compliance easier than buttering your bread; tax coercion will not work in the long run.

Fifth, an amnesty scheme would have worked better than DeMo, especially if the penal taxes charged were not extortionate. The 2015 Modi amnesty for those with foreign hoards, the 2016 amnesty for domestic tax evaders, and the post-DeMo Garib Kalyan Yojana were simply too extortionate to work. An amnesty scheme with 10 per cent penal taxes would have worked far better and generated more tax revenues than DeMo.

The moral of DeMo is this: there is no silver bullet for eliminating black money. It is a long painstaking journey.


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