India’s Demonetization: No Impact on Black Money Despite Huge Costs It Imposed

By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends much of her time in Asia and is currently working on a book about textile artisans.

The Reserve Bank of India (RBI) on Wednesday published its annual report, which assessed India’s demonetization policy, initiated last November.

Regular readers will be familiar with some aspects of this story, covered extensively by Naked Capitalism here, here, here, herehere, here, and here.  In this short post, I’ll bring the story up to date.

To recap, on the night of November 8, Prime Minister Narendra Modi delivered an unscheduled speech announcing the cancellation of Indian Rupees (Rs) 500 (about US$7.82) and Rs 1000 (US$15.65) notes– 86% of all cash then in circulation in what’s largely a cash-based economy– in order to ferret out black money.

The government estimated that demonetization would flush up to 1/3 of currency then in circulation from the economy, with holders of black money choosing to trash or abandon their holdings rather than admit its shady provenance. Central bank liabilities were expected to decline, and the government to reap a windfall.

Widespread and immediate chaos followed, as I observed firsthand as I was visiting India at that time (and wrote in some of the links included above).

India’s population suffered, but largely acceded to the policy. Most accepted the Modi line that demonetization was necessary to tackle corruption by eliminating the scourge of black money. The policy was widely criticized as misguided in that it wouldn’t achieve its stated objectives. Black money is not held in sacks or stacks of illicit cash secreted in basements, almirahs, safes, or lockable metal Godrej cabinets– contrary to what you might think if you watch too many Bollywood movies. Instead, it’s either invested domestically in real estate, art, gold, or other assets, or held offshore, either in the form of freely convertible currency or other assets.

Now, it turns out the critics were right. The RBI reported that 98.96% of the demonetized INR 500 and INR 1000 in circulation when Modi made his announcement were returned to banks by the final deadline of June 30. The actual figures showed Rs15.28 trillion (US$239 billion) returned out of a total Rs 15.44 trillion outstanding (US$241 billion).

While the deadline for most Indians to swap old notes for new was December 31, non-resident Indians (NRIs)– who at the risk of stating the obvious, live abroad– were allowed until June 30 to make their exchanges.

As reported by the FT in India demonetisation fails to purge black money:

The bank’s estimate follows media reports that complex money-laundering networks sprang up in the wake of the demonetisation to help wealthy Indians deposit huge volumes of previously undeclared currency without exposing themselves to tax authorities. Such people allegedly sold the old notes, at a discount, to brokers who then dispatched low-income Indians to deposit or exchange them at banks.

Many wealthy Indians turned to friends and relatives to help them funnel previously undeclared cash into the banking system, while others “advance paid” salaries for large numbers of workers. (Jerri-Lynn here: See also this post for further details.)

Government Employs Switcheroos to Rationalize Policy

Modi and his government have yet to pay a political price for demonetization. The latest RBI disclosures look unlikely to change that reality, either.

In selling and defending the policy, as this Asia Times account makes clear, Modi’s credibility hit as 99% banned notes return to RBI, Modi has not hesitated to modify the stated rationale for demonetization:

What is intriguing is how Prime Minister Modi kept moving the goal posts while defending demonetization. Three weeks into the exercise, he changed the narrative from a war against black money, corruption and counterfeit currency to a ‘cashless’ or ‘less-cash’ economy at par with developed nations.

On New Year’s Eve 2017, weeks before the crucial Uttar Pradesh (UP) assembly elections, Modi changed the narrative into a battle between the rich and poor by saying excess cash was causing inflation and black-marketing, therefore, hurting the poor.

This narrative found an echo in Parliament where he underlined the need to empower the poor by acting tough against those who are cheating the banking system. He called it a battle with people and the government on one side and a group of political leaders on the other.

And now, rather than concede the policy has been a total failure, which imposed widespread suffering on the most vulnerable part of the Indian population while failing to achieve its stated objectives, earlier this week, Indian Finance Minister Arun Jaitley yet again switched the stated rationale for the policy, as reported by the Economic Times:

Finance minister Arun Jaitley strongly defended demonetisation against accusations that it hadn’t met its objectives as evidenced by the numbers in the Reserve Bank of India’s annual report, saying the impact of the note cancellation had been “extremely positive” in multiple areas. The object of the massive exercise hadn’t been confiscation, he said, blaming the Opposition for confusing the issue while detailing the list of accomplishments.

“The real objects of demonetisation were formalisation (of the economy), attack on black money, less-cash economy, bigger tax base, digitisation, a blow to terrorism,” he told reporters. “We do believe that in each of these areas the effect of demonetisation has been extremely positive.”

Jaitley’s not the only one now trying to rewrite history. As this piece in The Wire Templated Tweets, Trolls Deployed to Proclaim ‘Success’ of Demonetisation on Social Media outlines:

A day after the Reserve Bank of India’s report on demonetisation proved that the whole exercise of scrapping high denomination notes in order to detect and extinguish black money simply wasn’t worth the time or effort, a concerted campaign is underway on Twitter, WhatsApp and other digital platforms to prove that Prime Minister Narendra Modi’s big economic gamble was in fact “a success”.

In a desperate attempt to change the narrative on social media about the Modi government’s ill-planned and poorly executed exercise that left nearly 100 people dead, destroyed informal markets, took away almost 1.5 million jobs and choked the money supply – and growth – of the nation, hundreds of Twitter handles were deployed to tweet the exact same ‘facts’ using the hashtag #DemonetisationSuccess.

I’ll limit what I write about this issue to the above quotation. For those interested in the phenomena of trolling and of forced trending, no one does it better than Modi supporters, and so I encourage you to read the full Wire account– which reproduces many tweets– to see just how this is done. I found this fascinating, actually. That article not only provides examples of how the trolls are deployed, but also reproduces the identical tweets government ministers are issuing, as part of the same program, in pursuit of the same goal of narrative shifting. Such message discipline! Trump would no doubt be very jealous of how Modi is able to get his Cabinet ministers lined up to march in step to the beat of a single drum.

Apologists Cannot Bring Themselves to Abandon This Sacred Cow

Despite the clear evidence that the RBI provided that demonetization was a colossal failure– outside apologists for the policy continue their hollow applause. Consider this FT piece by Abhishek Parajuli, Has Narendra Modi’s demonetisation gambit failed in India?

…demonetisation was a forceful nudge towards digital payments. Fintech start-ups formalised large chunks of the informal economy. Everyone from large multiplex owners to roadside vendors were forced to accept digital payments and, unlike cash payments, digital transactions cannot be under-reported to evade the tax collector.

Well, in theory, perhaps. Yet this, I’m sorry to say, is rubbish. I would concede it’s certainly true that such payments cannot be under-reported. What’s even more true is that given the state of the Indian digital infrastructure– particularly in the countryside– they simply cannot be made at all. In many places, coverage of digital networks is either non-existent or when one nominally exists, it often doesn’t work. It’s still either cash or nothing, particulatory for the smaller transactions. Try buying fruits of vegetables in any of India’s central city markets with a digital payment, let alone make a purchase in most smaller neighbourhood markets or shops, or in villages.

Also, digital transactions are not cost-free. Why should poor Indians– or any Indians, for that matter– have to pay anything (implicitly or explicitly)  to transact digitally when cash can be exchanged for free?

C Rammanohar Reddy elaborates further in this piece, Demonetisation: The chronicle of a failure foretold:

[T]here is digitalisation, the poster boy, if one can call it that, of the entire exercise. There are many questions about the desirability, preparedness and acceptance of the push towards digitalisation, which comes with its own costs for users. Suffice to say that while volumes and values of digital transactions are appreciably higher now than last year, the growth has considerably moderated from the heady “Paytm days” of November-December 2016. It just shows that you cannot compel people to go with a transaction practice they are not yet familiar or comfortable with. In any case, did we need to use the sledgehammer of demonetisation to accelerate a process that had been going on since the early 2000s?

(And I should mention, for those interested in further reading, that Reddy’s book, Demonetisation and Black Money, is the most comprehensive account I’ve yet seen on the demonetization debacle.)

The Bottom Line

So, the RBI has now confirmed what many had long predicted and expected: India’s demonetization policy has had no effect on black money, despite the lives and jobs lost, the business foregone, and its slowing of economic growth. The Modi government has paid no political price for this failure, nor has the Congress (party) or any other Indian political party– such as West Bengal Chief Minister Mamata Banerjee’s Trinamool Congress — reaped much benefit, despite their critiques and opposition.


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