India: Demonetization Debacle

By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She is currently writing a book about textile artisans.

Earlier this week, the Reserve Bank of India (RBI) published its annual report, which included further assessment of the government’s demonetization policy, imposed on November 8, 2016, when Prime Minister Narendra Modi announced the immediate cancellation of Indian Rupees (Rs) 500 and Rs 1000 notes– 86% of all cash then in circulation in what’s largely a cash-based economy.

As I wrote here:

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 discussed here, here, here, here, here, here and here.)

The latest RBI report reaffirms that far from ferreting out large sums of illicit money, most of the cancelled banknotes were exchanged for new currency, as reported by The Wire in It’s Finally Official: RBI Says 99.3% of Demonetised Money Returned to Banking System:

The Reserve Bank of India (RBI) has finally finished counting the money that was returned to the central bank after the Modi government’s decision to demonetise Rs 500 and Rs 1000 notes in November 2016.

The result of the RBI’s calculations: 99.3% of the scrapped notes came back into the formal banking system. [Jerri-Lynn here: see especially pp. 147-154 of the RBI report.]

The latest RBI report refines and finalises preliminary calculations made in last year’s annual report, which I discussed further here. Yet as this piece in The Wire, How Successful was Demonetisation? Four Takeaways From the RBI’s Annual Report, makes clear:

Now, even if 100% of demonetised currency returned to the system, it does not mean all of this cash was ‘white’ or money that was generated through wholly legal means. It is the job of the income tax department and various investigative agencies to determine how much of it is ‘black’ or illegally obtained and which depositors need to be examined for trying to cheat the system.

So far the government has not put out any credible evidence as to its efforts in this regard. At a press conference on Wednesday evening, senior finance ministry official Subhash Chandra Garg refused to elaborate on how demonetisation helped crack down on black money.

Or, to put it another way, the government clings to its talking points, even in the absence of supporting evidence. Sound familiar?

The Wire Four Takeaways article also highlights some lingering aftereffects of the impact of demonetization on the availability of currency earlier this year– 2018– long after the policy was imposed in November 2016:

While The Wire has over the last eighteen months reported and analysed how India’s currency-in-circulation (CiC) and currency-to-GDP ratio has not changed drastically after demonetisation, the RBI’s annual report provides further proof of how little things have changed.


Overall, the supply of currency notes declined by 14% in 2017-2018. As The Wire has reported, various states of India experienced a cash crunch earlier this year, with ATMs running dry. The lesser number of Rs 100, 50 and 20 notes being supplied in 2017-18, and the ATM system’s inability to adapt to the new Rs 200 notes quickly enough may have played a part in the cash crunch.

I happened to be visiting India again earlier this year and experienced this cash crunch firsthand in Calcutta– where ATMS ran out of currency (in late March or early April, IIRC). The crunch there was by no means as pressing as in other parts of the country, according to press reports I read at the time. Nor, for that matter, was it anywhere near as severe as in late 2016..  Then, daily ATM withdrawals were limited, and it was necessary to queue to withdraw currency, often available only in the form of Indian Rupee 2000 notes, which were of limited use for many day to day transactions, and for which change was simply not available.

Impact of Demonetization

Demonetization is estimated to have slowed India’s growth rate significantly– although growth projections released this week show its worst impact has passed, with growth for the June quarter estimated at 8.2%, up from 5.6% a year ago, according to India Hits 8.2% GDP Growth in June Quarter On Back of Manufacturing Boost And Base Effect. This, as the FT notes, in India’s economy surges 8.2 per cent in best quarter since cash ban, is “its fastest pace of expansion since Prime Minister Narendra Modi’s 2016 cash ban, a shock that drained liquidity from the economy.”

That doesn’t mean the failure of the demonetization exercise has been acknowledged by the Modi government or by his Bharatiya Janata Party (BJP). Instead, earlier this week, according to India Today in BJP stalls negative report on demonetisation drafted by parliament panel:

The Bharatiya Janata Party, using its majority in the parliamentary standing committee on finance, has derailed a discussion on or adoption of a report that criticised demonetisation as an “ill-conceived” exercise that “led to the lowering of the Gross Domestic Product (GDP) by at least 1 percentage point”.

The actions of the BJP members on the committee have saved the government the trouble of facing the report’s criticism of the demonetisation exercise.

The standing committee on finance is headed by Congress leader and former union minister M Veerappa Moily. The committee, which includes eminent economists such as former prime minister Manmohan Singh, completed drafting its report on the demonetisation way back in March this year.

The scathing report ran into opposition from the committee’s BJP members from Day 1. On March 19, the BJP members rose in unison to reject the report. BJP’s Nishikant Dubey, who is known for his expertise on financial and business matters, submitted a dissent note against the report.

The note disagreed strongly the report’s conclusion that the demonetisation decision was “ill-conceived”. The BJP members argued that demonetisation was a huge success in eradicating black money and promoting digital payments.

This week’s RBI report certainly suggests otherwise with respect to eradicating black money.

Since the committee’s term expired on 31 August, its demonetization report is effectively scuppered, according to this account in The Hindu, Govt seen ‘burying’ MPs’ panel report on DeMo:

According to the Congress, the main Opposition, the BJP is stonewalling the procedures using its numerical strength on the Committee. “Every sentence in the statement on demonetisation made by former Prime Minister Manmohan Singh in the Rajya Sabha has proven true. The entire process, as he said, was legalised loot and organised plunder. As a result of it, people have lost confidence in banks,” Congress spokesperson Jaipal Reddy said.

Another Opposition member, who was present at the panel’s meeting on Monday, said no drafts were sent to the members.

According to sources, the draft report says about 1 per cent of GDP was lost owing to demonetisation. It also points to job losses arising from the decision to invalidate ₹500 and ₹1,000 notes illegal, which effectively invalidated over 80 per cent of notes in circulation.

The Modi government paid little political price for the spectacularly inept demonetization policy, which imposed widespread hardship. Although many Indians support the goal of reducing corruption, the RBI numbers reaffirm that this policy did not achieve such ends.

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