Twelve months past, those queues are mostly a faded memory, the country has been remonetised adequately
Lasting legacy of the Modi experiment includes increased digital transactions and expanded tax base
Published: Sun 5 Nov 2017, 6:00 PM
Last updated: Sun 5 Nov 2017, 8:48 PM
On November 8 last year, Indian Prime Minister Narendra Modi made a dramatic announcement. In one go, he outlawed notes of Rs500 and Rs1,000 that constituted 86 per cent of the country's currency in circulation. It was perhaps India's boldest policy experiment in over a quarter century.
A year later, a paradox of sorts has emerged: while intellectuals and analysts in India have slammed the step, Indians at large have reacted positively to it. The usual explanation is that the economics and politics of demonetisation bear no connection, with the idea finding favour with citizens by virtue of the populist appeal of its moral logic. Lost in the noise are the modernising features of a larger process that began with creating no-frill bank accounts for the underprivileged and has culminated - for the time being - in a major tax reform, the Goods and Services Tax (GST).
In the weeks and months after November 8, 2016, Indians cutting across all lines -rich and poor, urban and rural - formed serpentine queues to deposit money and get hold of some precious but rationed cash for much-needed daily use. In a country whose economy was dominated by cash transactions, demonetisation was a drastic attempt to change the behaviour of Indians, moving them away from the use of currency notes towards electronic modes of transferring money. It was also an attempt to check black money by imposing what economists called a 'one-time shock' that would neutralise it.
The initial days after the announcement were chaotic, as expected. This was no surprise, since currency worth an estimated Rs15.4 trillion had been expunged as legal tender and remonetisation would take time.
Twelve months past, those queues are mostly a faded memory, the country has been remonetised adequately, and other policy measures such as the GST have been implemented by the Modi government. But a few voices against the move remain as loud as ever. Some criticisms have been pertinent, others merely petulant. The one with the strongest force was of the badly handled remonetisation of the economy.
What has much less credence is the charge that demonetisation has failed to 'fix' the country's problem of black money. This is an exaggerated point that is not really as stark as it has been made out to be. Originally, the hope indeed was that a substantial fraction of the unaccounted-for stock of money would be 'extinguished' as people would be hesitant to deposit their ill-gotten funds in bank accounts. The initial idea of withdrawing Rs500 and Rs1,000 notes was to prevent the use of these as a store of illicit wealth. Soon after the move was announced, however, economists led by Jagdish Bhagwati pointed out that this may not pan out.
It did not. On February 1 this year, Union Finance Minister Arun Jaitley gave Parliament a set of figures for 'high value' deposits made within the period that banks were accepting old cash. The sums are staggering. Deposits exceeding Rs8 million were made in 148,000 accounts with an average deposit size of just above Rs330 million. Similarly, smaller deposits, ranging from Rs200,000 to Rs8 million were made in about 10.9 million accounts with an average deposit of just above Rs500,000. Bhagwati and his colleagues estimated these deposits as accounting for over Rs10 trillion in all, about two-thirds of the currency stock demonetised. If any doubts were left about how much cash came to light, the Reserve Bank of India's Annual Report, released on August 30, put an end to it. Of the Rs15.4 trillion worth of high-value notes in circulation before the move, almost Rs15.3 trillion had been returned to the RBI by June 30, amounting to roughly 99 per cent of it.
Critics were quick off the gun and said this was the 'last nail' in the coffin of demonetisation.
At the very minimum, that is misleading. To begin with, the withdrawal of large-denomination notes was supposed to be a one-time strike on black money. That exercise is not yet over. A clear path to the goal would have been the instant extinguishing of cash that did not return to the banking system. But that path having closed does not mean there are no alternatives. The trouble with the 'last nail' critique is that it looks at demonetisation in isolation. In reality, for the Modi government it was only one in a series of steps meant to modernise the economy and reduce the corruption that has moved wheels in India for too long.
The early benefits of enhanced transparency were already at hand in August this year when the government shuttered 163,000 companies across the country on the basis of data mined after demonetisation
Somehow that larger picture eludes most critics. It is one thing to examine demonetisation and correctly point out problems in its wake, and something entirely different to look at the series of steps that began with the creation of Jan Dhan no-frill accounts all the way up till the GST. If one casts an extended gaze on this sequence, a coherent pattern comes into view. Two specific shifts are clearly visible. One lasting legacy of demonetisation is the great speeding up of digital transactions. Even if there has been some return to cash once the scarcity period was over, the changed landscape is broadly here to stay. But the semantics of it - whether you call it 'enforced' or a 'nudge' - makes little difference. The point is that these transactions leave an electronic trail and are subject to scrutiny by the tax authorities if they so choose. Not only do transaction costs come down when payments are made online, they can be called up onto an official screen to be examined.
Linked to all this is the second big problem that is now on its way to being solved. Since the advent of taxation in Independent India, vast numbers of self-employed individuals - businessmen, petty shopkeepers and traders among others - have managed to evade both direct and indirect taxes to a large extent. A cash-based economy made the expansion of the taxpayer base hard, if not impossible, in the absence of coercive methods being adopted. Some tough approaches were tried for a while in the 1970s but ended up being counterproductive. If implemented well - and with the ironing out of its glitches - the GST promises to deliver what India needs: sufficient money in the hands of the government.
It is a mistake to view bold policy experiments such as demonetisation in isolation of other economic steps and from political incentives that underlie the actions of ruling parties. In an intensely competitive polity like India, it is rare to see such policy-level aggression. The usual trend is for governments to carry out incremental changes, ones that opposition parties react to, or even copy, and the 'window of opportunity' created by minor political innovations - for example, welfare schemes hatched at the urging of non-governmental organisations - then quickly close. To use the language of equity investors, there is little room for 'political arbitrage' in India. What Modi and his team have done is to open such a window that will not shut easily: Indians want an honest government and demand that the system deliver results. What happens in the future cannot be known, of course, but an attempt has been made.
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