Deconstructing demonetisation

A non-partisan look at the gains and losses of ‘the most creative destruction since 1991’

DS Saksena | January 17, 2017


#Demonetisation   #Narendra Modi   #Cashless Economy   #Mann ki Baat  
Representational image
Representational image

These days demonetisation is too much with us. It started with the PM’s address on November 8 and ended with the PM’s address on December 31, but its aftershocks are still being felt. In Mumbai, look at a BEST (sorry, MUTP) bus and as often as not you would find the PM’s stern visage looking back at you with an added warning for tax evaders. Ditto for hoardings and bus shelters. If you turn on your FM radio, every ten minutes you would find the RJ discussing demonetisation. Open your newspaper and you will find some news about demonetisation hogging the headlines. It remains a key theme in social media discussions. Demonetisation has inspired a new genre of jokes and wisecracks that is now the staple of all friendly conversation.

The PM mentioned demonetisation in his ‘Mann Ki Baat’ and umpteen other forums. All netas are discussing it ad nauseam. One can safely say that today demonetisation is the country’s obsession number one. With elections round the corner, the government and all its ministers are singing paeans to it; and the opposition is trying its best to run it down in all forums. The atmosphere has become so surcharged that harangue has replaced debate and grandstanding has taken the place of logic.

No wonder there has been little impartial discussion about demonetisation. This leaves one wondering whether one should support it with all vigour (as the government would want us to do) or to be vary of it (as is the public’s perception about most government schemes)?

By answering a set of questions, I attempt to deconstruct demonetisation with its bells and whistles, warts and all for readers to judge its worth. I may add that this article is based on my interaction with a diverse cross-section of the public – daily wage earners, realtors, brokers, small traders, jewellers, and diamond merchants.

Was demonetisation a political decision or an economic one?


We would never know. Demonetisation being an accomplished reality, this question is only of academic interest.

Have its objectives been achieved?

It was brought in to eliminate corruption and hit drug dealers and terrorists. The jury is out on the last two. As regards eliminating corruption, even in the first week, bribe money was recovered in new notes and anecdotal evidence suggests that bribe money came to be paid in other forms or even in instalments. Detractors of demonetisation argue that it has spawned new avenues of corruption with bankers, tax evaders and even the general public ganging up to defeat its very purpose.

However, it is a fact that as of now 97% of the currency printed by RBI has been deposited in banks and some more may come in (from NRIs, foreign banks and foreign citizens) and the ownership of all currency is now on record. The income tax department has already deployed data analysis tools to analyse the cash deposited and the process of issuing notices to errant depositors has begun. It would seem that the war against black money has been joined in right earnest. However, the success of the whole exercise of fixing tax evaders would depend on the ingenuity of the income tax department, which is woefully under-staffed, and the views of judicial forums on the taxability of the deposits and the culpability of the depositors.

What then have been the unquestionable gains?

The first gain, as mentioned earlier, is that more than 97% of the currency has been deposited in banks and there is a name to its ownership which would make tax evasion through cash transactions difficult in the near future. Secondly, the country has been made aware that all transactions need not be in cash. Thirdly and most importantly, people have realised the value of money. Here also, detractors point to the weddings of politicians’ progeny which did not appear to be hit by demonetisation. Be that as it may, these are some of the lasting gifts of demonetisation.

What is the downside?


First and foremost, the human cost. More than hundred people have lost their lives in queues outside banks. All businesses, particularly small businesses, have suffered. Daily wage earners lost their employment. Farmers had to resort to distress sale of their crops as a result of which small farmers incurred huge losses. Many man-days were wasted in queuing up outside banks. Billions of pieces of new notes had to be printed and the demonetised currency had to be disposed of. The economic cost of demonetisation has been estimated at Rs 1.25 lakh crore. In his New Year address, the president has noted the ill effects of demonetisation on the Indian economy and has asked the government to take steps to ameliorate the sufferings of the poor.

Much more importantly, demonetisation has dented the credibility of the government and the Reserve Bank of India. In a period of 62 days more than 150 directions were issued of which a large number were reversed or modified, leaving the public thoroughly confused. During this period, the government constantly redefined the goals. Firstly, demonetisation was said to be aimed at corruption, black money, drug mafia and terrorism. At a later stage, the government conjectured that a significant proportion of the demonetised currency would not be returned leading to windfall gains for the government. When it became clear that most of the currency would come in, the government started saying that demonetisation would promote a cashless economy. Such a rapid change of stance has led the public to conclude that demonetisation was implemented without proper forethought.

During demonetisation, the public genuinely felt short-changed (literally) when they could not access their own bank accounts even for their genuine needs. Finally, instead of reining in corruption, demonetisation opened up new avenues of corruption.

What went wrong?

There was an absence of planning. This was an exercise that affected all Indians. Former RBI governor D Subbarao has termed it as “creative destruction and the most disruptive policy innovation since the 1991 reforms”. It seems that the persons who conceptualised demonetisation had no clue about the extent of disruption it would cause. Rather, they proceeded on the assumption that the woes would be short-lived and the shortage of currency would be over quickly. They never realised that the shortage of cash would derail the economy and bring commerce and industry to a standstill. The planners never realised that the process of currency printing was slow and many logistical bottlenecks were involved and that even after 50 days there would be long queues outside banks and people would not be able to resume their normal activities because of cash shortage.

Initially, demonetisation was seen as a step to put down the rich and the corrupt and there was great enthusiasm for it but public euphoria began to evaporate once cash shortage started to affect the day-to-day lives of common people. Also, the public never saw any celebrity queuing up for cash with them – except for a photo-op. 

The ideological reason for the failure of demonetisation was that the demonetisers proceeded on the erroneous assumption that cash equalled corruption. In India 98% transactions were in cash. It could have been no one’s case that 98% of transactions had an element of corruption. The labourer, the farmer and the small supplier (say, vegetable vendor) got paid in cash and with the propensity of such people to save in cash (because of illiteracy and/or non-availability of banking facilities) it would not have been difficult to foresee that these people would be the most affected by demonetisation. The planners also did not appreciate that the purchasing power of the Rs 500 note was pretty low and even the poor had a large number of such notes. 

Could demonetisation have been handled better?

Definitely. Its effects should have been fully assessed before going for it. For example, modes of cashless payments like cards and digital wallets should have been promoted months before announcing demonetisation. ATMs should have been stocked with only Rs 100 notes at least six months prior to demonetisation. This would have ensured that post-demonetisation, the public had enough cash for their daily needs (because a sufficient number of small notes would have been in circulation) and their day-to-day lives were not affected. Also, the new notes should have been the exact size of their predecessors. This would have ensured that all ATMs would have run smoothly without recalibration.

Lastly, a more lenient version of the Pradhan Mantri Garib Kalyan Yojana (PMGKY) should have been announced simultaneously with demonetisation. Had this been done, the parallel money-laundering industry would not have sprung up because people would have been happy to pay tax and make their money white instead of running after intermediaries and exchanging old black money for new black money. But in actuality, by the time PMGKY was announced, the big players had already taken care of their black money. Only ordinary people were waiting for crowds at the banks to thin down.

Going a step further, demonetisation should have been announced simultaneously with the Income Declaration Scheme (IDS), 2016. Had this been done, people would have been forced to declare their unaccounted holdings properly because they would have had no opportunity to change the nature of their unaccounted holdings via cash. I would like to inform my esteemed readers that this is not a statement made with the benefit of hindsight. I had said the same things in a TV show right after demonetisation was announced.  

So what are the lessons?

Measures affecting a large number of people should not be taken unilaterally. More particularly, the financial setup of the country should not be monolithic. It would appear that demonetisation was thought of at the very top and was communicated to the RBI as a fait accompli. Further, the day-to-day implementation of demonetisation was dictated by the finance ministry to RBI, which simply passed on instructions to banks. This is probably the reason why so many instructions issued by the RBI had to be reversed or modified.

The RBI is an independent regulator. The finance ministry should act on the advice of RBI and not vice-versa. Again, banks are commercial entities which should normally work on business principles and not according to the dictates of the ministry. At the time of the meltdown of 2007-08, Dr YV Reddy, the then RBI governor, refused to buckle under the government’s pressure and the country sailed through the meltdown. More recently, Dr Raghuram Rajan refused to lower interest rates and the country saw good growth along with low inflation. Such independent spirit seems to be lacking today.

So what is the way forward?

Demonetisation would continue to bedevil the economy for some time to come, say, six months at the very least. The Indian economy is resilient and would bounce back as soon as enough cash becomes available – after which demand would pick up and supply channels would be restored.

There would be an increase in cashless transactions but not to the extent the government wants it. The increase in cashless transactions would be limited firstly by lack of education of masses and secondly by the charges levied by card companies and mobile wallets on cashless transactions. Additionally, there is the issue of data security. A significant security breach would put paid to all efforts to achieve a cashless economy. Lastly, there is the force of habit. Once sufficient cash is available many people would go back to their bad old cash spending ways.

On the plus side, the awareness built about corruption would deter small corruption. Similarly, the reduction in cash transactions and lesser cash availability would deter small crime.

However, the battle against corruption has only started. Till the time government procedures and processes are simplified and responsibility (including responsibility for delay) is fixed at all levels, there can be no significant reduction in corruption. Till such steps are actually taken, black money would continue to be generated.

Finally, looking at demonetisation in another perspective, one finds that almost everyone – right from the businessman who increased his cash balance to the Jan-Dhan account holder who allowed black money to be parked in his account to the banker who facilitated unaccounted conversion to the shopkeeper who accepted demonetised currency, to the political party which allowed misuse of its bank account – all were complicit in money laundering. Taking a cynical view, can or should honesty be enforced in a country where every other person is dishonest? The answer to this question is hidden in the proverb ‘Where ignorance is bliss, ‘tis folly to be wise’. Substitute ‘dishonesty’ for ‘ignorance’ and ‘honest’ for ‘wise’ and you would have the answer to the question.

Saksena, an IRS officer of 1979 batch, retired as principal chief commissioner of income-tax, Mumbai in September 2016.


(The column appears in the January 16-31, 2017 issue)

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