One thing the Demonetisation (DM) announced by PM on 8 November 2016 has done – it has made a large number of people pretend to be economists and experts. Political opposition has been vociferous from Day One about how bad a decision it is etc. No one would deny the surprise element in it and how in the porous corridors of Lutyens’ Delhi it was really kept a secret till it was broadcast on TV / Radio.

We have argued in the immediate aftermath of the announcement that the success of the move depends on how many notes return to the banks, and also that it will reduce level of corruption/ black money in the economy.

See the links below:

1. Success of Centre’s move depends on how many notes return to the banks’
2. It could end Womb to Tomb corruption.

But surprisingly a significant portion of the demonetised currencies called Specified Bank notes [SBN] by the Reserve Bank of India (RBI) have been returned to banks.

“The RBI Annual Accounts for 2016-17, at note XI.6.2 Liabilities of Issue Department – Notes Issuedin para (ii) mentions –

“Until June 30, 2017, SBNs were received by the Reserve Bank either directly or from bank branches/post offices through the currency chest mechanism.  Some of these SBNs are still lying in the currency chests.  The value of the SBNs received by the currency chests has been credited to the banks’ account on “said to contain basis”.  Till such time these notes are processed by the Reserve Bank for their numerical accuracy and authenticity, only an estimation of SBNs received back is possible.  Subject to future corrections based on verification process when completed, the estimated value of SBNs received as on June 30, 2017, is Rs.15.28 trillion.” 

From the reports/ data published earlier by the RBI, currency in Rs.1,000 and Rs.500 denomination in circulation was at Rs.15.44 lakh crore.  [6857.82 million Notes of Rs.1000 and 17165.06 million notes of Rs.500 amounting separately to Rs. 685782 crore and Rs. 858253 crore].  Taking into consideration, the value of SBNs now reported to have been counted, approximately 98.96% of SBNs in value terms have come back to the RBI after demonetization.  In other words, only an estimated Rs.16000 crore worth of SBNs have not come back to the RBI so far.“

Source: E-Release on Demonetisation by Press Information Bureau

This is the first point of criticism. That is, not much impact on black or unaccounted money.

The argument falls flat in the face of following facts:

• Earlier, estimates suggested that around Rs. 3 trillion would not return to the banking system because it was unaccounted money. Then attorney general Mukul Rohatgi said in SC in December around Rs 4-5 trillion would probably not find its way back into the system.

• But our black money holders are clever. There were long queues before banks to exchange old notes to new ones. We did not see any big businessman/Film actor/sports persons/retired Judges/ Rtd Army Generals/Bureaucrats and of course political leaders in that queue. None can argue that only poor and lower  and middle classes in those queues were having black money and none of the elites!—That type of argument would be hilarious. All elites used their servants/dog walkers/drivers etc. to exchange as much as possible. They also would have used some corrupt bank officials. In an anecdotal incident, a college owner in South asked each of his student/family to exchange Rs 50 lakhs for a motorcycle as gift. He had 200 students.

• Hence one can surmise tax evaders had managed to legalize their unaccounted money using mules and         proxies to make deposits, made high-value purchases using back-dated bills and colluded with         bank   officials to exchange old currency.

• Measuring the success of demonetisation on the basis of how much cash has come into the system shows “an inadequate understanding”, finance minister Arun Jaitley has correctly said.

• Indeed, “the fact that the entire demonetised money has come back shows black money has been accounted for completely. In that sense, demonetisation has been a success,” said R. Gandhi, former deputy governor of RBI. It is now up to the tax department to do its job, he added. In January, the government decided to use data analytics to identify people whose deposits didn’t match their known sources of income.

• In his Independence Day speech this year, Prime Minister Modi said that more than Rs. 1.75 trillion             deposited in banks after demonetisation was under the scanner. “The trail of deposits” of bank notes “into     bank accounts may provide valuable information to the revenue authorities in tracing unaccounted                       money”, RBI said in its annual report.

• The ministry’s note added that demonetisation had resulted in a 24.5% increase in the number of income tax returns filed till 5 August. Hence, now the ball is in the Income Tax department’s court.

STR and DM: There are other clues to suggest such a situation. For instance, RBI’s annual report shows a spike in the number of so-called suspicious transaction reports [STR] filed by banks, financial institutions and intermediaries. Banks filed 361,214 such reports in 2016-17, up from 61,361 the previous year. This is evidence that people have been forced to deposit money “illegitimately lying with them”, Jaitley said in a press briefing after the release of the RBI annual report.

PMJDY and DM: Also, a substantial amount was deposited in the so-called poor man’s account, i.e. PMJDY –Banks in the country have added 46.65 lakh new accounts under the Pradhan Mantri Jan Dhan Yojna (PMJDY) during the five weeks after the demonetisation of ₹500 and ₹1,000 currency notes on November 8.

The total number of PMJDY accounts, which stood at 25.51 crore as on November 9, increased to 25.97 crore by December 14. The total balance in PMJDY accounts increased to ₹74,123.13 crore as on December 14 as against ₹45,636.62 crore on November 9, recording a growth of ₹28,486.51 crores.

Any which way, the Indian black money holders did not shy away from the banking system – they only hope they may not be caught.

Household Financial Savings and DM: Typically, the Bharatiya households are major savers in the economy contributing 70 to 80 % of the gross domestic saving. Of these, the physical assets –house/gold etc. –constitute a major portion and the financial assets are mainly cash/bank deposits/ etc.

Interestingly the recent data from the Reserve Bank of India (RBI) shows that gross financial savings rose to 11.8% of the gross national disposable income (GNDI) in fiscal year 2017, a notable climb of 90 basis points from 10.9% in the previous year.

Not surprisingly, the improvement in financial savings was led mainly by bank deposits. After all, Bharatiyas were given 50 days to deposit their invalid cash into their bank accounts. And that is exactly what the people were preoccupied with during the demonetisation months.

So, savings into bank deposits surged to 7.3% of GNDI in fiscal year 2017 from 4.8% in fiscal 2016. Other products also caught a slice or two of financial savings.

Bharatiyas invested 1.2% of their disposable income into shares and bonds, a massive improvement from the average 0.2% in the years past. A look at how stock indices have soared since demonetisation should be enough to add a sense of certainty to this. The inflows into equity mutual fund schemes are another indicator of how the stock market gained from getting a bigger slice of household savings. The insurance sector also benefited with 2.9% of disposable income flowing into it.

In other words, DM seems to be encouraging people into financial products including MFs etc.

Also, one finds that there is a decline in the ratio of white to black transaction in real estate sector. Earlier what used to be 60/ 40 levels—that is white 60% and black at 40% – has come down to as low as 85/ 15 levels. A large number of people do not want to carry huge amount of cash. Even in transactions like TV/ Fridge, purchase of gold etc, use of cash came down. The regulations in terms of cash transactions have become stringent and people are concerned about IT capturing data from transactions.

Many pseudo-experts argue that black money is kept in the form of real estate. Unfortunately, economists are not taught rigorous courses in accounting. A transaction has two sides. If I buy land or house paying let us say Rs 50 Lakhs in cheque and Rs 30 Lakhs in cash, then the seller gets my black money of Rs 30 Lakhs — it is not obliterated.

Hence any attempt to tackle holding of cash will be useful as we will see later.

Technology and DM: One of the important points stressed by the PM regularly is using digital modes of transaction in day to day life. He thinks larger digitization will reduce corruption, and to some extent rightly so. The invalidation also resulted in an increase in digital transactions. In a note, the finance ministry said that number of digital transactions increased 56% between October 2016 and May 2017 to 1.1 billion. The demonetisation exercise was announced on 8 November 2016. At the retail level one sees more use of methods like Paytm/ BHIM/ Credit cards etc even in the level 2 and 3 towns. And technology in a sense is addictive—once you start using it you continue due to ease of transaction/ ability to keep records etc.

Terrorism and DM: There has been significant impact on Naxal terrorists and Kashmir Jihadists due to DM since old notes could not be used. Even trafficking in women from East and NE has come down. The looting of banks in J&K indicate the desperation of the Jihadi groups to get new money.

But the implementation was poor: As we have argued elsewhere the implementation of any such idea is more critical in a country like Bharat than the policy itself.

Of course the opposition talks of hundreds of deaths due to DM – but such hyperbole needs to be taken with a ton of salt. The Government could have minimized the suffering by better planning. In the initial stage, BSF/ CRPF/ Police vehicles could have been used to transfer funds to far flung locations instead of depending only on bank approved security vehicles. We also have companies – both in FMCG and Financial sectors – who have extensive country-wide networks. We have HLL/ ITS/ Sundaram Finance/ Oil companies/ Shriram / LIC etc. who have branches and distribution networks in far flung locations. These should have been co-opted as “temporary Banks” or “correspondence Banks” to distribute new notes etc. Also, RBI should have alerted Government about incompatibility of ATMs with new notes and time taken for re-calibration.

Of course, the element of secrecy might have been lost if so many were involved in the planning stage itself.

Introduction of larger denomination of Rs.2000 is not related to DM at all. That decision was done as early as June/ July and was getting implemented.

We estimate at least 10% of our GDP every year is not accounted or black money. At around Rs. 150 Lakh crores of GDP in 2016-17 – it comes to Rs.15 Lakh crores. This is an annual number and hence there is a need to tackle it on a war footing.

The next best step would be to limit the holding of cash to Rs. 10 or 15 lakh per individual, which if implemented will dramatically change the whole situation. Currently there is no restriction on holding any amount of cash. An expert committee formed by L K Advani in 2008, just before the 2009 general elections, which I was a part of, had proposed certain measures to curb the black money menace. One of the proposals was to make the possession of cash above Rs. 10 lakh or Rs 15 lakh a crime, a punishable crime. That will automatically lead to reduction in stashing the cash. I hope this government will do it.

Illicit Money Abroad: We had submitted a proposal to the government – as part of the earlier mentioned report -on how to acquire foreign currency accounts. We have particularly batted for introducing a new legislation – Nationalization of illicit wealth held in tax havens – which will provide for the acquisition of foreign currency accounts held outside Bharat and appointment of a government custodian for such accounts. After demonetizing existing currencies and restricting the possession of cash per individual, the third step should be to control the flow of international black money. Also to keep in mind jewels in gold /rubies/diamonds stashed in the vaults of various global banks located in Tax havens. One hopes an ordinance in this direction will be introduced soon.

Hence an overall assessment gives us a clue that DM is not a disaster as it is made out. The positive aspects will take time to be visible in the system. Unfortunately, like many other good policies of the Government, the implementation was totally inadequate and did cause lots of difficulties.

But our society went through this level of dramatic change with forbearance and fortitude and our common people deserve a big round of applause for that. We feel average people genuinely felt that the PM was trying to change the system and hence needs support. The whole world was watching and Bharat proved once again it can and will manage with all the warts and all.

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