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Business News/ Opinion / Demonetisation will cost more than slow growth

Demonetisation will cost more than slow growth

The government failed to anticipate the economic fallout of demonetisationboth the duration and the magnitude

Demonetisation will go down in history as a failed policy experiment. Photo: APPremium
Demonetisation will go down in history as a failed policy experiment. Photo: AP

The Union ministry of finance (MoF) has put out a note defending the Demonetisation Initiative of November 2016. It provided much information to show that it has indeed delivered the results they had expected. It is a well-drafted note. But I have a quibble.

The quibble is that the note says that the government always expected almost all the Specified Bank Notes (SBN)—the 500 and 1000 notes—to return. That is not true. The official government estimate at the time was that SBN not returned would be 20%. It could have been “lazy mental arithmetic". But that was mentioned. In any case, the amount of currency returned (or not returned) is not a good metric for measuring the success of the Demonetisation programme. I had said as much in a lengthy interview with Bloomberg Quint in February this year.

How can it be a failure if, on 31 December, the government had at least a better idea of who held the SBN than it did on 8 November? The second reason is that the return of almost all the SBN is an indictment of the values and attitudes of the people. If the Indian state is part of the problem, so is Indian society. It is also clear that banks colluded with the offenders to help them recycle unaccounted cash. Much of that story remains to be told.

On its part, the government has put out impressive revenue growth numbers to show that it has put to use the information content of the returned SBN. But they also represent a problem.

It is quite possible that these numbers represent a state that has turned vindictive with excessive zeal, just to prove itself right and its citizens wrong. That fear is aggravated by the fact that nominal gross domestic product (GDP) growth has slowed from 10.4% in April-June 2016 (over April-June 2015) to 9.3% in April-June 2017 (over April-June 2016). For tax revenue to grow at such impressive rates in spite of nominal GDP growth rate slowing indicates a tax machinery that is working well, or too well, in some respects.

At another level, it is an indictment of the structure and administration of the tax system,which still takes more from the people than the government is able to give back in terms of amenities, security, safety, infrastructure, education and public health. The fact that rains again paralysed Mumbai on the 10th anniversary of the report that called for Mumbai to be developed as an international financial centre must be particularly galling.

The government’s failure is not so much that almost all the SBN came back—its failures lie in the following areas:

1. Failing to anticipate the economic fallout—both the duration and the magnitude.

2. The failure in (1) was compounded by the fact that subsequent measures have all aggravated and lengthened the duration of the impact on economic growth .

3. Failing to come up with either simple, short-term palliatives or structural growth initiatives—on education (whatever happened to the 20 world-class institutions initiative?), settling retrospective tax claims, setting goods and services tax (GST) rates in a manner that facilitates rather than impedes activity, extending the idea of government sharing of the labour-cost burden on businesses, announced first in the budget of 2016-17, and following through with corporate tax reduction, not evolving political and policy consensus on banking non-performing assets (NPA) in a timely manner, etc.

As I had written in these pages several months ago, the NDA (National Democratic Alliance) government, to its credit, made informal economic activity more difficult, but it has not made formal economic activity easier. If anything, it has become more difficult. The real barometer has to be the extent to which the government formalizes the economy and expands the formal economy. On that score, the government does not have much to show. Economic growth in the first quarter of 2017-18 confirms that. Estimate of growth in “Gross Value Added" at basic prices (2011-12 prices) has dropped to 5.6% (April-June 2017 over April–June 2016) from 7.6% in April-June 2016 (over April-June 2015). In terms of GDP, the fall is steeper—from 7.9% to 5.7%.

When Gulzar Natarajan and I were researching data for our joint work, Can India Grow?, published last November, we realized that the current production structure in the Indian economy—whether in farms or in factories—was extraordinarily primitive and, hence, inadequate to help it achieve sustained high economic growth. That is why, notwithstanding the unprecedented nature of the “SBN withdrawal" decision fraught with short-term economic setbacks, some of us hoped that it might well be the painful but necessary “catalyst" that would spawn further policy changes facilitating formalization and scaling up of the Indian economy.

Those hopes have not been fulfilled so far. The culprit may not be just the government of India. Several conversations suggest that the Reserve Bank of India (RBI) sees itself as the guardian of the status quo in the Indian banking system and is being unhelpful in moving the agenda forward on digitization, etc. Indeed, it might not even be out of place to suggest that had RBI been the banking regulator in Kenya, m-pesa may not have happened there.

These, and not the short-term slowdown in economic growth, are what make the “note ban" exercise costly and prime it to go down in history as a failed policy experiment.

V. Anantha Nageswaran is senior adjunct fellow (geoeconomics studies) at Gateway House: Indian Council on Global Relations, Mumbai. These are his personal views. Read Anantha’s Mint columns at

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Published: 05 Sep 2017, 12:15 AM IST
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