It has been almost two years since the demonetization of 8 November 2016, but why it was done and what it achieved continues to be a matter of debate. The latest annual report of the Reserve Bank of India (RBI) has now confirmed what was already known to everybody—that demonetization failed to provide any windfall gain to the government. The latest estimates suggest that of the total amount of specified bank notes (SBN) of ₹ 500 and ₹ 1,000, 99.3% have come back to the banking system. The remaining 0.7% or more are stuck with international banks, such as the Rashtriya Nepal Bank (RNB) and other neighbouring countries, where Indian currency was used as legal tender.
Since November 2016, government functionaries, as well as proponents of demonetization, have been busy inventing new justifications of why was this extreme step taken. The benefits of demonetization were touted as reduction in cash transactions, elimination of terrorism and illegal activities, increase in tax compliance, elimination of counterfeit currency and, finally, windfall gain to the government as a result of the money that was supposedly not coming to the banking system. None of these benefits have been achieved even after two years. The so-called figure of ₹ 3 trillion that would have accrued to the government as windfall gain is nowhere to be seen. Cash in the economy is higher than what it was before demonetization and there is no evidence that it has quelled insurgency and terrorist activities. The so-called evidence on tax compliance does not suggest that the increase in tax compliance is entirely due to demonetization. Hard evidence on most of these are in the public domain and bear no repetition.
In the end, the issue is not just about whether demonetization has achieved its stated objective, but also about the whole process of policymaking in the country.
Remember, the context of demonetization was an economy already suffering from two years of back-to-back drought, and a slowdown in the rural economy. At a time when the government of the day should have used its mind to stabilize the economy and revive demand in the economy, it went ahead with an extremely disruptive move bypassing the institutional processes, and against the advice of most financial institutions.
The end result has been a severe disruption in the economy in the short run. There has been a decline in economic activity, which is finally showing signs of stabilizing after two years. But more importantly, it hurt the informal sector and the rural sector, where cash was the order of the day. The consequences on employment, livelihood and credit are still playing out. Real wages, which showed signs of a recovery after July 2016, have declined since then, and there has been no evidence so far of recovery of employment.
There is no doubt that the move was ill-timed and lacked any rationale. But then why did the government of the day do it? Political expediency is an afterthought and, despite success in the elections to Uttar Pradesh legislative assembly, this is neither a justification for such a disruption, nor is it the surest and the best way of winning elections.
The problem is much deeper and it stems from the basic distrust that the government has in its citizens, but also on hard economic data. The idea that the government of the day knows everything about the functioning of the economy of the country and does not need any supportive evidence is dangerous, at the least. But it is also symbolic of the way economic policies are made in vacuum and with utter disregard for hard evidence or logic.
Unfortunately, it is not the first example of governments behaving in an autocratic fashion in the name of public good. The forced use of Aadhaar for public service delivery is another example of use of policy instrument with complete disregard of evidence on identity fraud and leakages in public service delivery. In both cases, the ultimate losers were the poor and the marginalized. In both cases, institutional processes were violated and legislative processes bypassed.
If there is one lesson from demonetization, it is not that demonetization was a disaster with costs of demonetization far outweighing the benefits. It is that government policy requires better understanding of the functioning of the economy. Importantly, policymaking should respect the institutions and the evidence produced by these institutions. The need is to build these safeguards and to strengthen these.
While there is unlikely to be another adventurous move of demonetization, there is no guarantee that another government will not attempt any such move which is equally disruptive for the economy. Building such safeguards is not just necessary for the stability for economic growth and well-being of its citizens, but is also essential for the democracy to function.
Himanshu is associate professor at Jawaharlal Nehru University and visiting fellow at the Centre de Sciences Humaines, New Delhi