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Home / Economy / Facts shouldn’t come in the way of a good story – Demonetization, 5 years later

Facts shouldn’t come in the way of a good story. If there is one sentence that explains the narrative success of demonetization of the 500 note and the 1,000 note, which formed more than 86% of the currency in circulation, on 8 November 2016, five years back, this is it.

As the Press Release, which accompanied the decision to demonetize 500 and 1,000 notes, pointed out: “High denomination notes are known to facilitate the generation of black money." This story was sold to the country to build a positive narrative around the decision that created huge problems for the economy at large. And many people bought the story. Many still do.

Of course, black money is indeed easier to store in the form of higher denomination notes. As Gottfried Leibbrandt and Natasha De Teran write in The Pay Off—How Changing the Way We Pay Changes Everything: “ Large notes are clearly convenient for those of a criminal persuasion: $1 million in single dollar bills weighs more than one tonne and has a volume of more than one cubic metre, but $1 million in $100 notes weighs about 10 kg (22 pounds) and fits neatly into a briefcase. In the even higher denomination €500 note, that same $1 million would weigh only 2 kg and fit in a small bag – or a large stomach."

What’s true for the American dollars should be true for the Indian rupee as well. So while the weight and the volume might differ, the logic stays the same.

Nonetheless, there were two basic problems with this supposed attack on black money or money earned and stashed away without paying taxes on it. The first problem is simple. If it was easy to stash away black money in the form of 500 and 1,000 notes, it is far easier to do so with 2,000 notes. Hence, introducing a 2,000 note to replace erstwhile 500 and 1,000 notes beat the entire logic of higher denomination notes facilitating the generation of black money.

In fact, the government and the Reserve Bank of India (RBI) seem to have acknowledged this, and since March 2017, both the volume and the value of 2,000 notes in the currency in circulation or the cash in the financial system have been coming down. Take a look at the following chart, which plots what proportion of the currency in circulation is formed by 2,000 notes.

Source: CMIE
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Source: CMIE

As of March 2017, the 2,000 notes formed half of the currency in circulation. This was down to 17.34% by March 2021. This tells us that the RBI has stopped printing 2,000 notes, and the importance of the 500 note has gone up in the financial system. It has jumped from 22.45% to 68.41% during the period.

In volume terms, 2,000 notes are down from 3.28% of total notes in the system as of March 2017 to 1.97% as of March 2021.

The second problem with demonetizing 500 and 1,000 notes is that people do not store their black money in the form of cash or at least not a major part. As the Finance Ministry’s White Paper on Black Money released in May 2012 had pointed out, only 5% of the total black money or undisclosed wealth seized during search and seizure operations (or what is popularly referred to as an income tax raid) was held in the form of cash. Clearly, very few people were stashing away cash under their mattresses.

Further, the cash in the system or the currency in circulation has gone up since demonetization. As of 4 November 2016, four days before demonetization, the total currency in circulation had stood at 17.98 trillion. As of 29 October 2021, the latest data available, the total currency in circulation stood at 29.45 trillion or almost 64% more. But, of course, the size of the Indian economy has also gone up since then, and we need to take that into account. The currency in circulation rises as the economy grows in size.

Take a look at the following chart, which plots the currency in circulation to the gross domestic product (GDP) ratio. This takes the size of the Indian economy into account.

On the rise
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On the rise

As can be seen from the above chart, the currency in circulation to GDP ratio of the Indian economy was around 12% for many years. It fell to 8.68% as of March 2017, the period after demonetization when enough paper money hadn’t been pumped into the financial system. Since then, the ratio has been increasing and stood at 14.45% as of March 2021 and 14.24% as of June 2021, significantly higher than the trend of 12%.

There are two reasons for it: The GDP contraction in 2020-21 and people are hoarding more cash for a possible emergency during the pandemic.

Nonetheless, even as of March 2020, the ratio was at 12.03% or was back at its trend of 12%, and it has been continuously rising since March 2017. So, cash continues to thrive in the economy. As Gottfried and De Terán put it: “Doing away with cash… is easier said than done. Emotions run high, attachments are strong, habits are seemingly unbreakable."

While there was no mention of moving towards a cashless society in the original press release accompanying demonetization, prime minister Narendra Modi talked about it in the Mann ki Baat programme on 27 November 2016, where he said: “The great task that the country wants to accomplish today is the realization of our dream of a ‘Cashless Society’."

While cash continues to thrive, there has been a significant increase in digital transactions in everyday life, and that’s a good thing. This has often been pointed out as one success of demonetization. But the fact of the matter is that digital transactions had been rising even before demonetization, and if promoted by the government in the big way they currently are, they would have continued to rise irrespective of it.

Also, as journalist Arup Roychoudhury put it on Twitter, “saying demonetization was necessary for digitization is like saying shutting down 86% of petrol pumps is necessary to promote electric cars."

Finally, as we all remember, more than 99% of the demonetized notes came back to the RBI. So, the black money that was supposed to be purged thanks to demonetization turned out to be much smarter than that. Or, as Leibbrandt and De Terán put it: “ India’s money-laundering schemes are more effective than its money-purging ones."

Nonetheless, all this did not and still does not come in the way of a good story, that demonetization attacked black money and the rich. It didn’t. But then try saying that on a WhatsApp group.

Vivek Kaul is the author of Bad Money.

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