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A case of what could have been for India's demonetization drive

Publication Date: 10 Sep 2018 - By Anuj Dhawan By Anuj Dhawan
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On the evening of 8 November, 2016, the Prime Minister of India Narendra Modi announced that the erstwhile notes of INR1,000 and INR500 were no more legal tender. This step was taken in line with the erstwhile government’s stated agenda to curb the prevalence of black money.

Demonetization or ‘DeMo’ was one of the several suggestions by Anil Bokil, the founder of Pune based think-tank Artha Kranti Pratisthan. In addition to demonetization, the group had also been advocating doing away with taxes in their current form and replacing them with a banking transaction tax. 

Outcomes of DeMo

DeMo attracted a slew of feedback – while some quarters found it to be an extremely positive step, others have called it a scam. Another raging debate had been on the cause of over 100 deaths of people standing in DeMo queues. 

The biggest strength of India is also the source of India’s biggest administrative nightmare – a hugely diverse population, with varied allegiances. While DeMo caused initial anguish amongst hoarders, the age-old thought process of applying ‘jugaad’ or canny fixes to the most complex of problems came in handy. 

From donating to temples, to hiring ‘Jan Dhan’ account holders, the hoarders applied many ploys. The tax department tried to catch hold of many and issued over 1 lakh notices, leading to an increase in the tax base.

Coupled with the introduction of General Sales Tax, despite a decline in nominal GDP, DeMo indirectly contributed to an increase in tax collections. It is interesting to note that tax collections had gone up despite a falling GDP growth rate; any increase in GDP is likely to translate into incremental tax collections. If the surprise 8.2% growth rate in 1Q19 GDP growth rate is an indication, it is going to be 'Achhe Din' or positive days for the Indian government’s finances. The sustainability of this growth rate, due to the base effect, would be another matter altogether.

As per the numbers released by the Reserve Bank of India (RBI), DeMo did not lead to any significant reduction of cash in the economy:

  • Over 99% of the notes in circulation had been returned to banks: “The total value of SBNs in circulation as on 8 November, 2016, post verification and reconciliation, was `15,417.93 billion. The total value of specified bank notes (SBNs) returned from circulation is `15,310.73 billion.” 
  • Due to DeMo, the average value per note (piece) had fallen to INR 451 from INR 774 a year earlier; this value is back to pre-DeMo levels of INR 721
  • The average cost of printing per note has gone up significantly from INR 1.6 levels to almost INR 2.0

What DeMo could have been

While the intent behind DeMo was noble, the execution challenges diluted the end objective. Had the government provided a longer timeframe and incentives to deposit, the complexion of the entire situation would have been very different. A possible variation of DeMo could have been as follows:

  • Instead of a 6-month window to return notes, an 18-month window could have made life easier for all.
  • Instead of introducing newer series of notes, all printing of notes should have been stopped. 

Furthermore,   

  • Each rupee of cash deposited could have given the depositor a benefit of (say) 5% – for INR 100 deposited the government could have contributed Rs 5 to the depositor.
  • Each rupee of cash withdrawn could have attracted a penalty of (double the incentive percentage) 10% – for INR 100 withdrawn, only INR 90 should have been disbursed. The balance INR 10 could have gone to the DeMo account, for funding the depositors.
  • People bringing the unbanked public in the banking system (by way of Jan Dhan or through one of the wallets) should have been given some incentive (say INR 100) for each successful referral. 

Gaming the system would not be possible – for a deposit of INR 100, one could only withdraw INR 94.5 (90% of 105) and within the window of 18 months, most (if not all) transactions would have moved online. More importantly, people would have willingly undertaken this exercise. 

From a cost – benefit standpoint, not only could have the exchequer spent much less (than the INR 1,284 billion, as per CMIE’s estimate) but also could have had the chance to make money through the DeMo exercise. 

Since the model is highly dependent on the incentives, fine-tuning the incentive structure could have further reduced the costs.

Only at incentive levels of 35% and above would the government have had to spend any money! While time can’t be turned back, there is no time for a noble deed.The whole exercise could be construed as an opportunity lost in some ways. 

Reference notes:

  1. https://indianexpress.com/article/india/india-news-india/narendra-modi-prime-minister-address-to-the-nation4364609/?#liveblogstart
  2. https://indianexpress.com/article/india/india-news-india/narendra-modi-prime-minister-address-to-the-nation4364609/?#liveblogstart
  3. https://www.business-standard.com/article/economy-policy/anil-bokil-man-behind-demonetisation-wants-existing-tax-system-abolished-116112101331_1.html
  4. https://www.livemint.com/Opinion/6FJKaHXaq9lqCYeI93NYsN/Demonetization-is-a-net-positive-move.html
  5. https://economictimes.indiatimes.com/news/politics-and-nation/demonetisation-countrys-biggest-scam-says-rahul-gandhi/articleshow/65616565.cms
  6. https://www.forbes.com/sites/timworstall/2016/12/08/indias-demonetisation-kills-100-people-apparently-this-is-not-an-important-number/#44167fb237a7
  7. https://www.livemint.com/Politics/pTWJQEubcDsgtJhe8oxQ5L/Income-tax-notices-to-116-lakh-for-cash-deposit-of-over-Rs2.html
  8. https://www.thehindu.com/business/what-demonetisation-did-to-tax-collections/article23550004.ece
  9. https://economictimes.indiatimes.com/news/economy/indicators/indias-gdp-grows-at-8-2-per-cent-in-2018-19-q1/articleshow/65623967.cms
  10. https://rbi.org.in/Scripts/AnnualReportMainDisplay.aspx
  11. https://www.cmie.com/kommon/bin/sr.php?kall=warticle&dt=2016-11-21%2015:12:31&msec=360
  12. https://www.livemint.com/Industry/CJk2Yalf8NYRdgp8HcvFFJ/19-crore-Indian-adults-dont-have-bank-account-World-Bank.html

 

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