The question of whether demonetisation failed or succeeded is not a spiritual or a moral question

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New Delhi | Published: September 1, 2018 1:14:39 AM

Is it too much to expect that, in this data-dependent world, one should discuss hard evidence rather than soft opinions?

The question of whether demonetisation failed or succeeded is not a spiritual or a moral question (File photo)

It must be election season. The uniformity of the media response to the annual RBI report stating that all the demonetisation cash had been returned to the system, and therefore demonetisation was a failure, deserves a serious examination. By now, all have made up their minds as to what they think about demonetisation. We went through the same exercise last year at about the same time—RBI stated it was still in the process of finalisation, but indicated that all the demonetised notes had been returned. What is the news content in the recently released RBI report on demonetisation? Zilch. But if one were to go by the discussion in the media, the editorials, etc., it appears that this is a new “fact” deserving of penetrating analysis and deep insights.

If this article reads as if you have read it before, you have. I have written several articles on demonetisation, starting with the first one, eleven days after D-day, (  In that article, I argued that increased tax compliance was the most important metric to judge the success or failure of demonetisation (All my demonetisation articles are available for ready reference at

Was demonetisation a success or failure? Depends on whether it achieved its objectives (stated and unstated) and the costs of achieving the results, and the benefits accrued. The major goals of demonetisation are discussed below.

The return of cash: Many of us felt (including the government) that of the Rs. 15.8 lakh crore (or trillion) rupee notes that were demonetised, about `2-3 trillion would not be returned. The assumption was that this was the minimum amount of black cash in the system, and since those hoarding cash would be afraid of getting caught by the taxwoman, they would burn the cash, rather than return it to the authorities.

What happened was that all the cash got returned, and those expecting that this would not happen, were naïve. Let me speak for myself—I am surprised that all the cash got returned, and at the same time I am impressed by the ingenuity of Indians, especially those with black money. If the only objective of demonetisation was to not get all the money back, then clearly the policy failed.

Today, there is more cash in the economy than there was on November 8, 2016. Double failure, the hoarse critics shout. You said there was too much cash in the system? What do you have to say now? But this metric—comparing the absolute level of cash before and after—reminds me of my first class in statistics. The teacher pointed to a graph relating the number of people suffering from mental illness in the UK (Y axis) and the number of radios sold (X axis). (The study, as you might have guessed, was in the early 1950s). The graph revealed a perfect fit between the two. But any time-dependent variables would give you a near perfect fit.

Thus, the first statistics implication of the demonetisation debate (which, lemming like, many “intellectuals” have fallen for) is that cash has to be scaled by another variable, such as GDP. No one I know (especially from the government—political and media opposition is another story) claims that cash should have gone to zero post de-monetisation. Equivalently, no one I know believed that the absolute value of cash will not come back, at some point in time, to pre-demonetisation levels. If one scales cash by GDP (for the technically oriented, cash is related to GDP by the transactions demand for money) then one obtains the following result—cash in fiscal year 2017-18 is 10 % below what it was in 2015-16 (the GDP has gone up for those wondering).

Tax compliance: I remember arguing in one of my articles that I wished all the cash was returned to the banks. Why? Because such people will be identified and will have to face the consequences of gaming the system. This is a long litigious process but major hints of the magnitude of black money involved (the one that was not supposed to be returned) is high. In his February 1, 2017, Budget speech, finance minister Arun Jaitley stated the following, “After the demonetisation, the preliminary analysis of data received in respect of deposits made by people in old currency presents a revealing picture…Deposits of more than `80 lakh were made in 1.48 lakh accounts with average deposit size of `3.31 crore”.

Let us pause and reflect on these data for just a minute. Just after demonetisation, and even over the last few days, a lot of experts continue to opine that demonetisation was doomed to failure because “no one hordes black money in cash”. Just think about it—`3.31 crore wasapproximately $500,000 (2017 exchange rate) and there are 148,000 such individuals. There are not that many Colombian drug lords who individually keep $500,000 in cash. In the aggregate, this cash—and it is reported to be cash—is close to `5 trillion. How far is this number from the `2-3 trillion that was supposed to not come back? It maybe the case that most of us made a very conservative estimate of black cash in the Indian economy.

What about the estimate that a 100 people died standing in queues? Isn’t that a cost of demonetisation? Untimely, death is horrific and cannot be weighed in rupees. There are expert references to such deaths as “proof” that demonetisation failed. But, be careful—if a critic is willing to invoke deaths as a criterion, then she should equally ask herself as to how many deaths were caused, or poor people were not helped, because the rich failed to pay their taxes. A fact worth remembering is that, as far back as 2002, I had estimated (Vijay Kelkar report on direct taxes) that aggregate tax compliance (tax paid as a proportion of what should be paid given the tax schedule) was in the low teens in 2001 i.e., less than 15 % of tax revenue that should have been collected by the government, was collected. A small increase in tax compliance could have gone to schooling, medical care, nutrition, and avoidance of deaths of the poor.

One medium-term indicator of tax compliance is tax buoyancy i.e., the ratio of growth in tax revenues and growth in nominal GDP. Personal income tax (PIT) buoyancy averaged 1.31 between 2002 and 2005, jumped to 2.18 between 2006 and 2007, collapsed to 1.08 between 2010 and 2015, and averaged 2.1 in 2016 and 2017. No matter how one slices the personal income tax data—whether by record increases in the number of tax payers or by tax buoyancy—the fact remains that improvement in tax compliance has been a major success story of demonetisation. And, let the people, and historians, compare the failed realisation of all the cash coming back with a structural improvement in India’s tax compliance.

Besides improvement in tax compliance, the other major objective of demonetisation was a move towards a less cash-dependent economy. (This will have, down the line, major advantages in tax compliance i.e., individual expenditures will have no place to hide). The formalisation process was well underway before demonetisation—the question is has this formalisation accelerated? It definitely has. Withdrawal of cash from ATMs (plus paper clearing) as a proportion of all transactions (e.g., RTGS, POS, IMPS) has declined by 30 % in volume and 17 % in value. The two periods are Jan-June 2016 (pre-demonetisation) and Jan-June 2018 (post-demonetisation).

Finally, it can be argued that demonetisation has eased, and increased, tax compliance with GST. Future research will attempt to quantify this benefit.

The problem with election years is that analysts (and opinion makers) see everything via a political lens. But we should take time-out—30 minutes each day—to check the facts, and opinions, floating around. I have attempted to do that in this article (and others before). Is it too much to expect that, in this data-dependent world, one should discuss hard evidence rather than soft opinions?

The writer is a Chairman, senior India analyst for the Observatory Group, a New York-based macroeconomic policy advisory firm, and part-time member of the PM’s Economic Advisory Council.

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