Is demonetisation going to pay off?: Business Line December 5, 2016

The impact on future black money generation and the extent to which scrapped currencies do not return are crucial metrics

How can one judge the success of the demonetisation or rather re-monetisation programme of the Government? The stated purpose of such a scheme, when it was announced, was that it was that it was a bold attempt to eliminate black money besides countering the phenomenon of counterfeit currency. As time went by, other objectives were also spelt out. These included more ideological issues such as why there should be cash in the system when there were cards and e-wallets available. The scheme was also intended to transform the way in which we conduct our lives where we adapt to technology rapidly.

Hence, such a scheme cannot be evaluated in the short term as some of the goals specified are transformational and will take time to materialise. But there could still be yardsticks drawn up for evaluation.

Rejecting bad money

First, there is the hope that a large part of the currency in high denomination notes which aggregates around ₹14.25 lakh crore would not enter the banking system, thus making it redundant. The amount that disappears from the system can be the first metric for evaluating the scheme. Presently, around ₹8 lakh crore has gone back as deposits and there are still 30 days left for the doors to close. Will 10 per cent or 20 per cent or 30 per cent not returning to the system be a measure of success? A ratio of 20-30 per cent seems a fair number that can be targeted to justify this vast exercise.

Second, the Government has also stated that any suspicious transactions when converting cash to bank deposits through the Jan Dhan programme or any other means would attract tax plus penalty-cum-fine which can vary across the spectrum. Such identification will clearly earn revenue for the Government.

Hence every ₹1-lakh crore of identified black deposits could earn the Government a bonus of at least ₹50,000 crore revenue. Any success here will reflect on the alacrity with which the Government has plugged loopholes that were being exploited by holders of black money.

Visible effects

Third, the Government has spoken of a window of 50 days ending December 30 to restore normalcy, which is fairly aggressive. Insofar as the currency crunch that prevails in the system is quite stark, currency should be available at all branches and ATMs in the country by this date. Often the queues outside these points are used to vindicate the success of the distribution system which, however, can be misleading as lines tend to get shorter when limited currency is available. An objective measure would be the time taken to revoke all the curbs that have been placed by the Reserve Bank of India on withdrawal of currency from banks. Any delay in such announcements would mean the system is not yet ready with the required amount of currency which was promised.

Fourth, it has been agreed almost unanimously that the economic growth process would get retarded in Q3 of the year, thus affecting overall growth for the fiscal. One metric to judge the re-monetisation scheme would be the speed with which GDP growth recovers and moves upwards. If Q4 growth is lower than Q3, quite clearly the scheme has debilitated growth, which was not in the plan. If things do normalise, Q4 should be the turning point after the expected drop in Q3.

Fifth, the sector that is host to black money is real estate. While there are arguments on both sides as to how this sector is affected by downplaying the role of cash in transactions, the litmus test would be whether or not real estate prices come down. The RBI or NHB price indices would provide some clue to whether there has been any moderation in the prices of property in the country.

Sixth, the volume of cash holdings should come down in case the broader goal is satiated. Hence, over a period of 6 to 12 months, the ratio of currency to GDP should come down from the present level of around 12 per cent. If we are speaking of global norms, it should be halved to begin with. In case households and businesses go back to holding similar amounts of currency, then the transformational objective would get vitiated. It would also mean that we do require such sums of currency for the three classical purposes put forward by monetarists — transactional, precautionary and speculative.

A new black economy?

Seventh, as the main objective was to target black money and eliminate it to the extent that it resided in cash, a question to be posed is whether or not it will lead to the creation of a new black economy considering that high denomination notes of ₹2,000 become easier to hold. Here it will be hard to devise a metric because the extent of such holdings is known only ex-post.

But it will probably take 5 to 10 years for such an economy to come up; however, it can be delayed by more stringent tax laws. This is where the tax system must be tightened so that slippages are eliminated.

The benefits from this scheme are important considering there are considerable costs the country has been subjected to — some that can be measured and others that cannot. The most tangible cost is the loss of GDP and 50 bps cut in the GDP growth rate would amount to around ₹70,000 crore. If the loss on an annual basis is higher, then the cost for the economy will increase proportionately. There are also intangible costs such as time spent by households and businesspersons to deal with the new situation.

Another cost in the economic sense has been the wide distortion caused in the markets which include stocks and GSecs in particular. Yields have become volatile as the RBI grapples with the excess liquidity problem in the system that cannot be supported by their holdings of government paper.

Banks have borne the brunt of higher costs in the execution of this programme such as late hours, reconciliation, overtime, recalibration of ATMs, security and so on, which would be considerable even as some cannot be quantified. The icing has been the recent 100 per cent incremental CRR.

Hence, the success of this scheme can be evaluated in stages and a complete picture will be seen after probably a year when customer habits can be reassessed. Hopefully, the gains will outweigh the costs at the end of the day when the system is largely cleaned up. The challenge then would be to ensure that a new black economy does not get generated.