Realist, not conformist analysis of the latest financial, business and political news

India’s Demonetisation Was Hugely Successful – Don’t Let Them Tell You Otherwise

It appears that all of the notes made worthless by India’s demonetisation experiment have made it back into the banking system. Therefore, it is said, the whole experiment was a failure, even should not have been tried. This is to be incorrect about such things. But then the critique is from a piece in The Guardian and we all know about them and matters economic. Never met a theorem they’ve not picked up the mucky end of. The definition of success depends upon what you think the goal was in the first place. And I think it’s done just fabulously at what I think was the main aim:

More than 99% of the currency that India declared void in a surprise announcement in 2016 was returned to the country’s banks in subsequent weeks, according to a Reserve Bank of India (RBI) report.

The figures suggest prime minister Narendra Modi’s demonetisation policy, which likely wiped at least 1% from the country’s GDP and cost at least 1.5m jobs, failed to wipe significant hordes of unaccounted wealth from the Indian economy — a key rationale for the move.

Modi shocked Indians in November 2016 when he announced on live television that all 500 and 1000-rupee notes, equivalent to about £6 and £12, would be banned in four hours’ time.

People were given several weeks to exchange their demonetised currency for new notes at banks.

There’s The Guardian’s first error. When you put those notes back into the bank you had to, err, put them into the bank. Into an account linked to your name and Aadhar number. That is, this wealth was now in the tax system. Good luck on getting it out of that again. That is, even if absolutely every note made it back into the banking system, then to be drawn out again later as new notes were made available, it was still a success.

As India’s massive informal economy reeled, Modi implored the country to give the policy time to work, arguing it would flush out untaxed wealth being hoarded by wealthy Indians, help to digitise the economy — one of the most cash-based in the world — and starve terrorists and criminal gangs of cash.

The RBI’s annual report on Wednesday found 99.3% of the money withdrawn from circulation had been returned to banks, indicating either there was less “black money” than expected, or that schemes to launder money were more successful than thought.

Thus that’s just not right. The RBI report is here. But there’s another and much more important point to make. Which I made elsewhere at around that time:

“I might have done as much as any other reporter outside India to cover this issue and given that I report on matters economic I can see a little deeper into the story than many others. No, not because I’m a better reporter (I’m not) but because I’ve the hinterland in economic policy to be able to see what is being aimed at.

Along the way I’ve pointed out that most of those bank notes being cancelled have been deposited in bank accounts. This is lowering interest rates and also inflation. That the process is likely to shrink India’s GDP in the short term but that’s by no means certain. That the real background issue is really all about Adam Smith. And that in the medium term this will boost India’s reported GDP, without a doubt, but possibly that won’t be important in the slightest.

And to come back to the major and important point. Is demonetization, as just demonetization, a great success? No, it isn’t, and it never would have been. The aim is to crack down upon black money in the Indian economy. To get everything moved into the licit and taxed economy. Both so it can be taxed and also so that the pernicious effects of bribes and favors which so distort the economy can be limited. The reason it never was going to have much effect is that the major distortions here are not in cash rupees. Seriously rich people are in land, or gold, or dollars, or Switzerland. It’s very much the small scale stuff that is taking place in Rs 1,000 notes. No, really, vast black market transactions do not take place with piles of $15 bills.

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