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A year ago, Prime Minister Narendra Modi announced the scrapping of high-value banknotes
which amounted to 86% of currency in circulation. The demonetisation of currency notes was
supposed to be an attack on black money, on counterfeit notes, and projected as part of a
broader push to promote digitization and non-cash payments. A year later, progress on all
these counts appears to be very modest, and should make us question whether this exercise
was needed at all to fulfil its stated aims.

The costs imposed by the currency-scrapping exercise were, however, quite severe, at least in
the short term, disrupting ordinary life across the country for several weeks. The hardest-hit
were those in rural areas, where access to banking and the internet are quite low. A 2016
Reserve Bank of India (RBI) report on branch authorization policy classified 93% of rural
centres in the country as unbanked, with the population dependent on roving banking
correspondents and on distant urban or semi-urban branches. Access to the internet is equally
patchy, with only 3% of households in underdeveloped rural areas reporting access to internet
in a 2016 consumer economy survey.

Economic costs

The rural and informal economy suffered disproportionately because most transactions are
cash-based. The liquidity squeeze led to a pile-up at wholesale markets, leading to a sharp
decline in the Wholesale Price Index (WPI) of perishables such as fruits and vegetables in the
immediate aftermath of demonetisation. By turning farm markets into buyers’ markets,
demonetisation may have also contributed to the decline in prices of pulses. Rural consumer
sentiment too took a hit, with domestic sales of two-wheelers plunging sharply. Car sales also
declined but the decline was less severe than in the case of two-wheelers.

The slowdown in the economy, which started before demonetisation, also seems to have been
exacerbated by demonetisation. New project announcements declined sharply in the wake of
demonetisation, a Centre for Monitoring Indian Economy (CMIE) analysis showed, hurting
the capex cycle.

Contrary to what some economists predicted, the dividend from RBI to the government was
lower because of demonetisation. RBI’s domestic earnings declined as it had to pay interest
of Rs17,426 crore after it mopped up excess liquidity in the banking system following
demonetisation. The previous year, the central bank had earned interest of Rs506 crore in its
liquidity management operations. RBI’s printing costs also went up because of the move.

Uncertain benefits

The one big promise of demonetisation was a rapid expansion in the tax base but the actual
results have been quite modest. According to the finance ministry’s estimates published in the
latest Economic Survey, the tax base expansion attributable to demonetisation was Rs10,600
crore, lower than what RBI spent on interest expenses, and equivalent to only 0.1% of India’s
gross domestic product (GDP). The full effect on tax collections “will materialize gradually”
as reported income of new taxpayers grows, said the survey. How far such gains materialize
remains to be seen.
Another stated aim of demonetisation was to detect and eliminate counterfeit notes. The
growth in detected counterfeit notes after demonetisation has not been unusually large, shows
RBI data, even as counterfeits of the freshly issued notes have already emerged in the system.

Demonetisation did provide a boost to non-cash payments in the short term but that effect
may be waning, with the cash-to-GDP ratio back to double-digits. There seems to have been
some impact on the stock of black money (rather than the flow), given that the construction
sector has been hit hard. But this may also have led to large-scale job losses. The proportion
of high-value notes (Rs500 and above)—often viewed as conduits of black money—has also
been rising as new notes have entered the system. At the end of fiscal year 2017 (FY17), the
proportion of high-value notes stood at 74%, considerably lower than that in FY16. But this
figure may rise significantly by the end of FY18.
There’s enough for the government to claim success, but
also grounds for the Opposition to be dismissive
Has demonetisation achieved its original objectives? On November 8, 2016, these were
tackling corruption, counterfeit currency, and terror funding. Thereafter the Prime Minister
added reducing dependence on cash.

Now that we know that 99% of demonetised money has come back, the government’s
estimates of how much black money would be extinguished have been proven horribly
wrong. The Attorney General told the Supreme Court that he expected ₹4-5 lakh crore to be
“neutralised”. Then, a Finance Ministry official told reporters that ₹3 lakh crore would not
return. In the end, just ₹16,000 crore didn’t come back.

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This means previously unbanked money has now been credited to bank accounts. As they
yield returns, it will be taxed and that’s a clear gain. If large proportions are proven to be
black, revenues will increase substantially.

The critical question is, how much of the money can the authorities establish is black? In his
Budget speech, Finance Minister Arun Jaitley revealed that ₹4.9 lakh crore had been
deposited in 1,48,000 bank accounts of a minimum value of ₹80 lakh, each amounting to an
average deposit of ₹3.31 crore. At the time, Business Standard Chairman T. N. Ninan, wrote:
“It’s all but certain... this is black money unearthed by notebandi.” On Wednesday, the
Finance Ministry said 18 lakh accounts are under “scrutiny” and “Advance Data Analytics
Tools” have identified a further 5.56 lakh. This is a huge number for the Central Board of
Direct Taxes to scrutinise given that it only investigates 3 lakh accounts annually.

On the assumption that most black money is detected, the economist Surjit Bhalla has
calculated the additional revenue in the first year as ₹2.5 lakh crore with a further ₹1.5 lakh
annually in perpetuity. If that happens, it’s a huge gain, but ‘if’ is the operative word. For
now, all we can say is some black money will be identified and taxed but what proportion
that is of the total and what the gain will be is unknown.

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However, the objective of reducing counterfeit currency seems unachieved. In 2015, the
National Investigation Agency established that at any point only ₹400 crore of counterfeit
currency is in circulation. That’s 0.028% of total currency. Now, CNBC has calculated only
0.0007% of the returned ₹1,000 notes as being fake and only 0.002% of the ₹500 notes. In
value terms the total is just ₹41 crore. So either a lot of fake currency hasn’t been detected or
didn’t exist.

In terms of tackling terror funding, the Finance Ministry has said: “As a result of
demonetisation of specified bank notes, terrorist and Naxalite financing stopped almost
entirely.” If true, this is a huge success, but no proof has been provided.

Finally, have we reduced dependence on cash? Both in number and value, digital transactions
increased sharply after November but also dipped sizeably thereafter. There were 671.49
million transactions in November, rising to 957.50 million in December before shrinking to
862.38 million in July. In value terms, it was ₹94 lakh crore in November, ₹149 lakh crore in
March, and ₹107 lakh crore in July. So, the use of cash initially diminished but has been
steadily increasing thereafter.

This is a mixed picture. There’s enough for the government to claim success, but also
grounds for the Opposition to be dismissive. Clearly, the demonetisation controversy

Karan Thapar is a broadcast journalist