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Counter Point: Slow demonetisation would have given govt better results

Since all demonetised notes came back, there was no money to stimulate the economy.

, ET CONTRIBUTORS|
Updated: Sep 08, 2017, 10.33 AM IST
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The government ignored these suggestions and proceeded with sudden demonetisation branding it as a “surgical strike against black money".
The government ignored these suggestions and proceeded with sudden demonetisation branding it as a “surgical strike against black money".
After months of rhetoric, numbers have started talking now and RBI in its latest annual report has finally accepted that “99% of demonetised notes have come back“. Please note: this figure is as on June 30 and since the deadline for some agencies like co-op erative banks is after June 30, some more demonetised notes might have come back.First quarter GDP growth rate plummeting to 5.7%, lowest in the last 3 years, was another important number in this regard.

Since the main objective of demonetisation was to make black money hoarded in cash useless, it can be treated as a failure now.

To get a historical perspective, let us compare it with the earlier demonetisation done during Morarjee Desai's time in 1978.While only 15% of demonetised notes came back in 1978, 99% came back this time. But why , you may ask. Is it because there were high levels of black money in 1978 and no black money in 2016?

The demonetisation exercise was a grand success in 1978 because it was well organised and there was better coordination between government and RBI, something that was amiss in 2016.Former RBI governor Raghuram Rajan was against demonetisation and mentioned the same in his recent book. New RBI governor Urjit Patel also could not do much because he had just completed two months into his term at the time of demonetisation.

Second reason: difference in currency profile in 1978 and 2016.While the demonetised notes (ie 1,000, 5,000 and 10,000 rupee notes) were beyond the reach of common men in 1978, almost everyone had 500 and 1,000 rupee notes in their purses in 2016. 500 and 1,000 rupee notes constituted around 85% of notes in circulation in 2016 and that is why several people, including me, earlier suggested for a slow demonetisation, i.e. phasing out 500 and 1000 rupee notes slowly and replacing them with lower denomination notes.

The government ignored these suggestions and proceeded with sudden demonetisation branding it as a “surgical strike against black money“.

Since more than 85% of the currency went out of circulation overnight, this surgical demonetisation imposed heavy short term pain on the economy , especially on small and medium enterprises. It also caused pain for common men by forcing them to stand in queue for replacing their old notes. Banks were acting only as money changing agents for these 2-3 months and its negative impact on economy was huge.

The government knew about these short term pains, but went ahead with surgical demonetisation because it had estimated that only around 80% of demonetised notes will come back and hoped that it can utilise the remaining 20% (ie this will work out to `3.09 lakh cr) to stimulate the economy .

Since the entire demonetised notes came back this time, there was no money to stimulate the economy; so the short term negative impact continued for few more quarters. And that explains a part of the slow growth in first quarter (i.e. destocking before GST implementation is the main reason and it is not correct to blame only demonetisation for that).

I don't belong to the camp which says that there was no black money hoarded in cash because the entire demonetised notes have come back. I also agree with the government's argument that black money doesn't become white just because the same is deposited in a bank account.However, recovering taxes from these accounts will be painful and time consuming. Also, the objective of bringing hoarded cash into banking system could have been easily achieved by slow demonetisation.

Hypothetically , let us see what a slow demonetisation would have achieved. If government had announced that it will withdraw 500 and 1000 rupee notes at a later stage (i.e. say from March 2017), the entire hoarded money would have came out, mostly in the form of increased consumption.And unlike this surgical demonetisation that contracted the economy , it would have resulted in a demonetisation induced extra growth.

Introduction of 2,000 rupee note (i.e. higher denomination than the withdrawn 500 and 1,000 rupee notes) was another mistake.While professing against the existence of high value currencies, this introduction sent conflicting signals. This also helped hoarders of 500 and 1,000 rupee notes to convert them into 2,000 rupee notes easily and hoard again.And if the government sticks to its view of having only low denomination notes, it has to withdraw 2,000 rupee notes later. Hope the government will do it slowly , at least next time.

(Views expressed are personal.)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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