Sunday, November 19, 2017
ABOUT US CONTACT US ADVERTISE WITH US FOLLOW US ON    
 
Kashmir Times Logo www.kashmirtimes.com
Opinion
Decoding the great demonetization puzzle
No escape from adverse effect on economy
By Nilanjan Banik
November 8 marked the one-year anniversary of the great Indian demonetization move. India's demonetization move should not be looked in isolation. One can find instances of demonetization elsewhere as well. In October 2014, Singapore got rid of its1000 dollar note; in 2011 Canada stopped issuing 1000 dollar notes, and in 2013 Sweden did the same with the1000-Krona note, all as a way to stop financial crimes. Economists Larry Summers and Kenneth Rogoff also suggested doing away with high denomination 100 dollar notes to prevent money laundering and tax evasion.

However, in India, economists were widely divided over the efficiency and the impact of the move on the black money, which is variously estimated at 23 percent to 75 percent of India's GDP. Unlike most of the developed economies, which mostly rely on cashless transaction, for India a majority of the population was dependent on cash for day-to-day transaction, and hence there was greater hardship from demonetization.

Demonetization was intended to flush out black money and encourage the move to a cashless state and bring the parallel sector into the mainstream economy. Data from the Ministry of Finance reveals that during 2014-2015, only a meagre 4 percent Indians paid tax, with the government losing anything between Rs 6 lakh and Rs 9 lakh crore on account of people evading paying tax. Demonetization was also seen as a way to tackle counterfeit currencies. A study undertaken by Indian Statistical Institute, Kolkata, estimates the number as Rs 4 billion, with the old Rs500 and Rs1000 accounting for three quarters of these counterfeit notes. Finally, the demonetization move was seen as a nudge strategy for a greater financial inclusion. Financial exclusion obviously imposes a high cost on the people. In India, 98 percent of people use non-banking channels, such as hawala, and pay exorbitant costs to remit or receive money from their family members living in other regions. A survey of Indian migrant workers shows average commission of 4.6% when transferring money through informal routes, whereas transfer through formal banking system comes at no cost. Importantly, the demonetization move has operationalized the Jan-Dhan accounts, which were seldom operational.

However, critics point out that demonetization is unlikely to bring out much black money, since the bulk of it is held in illiquid assets such as land or gold and jewelry. Without taking supplementary policy measures to track these stock of undeclared wealth, the fight against black economy deserves little merit. In fact, 98.96 percent of the scrapped Rs 1000 and Rs 500 notes returned back to Reserve Bank of India by the end-June, 2017. Also, only 3.4 percent of all notes that came back to the system post-demonetization were fake. And most of the financial inclusion that happened thanks to demonetization was because otherwise poor people merely started depositing unaccounted money of the rich and corrupt into their own bank accounts for a commission (with a promise to pay back at a later date). Meanwhile, the common man has had to bear the economic hardship as 90 percent of all transactions are paid in cash. The brunt of the impact fell on those associated with the informal sector, which accounts for 80 percent of all jobs, where 85 percent of the workers are paid in cash.

Although each one of these above arguments deserves merit, we need to understand the path through which demonetization has affected the economy. A way to examine the effect of demonetization is to use the famous Milton Friedman's Quantity theory of money equation. The 1976 Nobel laureate, Professor Milton Friedman argued that inflation is a monetary phenomenon and he depicted the money market (that is, demand and supply of money) through the equation: MV=PY (1) where, M is the money stock in the economy, V is velocity of money (number of times currency changes hands/amount of nominal GDP that money supply can generate), P is price level, and Y the real value of output.

Going by equation (1), when demonetization happens, the first thing that occurs is a reduction in money supply. Indeed, there has been a fall in currency in circulation, and commercial banks lending to businesses. Concomitantly, there was an increase in bank deposits. People were busy depositing money mostly in their Jan-Dhan accounts.

Two other things have also happened. Compared to other emerging economies such as Brazil, China, Russia and South Africa, in India we have a higher currency-to-GDP ratio. With a reduction in currency in circulation, there is therefore a likelihood of V also falling. What then follows from the quantity theory of money equation is, with a fall in M, there will also be a fall in P and Y.

What is interesting to note, the price of vegetables, eggs, foods and beverages all fell during the period following demonetization. The price of less income inelastic items such as education, healthcare, pan, tobacco and intoxicants, did not fell. This is quite natural: whether people have more income or less income, if they fall sick they will have to visit doctors. Similarly, for the sin-items such as pan, tobacco, and intoxicants, the addicted do not care whether they have more income or less income. What is, however, surprising is that the price of meat items is showing an increase post-demonetization. The causal relation of Uttar Pradesh meat ban (leading to less supply of meat in the market and hence a higher price) is yet to be scientifically validated, but that can be a possibility.

With prices falling, as predicted by equation (1), income will also fall. In fact, during the following quarters, India's GDP growth rate fell from 7.3 percent to 7 percent (Feb 28, 2017); 6.1 percent (May 31, 2017); and 5.7% (Aug 31, 2017). Economists, not favouring demonetization move are using these numbers, and saying India could have realized 8 plus percent growth rate, with government not undertaking demonetization. According to International Monetary Fund, the size of Indian economy is $2.54 trillion (nominal, 2017) and $ 9.48 trillion (Purchasing Power Parity, 2017). Hence, this 2.5 percent - 3 percent difference (what GDP could have grown without demonetization and how it has grown with demonetization) is indeed a big number.

In fact, the reduction in GDP growth rate will belittle the government success story of tracking down black money and shell companies. Finance Minister Arun Jaitley in a press interview announced that between November 2016 and the end of May 2017, income tax authorities detected a total of Rs 17,526 crore in undisclosed income and seized Rs 1,003 crore. As a result of the demonetization drive, there had been a substantial increase in the number of Income Tax Returns (ITRs) filed. The number of returns filed as on August 5 registered an increase of 24.7 percent compared to a growth rate of 9.9 percent in the previous year. The government has identified more than 37,000 shell companies that were engaged in hiding black money and hawala transactions. The income tax department has identified more than 400 benami transactions up to May 23, 2017 and the market value of properties under attachment is more than Rs 600 crore.

There is a good possibility that India's GDP growth will crawl back to its long-run structural level. Having said that, one cannot still deny the loss in interim GDP that India experienced because of demonetization. In all fairness, one has to give credit to the government when it says that more people are now paying taxes. Whether this nudging strategy will eventually help the government collect more taxes in the future in comparison to GDP lost at present, only time will tell.

—(IPA Service)

(The writer is Professor, Bennett University, Greater Noida.)


News Updated at : Friday, November 10, 2017
 
Comment on this Story 

 
 
Top Stories of the Day  
Police officer hit by stone at Shopian
SRINAGAR, Nov 10: Clashes occurred between protestors and security forces at Hajin in north Kashmir and Lassipora in south Kashmir during cordon and search operation. A police officer was injured in clashes at Meemander in Shopian. Reports said that clashes occurred today when security forces cordoned off Banger Mohalla in Hajin area of Bandipora district today. As the security men cordoned off Banger Mohalla, locals took to streets and pelted stones. The security forces burst smoke shells an
> Police vehicle fired upon at Qazigund
> Silence of international community on Kashmir unfortunate: Mirwaiz
> Dry spell to continue this week
> Pak to allow wife to meet Jadhav
 
 
Other Stories from Web  
 
 
 
Find us on
 
 
Weather Report
 
Shridev Sharma
 
Mata Vaishnodevi | Matavaishnodevi | Mata Vaishno Devi
 
Electric Blanket | Electric Bed Warmers | Electric Under Blankets | Electric Heating Blanket
 
 
 
Web Design Jammu, Web Design Company, Ideogram Jammu
 
 
Home | Contact Us | Kashmir Times | Kashmir Times E-Paper - Jammu | Kashmir Times E-Paper - Srinagar | Dainik Kashmir Times | Jammu Prabhat
Copyright 2013 Kashmir Times Group. All rights reserved. Powered by Ideogram Technology Solutions Pvt. Ltd.