Demonetisation: Has it delivered?

Image: Danish Siddiqui / Reuters (For illustrative purposes only)

The state assembly elections in Uttar Pradesh (UP), Uttarakhand, Goa, Punjab and Manipur were the first real test to understand what people thought of demonetisation. Modi’s critics were hoping that people would teach him and his party (BJP) a good lesson for all the troubles they were put through to access their own money. But they were in for a rude shock. BJP swept the polls in UP and Uttarakhand while managing to form the government in Goa and Manipur. People, it became clear, wholeheartedly supported Modi’s move to fight black money.

People’s support notwithstanding, is demonetisation a success? To answer that question, one has to look at the five broad objectives the move purported to achieve:
• Destroy black money in the system
• End counterfeit currency menace
• Widen the tax base
• Move to a less cash economy
• Generate higher tax revenues (and consequently lead to a lower tax rate regime)

Analysing how the exercise fared under each of these objectives will give some indication of its efficacy.

Destroy black money in the system: According to the data from Reserve Bank of India and the government, 4.5 lakh crore currency notes were withdrawn from circulation on November 8. The expectation was that not all of them will return to the banking system and get exchanged (after all, people with unaccounted cash will not deposit their money for the fear of being questioned by tax authorities). It was estimated that as much as 3 lakh crore notes will get extinguished leading to a windfall for the government. In the end, almost all the notes returned. This does not mean that there was no black money in the system. Unaccounted cash has found its way into the banking system post-demonetisation as deposits. Finance Minister Arun Jaitley offered a glimpse of this when he stated in his budget speech that between November 8 and December 30, 2016, 1.09 crore accounts had deposits ranging from Rs 2 lakh and Rs 80 lakh while 1.48 lakh accounts saw deposits to the tune of Rs 80 lakh or more. The government is now scrutinising these accounts to identify the ill-gotten wealth and penalise the tax evaders. It is early yet to determine the number of evaders and the quantum of black money that has been deposited in the bank accounts. Also, unaccounted wealth in not necessarily kept in the form of cash alone. Experts say that only 5 percent of black money is in cash form and the rest are either in gold, real estate or stashed away abroad. Unless steps are taken to target the non-cash form of ill-gotten wealth, the fight against black money will remain incomplete.

End counterfeit currency menace: The problem of fake currency notes in the economy was reaching alarming proportion. Unverified estimates put the figure at over Rs 300 crore. Some even put out a higher number saying it (the Rs 300 crore estimate) does not reflect the fake currency that remained outside the banking system. Sudden withdrawal of Rs 500 and Rs 1000 notes made these counterfeit notes worthless. Also, the new Rs 500 and Rs 2000 notes came with strong security features which are not easy to replicate. Success of domenetisation on this front will depend on how long it takes for counterfeiters to succeed. Recently Lok Sabha was informed by the government that RBI and police have detected fake Rs 2000 notes to the tune of Rs 66 lakh. Investigations are on to determine if any security features have been compromised.

Widen the tax base: India’s tax to GDP ratio at 11 to 12 percent is far lower than that of developed economies’ 30 percent or more. Jaitley in his budget speech said that of the 76 lakh individual assesses who declare income above Rs 5 lakh, 52 lakh are in the salaried class. People, he said, declaring income above Rs 50 lakh is just 1.72 lakh while pointing out that 1.25 crore cars were sold in the country in the last five years and over 2 crore people travelled abroad either for business or vacation. “We are largely a tax non-compliant society,” he concluded. Demonetisation has seen a sudden increase in deposits which when scrutinised should lead to identification of tax evaders who cannot escape the tax net in the future. That apart, implementation of Goods and Services Tax (GST) will widen the formal economy leading to a wider tax base. A strong measure like demonetisation has also instilled a sense of fear in the minds of the people who are increasingly beginning to realise the futility of evading tax (after all the tax rates have declined over the years and use of technology has made evasion easy to detect).

Move to a less cash economy: Even as cash was sucked out of the system during demonetisation, government began to promote the virtues of digital payments. With virtually no cash in the system people embraced it. The advantage of a digital payment is that it leaves a trail and enterprises cannot evade tax on that transaction. It leads to higher indirect taxes first followed by higher direct taxes. But the fear in everyone’s mind was that will people go back to their old ways of using cash once the re-monetisation is complete. Govind Rajan, former CEO of Freecharge, a digital payment platform, was confident that once people get used to digital payments they will not go back to using cash. If they use digital payment one time a month, there is 50 percent chance that they will come back to make digital payment again. If they use it three times a month, the chances are that they will come back is 80 percent and if they use 5 times per month the chances are 95 percent they will stick to digital payments, he said. The fact that digital payments are secure, easy, obviates the need to look for change or carry cash make them endearing, he added.

But he has been only partly right so far. State Bank of India’s chairperson Arundhati Bhattacharya has gone on record saying adoption of digital payments has been falling as the cash situation improved. But it is still higher than the pre-demonetisation levels, she added. Recent RBI data reveals that card payments in February declined to 19 crore transaction from 26 crore in January. Transactions through UPI (Unified Payments Interface) also declined from 42 lakh in January to 38 lakh in February. Bhattacharya has also flagged infrastructure issues such as need for a dedicated spectrum for financial transactions as delays in making card payments is forcing people to pay cash. While the budget has many proposals to promote digital payments, more needs to done to get people to embrace it. There is a lot of headroom here. India’s per capita non-cash transactions is estimated at $ 100 compared to US’s $2,73,000 and Australia’s $24,700.

Kotak Securities in its recent report has said “expansion of infrastructure, high penetration of technology and most importantly, changes in social behaviour will be essential ingredients for a steady transition towards a less cash economy. However with unwavering commitment to this transition, India can achieve a significantly less-cash economy over the next 5 to 10 years.” It should be noted that low cash economies such as UK and Sweden took decades to become so.

Generate higher tax revenues (and consequently lead to a lower tax rate regime): Immediate increase in tax revenues will come from penal taxes that will be levied on unexplained deposits. Once in the tax net, these evaders will remain there forever. Even a 2 percent increase in tax to GDP ratio will garner Rs 1 lakh crore. That is the amount government of India spends on education and healthcare. As the tax base widens, so will the tax revenues. This will eventually lead to lower tax rates, as it has happened elsewhere in the world.

So benefits of demonetisation will take some time to materialise. More importantly, demonetisation should not be seen as a one shot effort but a part of a larger plan to expand the formal economy. Its success will also depend on what follow-up measures the Modi government takes in that direction. With state assembly elections over and people’s support strongly behind Modi, it is time for some more action from him on this front.

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