by Meera Sanyal
India’s Gross Domestic Savings Rate (as a percentage of Gross National Disposable Income) averaged between 32.5 per cent and 32.8 per cent in the 10 years between 2003–04 and 2013–14. This dropped to 30.7 per cent in 2015–16 and fell further to 29.6 per cent in 2016–17.24
At the level of the Household sector, demonetization resulted in a decline in both Gross financial savings (which fell from 10.8 per cent in 2015–16 to 9.1 per cent in 2016–17) and Net financial savings (which fell from 8.1 per cent in 2015–16 to 6.7 per cent in 2016–17).25
This is not surprising given the severely negative impact demonetization had on the jobs and livelihoods of people across the country. As their income vanished, so did their savings.
On the other hand, there is no doubt that there was a significant increase in ‘formal’ financial savings, post-demonetization, led primarily by a massive surge in bank deposits, as citizens were forced to deposit all their cash holdings and savings into banks.
According to the RBI,26 between 28 October 2016 and 6 January 2017 (i.e., days immediately prior to and after demonetization, for which fortnightly banking system data are available), total currency in circulation declined by about `8,800 billion. In turn, aggregate deposits of the banking system increased by about `6,720 billion during this period.
As banks, flush with funds, lowered deposit rates, savers moved funds into other financial instruments, notably mutual funds and insurance products, as shown in Table 6 below:
Table 6: Inflows into Mutual Funds and Insurance Premium
CategoryNovember 2015–January 2016November 2016–January 2017YoY Growth
Mutual Funds –311.9 1,007.6 >1,000 %
Insurance Premia27 396 533 34.5 %
Source: Extracted from RBI Report ‘Macroeconomic Impact of Demonetization – a Preliminary Assessment’, dated 10 March 2017, data drawn from SIBI and IRDA, Table 10 (p. 21) and Table 11 (p. 22)
This shift by individuals and households to more formal financial savings in the form of bank deposits, life insurance products, shares, debentures and mutual funds is a positive development, and a definite benefit of demonetization. These savings could, in principle, help capital formation, if invested in machinery, equipment, factories and other productive assets.
One should note, however, that ‘banks-were-flush-with-cash’ for only a temporary period. As depositors had been forced to deposit their cash but could withdraw only a limited amount, their money had effectively been impounded. But when the situation normalized, and the restrictions on withdrawals were removed, people started withdrawing cash. The growth in bank deposits, which rose to 11.3 per cent because of demonetization in 2016–17, fell sharply to 6.2 per cent in 2017–18, the lowest growth rate in the past 10 years.
As the RBI noted in its 2018 Annual Report: ‘Deposit growth slowed sharply after the post-Demonetisation bulge of the preceding half and also reflected the pronounced deceleration in domestic economic activity in Q1:2017–18… With the phase-out of restrictions on cash withdrawals and the gradual pick-up in currency demand, deposit growth started decelerating and reached its lowest level of 2.6 per cent on 8 December 2017.’28
Thus it is clear that demonetization had a significant negative impact on the aggregate Savings rate, though there was undoubtedly a greater formalization of financial savings, even though this may have been transient.
Impact on Investments
Let us now examine the data on investments to assess whether the higher formal ‘financial savings’ that resulted from the demonetization translated into higher investment. We can judge this through the actual numbers of projects and new investment proposals, as well as the investment (or the rate of Gross Capital Formation) to GDP ratio.
Entrepreneurs and business people make the decision to invest in new projects or to expand capacity based on their projections of future demand. If they are optimistic about selling more, and if their existing capacity is insufficient, they will go ahead and invest, thus adding to capital formation, the creation of new jobs, and, through this process, contribute to enhancing economic growth for the economy as a whole.
It’s important to note that finance – both its availability and its cost of funds – is a necessary but not a sufficient condition to enhance investment levels. Even if plentiful finance is available at a very low cost, investments will not take place unless the business person believes that demand in the future will rise.
The confidence and optimism of business people and entrepreneurs is thus the critical element that drives investment and growth, and these are the fabled ‘animal spirits’ that growth-oriented governments strive to keep enthused!
The data on Projects and New Investments shows that demonetization had a significant negative impact on both business confidence and investments. This data collated by CMIE covers the entire spectrum of listed and unlisted companies, and is based on their disclosures to stock exchanges, government bodies, and other public information. It is, therefore, factual and not anecdotal evidence.
According to CMIE, new investment proposals by India Inc. fell to a low of `1,25,000 crore in the December 2016 quarter, compared to the average `2,36,000 crore worth of new investments seen per quarter in the preceding nine quarters of the NDA government.
The impact of demonetization was immediate and very negative as summarized in the table below:
Table 7: Impact of Demonetization on New Projects/ Investments
Projects/ Investments1 October–8 November 20169 November–31 December 2016Decline %
New Inv. Proposals 227 proposals: ?81,800 crore 177 proposals: ?43,700 crore 46 %
Avg. New Projects Announced 6 3 50 %
Avg. Daily Value New Investments ?2097 crore ?824 crore 60 %
Source: The CMIE database on investments extends to over two decades. According to this data, the March 2009 quarter saw the highest value of investment proposals, at `8,21,564 crore, while the greatest number of projects were announced in the March 2011 quarter, a total of 1,676.
Unfortunately, the precipitous decline in investor confidence continued well after demonetization. CMIE reported that new investment projects announced during the quarter October–December 2017 were the lowest for any quarter since June 2004.
Interestingly, though banks were flush with funds, credit offtake remained lukewarm. While bank deposits skyrocketed by `6,720 billion (`6,72,000 crore) as a result of the demonetization bonanza, loans and advances by banks increased by only `1,008 billion (`1,00,800 crore) during 28 October 2016 – February 2017 period.
This was notwithstanding the fact that banks, across the board, had reduced lending rates. The weighted average lending rate (WALR) of banks in respect of fresh rupee loans declined by 56 bps (0.56 per cent) during the period November 2016–January 2017. Similarly, the one-year median Marginal Cost of Funds Lending Rate (MCLR) declined on average by a cumulative 70 bps (0.7 per cent) during November 2016–March 2017.29
What this shows is that business people were unwilling or unable to invest, despite the fact that interest rates had fallen. The decline in the Gross Fixed Capital Formation (GFCF)ratio from 28 per cent in September 2016, to 27 per cent in December 2016 and further to 25 per cent in March 2017,30 is a clear reflection of this fact.
Equally important, banks were also going slow on lending post demonetization. Lending is predicated only partly on how much cash banks have; bankers lend basis their perception of the risk profile of the potential borrower. In a situation of mounting non-performing assets or NPAs and frauds and with a major disruption in economic activities as a result of demonetization, the risk of lending in 2017 in India was extremely high. Thus, even as investors were reluctant to borrow, banks were reluctant to lend, preferring instead to park surplus liquidity in government bonds.
Commenting on the declining investment ratio, the Economic Survey 2017–1831 made some important observations:
A one percentage point fall in investment rate is expected to dent growth by 0.4–0.7 pe
rcentage points.
The fall in investments is mainly due to the decline in private investment. ‘Based on the break-up of investment and saving that is available up to 2015–16, private investment accounts for five percentage points out of the 6.3 percentage point overall investment decline over 2007–08 and 2015–16.’
Investment slowdowns are more detrimental to growth than saving slowdowns. Over the short-run, the government’s policy priorities must focus on reviving investment.
And, in a not-so-subtle criticism of demonetization, the Economic Survey bluntly stated:
Mobilizing saving, for example, via attempts to unearth black money and encouraging the conversion of gold into financial saving or even courting foreign saving are, to paraphrase John Maynard Keynes, important, but perhaps not as urgent as reviving investment.
Cautioning policy makers on the perils of measures that led to declining investments, the Survey went on to warn:
Cross-country evidence indicates a notable absence of automatic bounce-backs from investment slowdowns. The deeper the slowdown, the slower and shallower the recovery… Evidence from other countries, which have gone through a similar investment slowdown, seem to suggest that a full recovery rarely happens.
My Perspective
The famous Chinese philosopher Lao Tzu is reputed to have said: ‘Governing a great nation is like cooking a small fish – too much handling will spoil it.’
The economic impact of demonetization shows the truth of this statement. It was a totally unnecessary step which extracted a very high cost.
Instead of taking much needed steps to make it easier to do business in India, the government paralysed businesses with the chaotic demonetization.
The experience of Malti, my micro-entrepreneur fishmonger friend, was multiplied millions of times across the economy. As cash was sucked out of the system, individuals started losing their jobs, faced losses in their farms, and had to shut down businesses, howsoever tiny. They became increasingly more fearful of the future, and in an attempt to conserve cash and preserve savings, they and their families reduced consumption. As demand fell and people started to buy less, firms cut back on production, which led to lower capacity utilization.32 Confronted with falling demand and overcapacity, business people in the private sector postponed or reduced their investment plans.
Unwittingly or otherwise, the architects of India’s 2016 demonetization had accelerated the downward spiral in investment in the formal sector, mortally wounded those in the agriculture and informal sectors, caused innumerable job losses, and seriously impacted GDP growth.
As The Economist had pointed out: ‘India’s “Demonetization” is a cautionary tale of the reckless misuse of one of the most potent of policy tools: control over an economy’s money… Managing an economy’s money is among the most important tasks of the government. Clumsy use of monetary instruments comes with high risk.’
By not recognizing this risk, the NDA government caused a reasonably well-functioning economy to stop dead in its tracks. By not acknowledging the damage they had caused, and hiding behind a maze of confusing data, the government compounded the demonetization error. Since they refused to admit the blow that the economy had suffered due to demonetization and remained in complete denial, they also could not take corrective actions to revive the economy. This state of denial, therefore, compounded one error with another, leading to a much slower recovery than would otherwise have been possible.
6
Demonetization Report Card
The care of human life and happiness, and not their destruction, is the first and only object of good government.
– Thomas Jefferson
‘Tughlaqi firmaan’ is how many critics described demonetization, comparing it to the ill-conceived actions of a former Sultan of Delhi, Muhammad bin Tughlaq.
Tughlaq was the Sultan of Delhi during 1325–1351, whose reign was chronicled by Ibn Battuta, the famous Moroccan traveller and jurist, and a guest at his court. Battuta’s memoirs recount that ‘Tughlaq was hasty in nature, with most of his experiments failing due to lack of preparation. He depended on his own judgment and rarely took advice from others.’
His most famous failed experiments were the shifting of his capital from Delhi to Daulatabad (Devagiri in present-day Maharashtra) and the demonetization of gold and silver coins, replacing them with token coins of brass and copper. Both decisions wreaked havoc on his hapless populace. In 1327, having ordered the entire population of Delhi to march 1,500 km to Daulatabad, he reversed his decision in 1335, and reordered his people to return to Delhi. Thousands died on both journeys, and in the meanwhile, Delhi, which had been deserted, was laid to ruin.
Tughlaq’s demonetization decision was just as disastrous. Counterfeit coins flooded the market, and the brass and copper coins became valueless, while hyperinflation soared. In an attempt to stem the economic chaos that resulted, Tughlaq was forced to withdraw the token currency. As a result of public resentment and economic bankruptcy, by the time of his death, Tughlaq’s kingdom had shrunk to a small region around Delhi. A Tughlaqi firmaan has thus become a synonym for a grand, but poorly thought-out and badly executed policy measure that results in hardship and suffering for the common people.
Others compared notebandi to nasbandi, the infamous and flawed sterilization campaign undertaken by the former Prime Minister, Indira Gandhi, in an attempt to curb India’s population growth.1
During the Emergency imposed by Indira Gandhi in 1975, an ambitious population control programme was undertaken. Labelled as a ‘family-planning programme’, vasectomy or nasbandi was forcibly performed. It is reported that 6.2 million Indian men were sterilized that year, amongst them teenagers and old men.2 At least 2,000 men reportedly died in the process. In the 1977 elections, Indira Gandhi was decisively voted out of power and lost her own parliamentary seat. This was attributed to the unpopular Emergency measures, among which nasbandi was high on the list.
We may never know what the current Prime Minister’s motives were for the 2016 demonetization, just as it is hard to discover the motives for the Emergency being imposed by Indira Gandhi or the experiments by Muhammad bin Tughlaq. Were their ‘bold and audacious’ actions driven by a genuine belief that these measures were good for the people or were these cynical political moves?
Irrespective of their motives, history tells us of the outcomes for these two former rulers.3 It is too early to say how history will judge Prime Minister Modi’s note ban, but in fairness, any policy measure should be judged against the objectives that it sets out to achieve.
In this context, the Prime Minister, in his 8 November speech, explicitly described the objectives of India’s 2016 demonetization exercise. Over subsequent months, other objectives were added by the Finance Minister and senior officials of the MoF, subjecting the government to accusations of shifting goal-posts. Notwithstanding this criticism, there can be no doubt that many of the stated objectives were good ones – goals that most Indians believe are desirable, if our nation is to progress.
The question, however, is not if the goals were good ones, but if the demonetization exercise achieved the objectives that its architects had wished for.
What is the report card of this major step?
Though it is clear that demonetization caused great disruption and distress to millions of Indians and delivered a massive shock to the Indian economy, did it achieve any of its stated goals?
In order to be purely objective, factual data from Government of India sources is presented on each of the demonetization goals to enable the reader to arrive at a conclusion.
The Eight Big Goals of Demonetization
Prime Minister’s three main goals: Black money, corruption and terrorism
Flushing out Black Money: On 8 November 2016, while declaring demonetization, the Prime Minister said, ‘For years, this country has felt that corruption, black money and terrorism are festering sores, holding us back in the race towards development… To break t
he grip of corruption and black money, we have decided that the 500 rupee and 1,000 rupee currency notes presently in use will no longer be legal tender… notes hoarded by anti-national and anti-social elements will become just worthless pieces of paper.’
In this speech, ‘black money’ was referred to a total of 18 times.
Rooting out corruption: Referring to corruption, the Prime Minister said in the same speech, ‘The evil of corruption has been spread by certain sections of society for their selfish interest. They have ignored the poor and cornered benefits. Some people have misused their office for personal gain… it has been a matter of concern for all of us that corruption and black money tend to be accepted as part of life. This type of thinking has afflicted our politics, our administration, and our society like an infestation of termites. None of our public institutions is free from these termites.’
Fighting terrorism by rendering counterfeit notes useless: Explaining how demonetization would put an end to terrorism, the Prime Minister explained, ‘Terrorism is a frightening threat. So many have lost their lives because of it. But have you ever thought about how these terrorists get their money? Enemies from across the border run their operations using fake currency notes. This has been going on for years. Many times, those using fake 500 and 1,000 rupee notes have been caught and many such notes have been seized.’
Expounding further on this theme, the then Attorney General, Mukul Rohatgi, explained confidently to the Supreme Court: ‘Out of the total estimated money in circulation of `15–16 lakh crore, the government expect people to deposit `10–11 lakh crore in banks. The rest, `4–5 lakh crore, are being used in northeast and Jammu and Kashmir to fuel trouble in India. That will be neutralized.’
Prime Minister Modi’s fourth main goal: Digital/cashless/less-cash society
Moving to a Digital and Cashless India: Although the goal of a digital or cashless economy was not mentioned at all in the Prime Minister’s original speech on 8 November, full front-page newspaper advertisements by an e-wallet start-up displaying the Prime Minister’s image on the morning of 9 November heralded the dawn of a new era!