Almost fifteen minutes of the speech were over. It was at that point in time that Modi dropped the bombshell:
To break the grip of corruption and black money, we have decided that the five hundred rupee and thousand rupee currency notes presently in use will no longer be legal tender from midnight tonight, that is the 8th November, 2016. This means that these notes will not be acceptable for transactions from midnight onwards. The five hundred and thousand rupee notes hoarded by anti-national and anti-social elements will become just worthless pieces of paper. The rights and the interests of honest, hard-working people will be fully protected. Let me assure you that notes of one hundred, fifty, twenty, ten, five, two and one rupee and all coins will remain legal tender and will not be affected.
Modi justified his announcement on the ground that it would strengthen the hands of the common man in the fight against corruption, black money and fake currency. And then he listed out twenty-one major steps to help enforce demonetization. These steps included guidelines to people on how they can deposit the annulled currency with banks and what kinds of purchases they could still make with the old currency notes. It was an attempt to assure the people that those who were not dishonest had nothing to fear from the big announcement he had just made. (Please see the Appendix for the entire list of guidelines.)
The twenty-second step he announced pertained to the release of new currency notes of Rs 2000 and redesigned currency notes of Rs 500. In other words, currency notes of Rs 1000 were completely eliminated from circulation. He added that the RBI would make arrangements to limit the share of high-denomination notes in the total currency in circulation.
Many of these steps had to be revised in the next fifty days. The RBI issued more than twenty such notifications to amend the various norms for issuance of cash and the purposes for which old currency notes could be used in legitimate transactions. Modi was conscious that the move to annul the high-denomination currency notes would cause hardships to people and urged the ordinary citizens to make sacrifices and face difficulties for the benefit of the nation in its fight against corruption, black money, fake notes and terrorism. He tried to confer on demonetization the status of a Mahayagna (an offering before the fire god) to rid the country of corruption and black money. ‘My dear countrymen, after the festivity of Diwali, now join the nation and extend your hand in this Imandaari Ka Utsav (a festival to celebrate honesty), this Pramanikata Ka Parv, this celebration of integrity, this festival of credibility,’ he said.
Modi had begun his address with a reference to Diwali and ended it also with a reference to Diwali with a clarion call to every Indian to contribute to ‘this grand sacrifice for cleansing our country, just as you cleaned up your surroundings during Diwali’.
The Aftermath
Modi’s speech was telecast at 8 p.m. that evening. But it had been recorded earlier in the day before the Cabinet meeting began. It was a short meeting. There was hardly any discussion. The ministers, who attended the meeting, had to deposit their mobile phones with security before entering the conference room. For most ministers, the move was like a bolt from the blue. Soon after the Cabinet meeting, the prime minister’s address began. Ministers who attended the Cabinet meeting were made to sit at the same room till the prime minister’s address to the nation ended. At one point in his speech, Modi explained the logic of the secrecy maintained by the government. ‘Secrecy was essential for this action. It is only now, as I speak to you, that various agencies like banks, post offices, railways, hospitals and others are being informed,’ he said. Indeed, the decision-making process was shrouded in complete secrecy. Only a handful of people knew of the decision in advance and they included the prime minister, the finance minister, the RBI governor and the RBI deputy governor in charge of currency management. Few government officials knew of the move in advance. Chief Economic Adviser Arvind Subramanian, for instance, was in the dark about it.8 As he recalled, he saw the prime minister delivering the address on his television screen while he was still in office that evening.
That day, many departmental stores in the country did brisk cash business as late as till midnight, when they could accept the currency notes of Rs 1000 and Rs 500, whose legal validity was yet to be annulled. Several other desperate and adventurous shops, selling high-value items like jewellery, kept their counters open as there was a long queue of customers waiting to use the currency notes of Rs 500 and Rs 1000 for making purchases. Consumers came in large numbers, bought as much as they could. The nation was gearing up for facing one of its most devastating economic disruptions.
The enormity of the challenge could hardly have been overestimated. Demonetization, as announced by Modi that evening, would have flushed out about 86 per cent of the currency in circulation and its impact would have been huge for an economy like India, where the prevalence of cash was estimated at 12 per cent of gross domestic product or GDP and it accounted for almost 90 per cent of all its commercial transactions. As many as 250 million new bank accounts had been opened in the previous two years in an attempt to improve the banking sector’s reach and financial inclusion. However, the overall penetration of banking services were still very low at the end of 2016—at nine branches per 1,00,000 persons and less than forty branches per 1000 square kilometres. The numbers for rural India were even more alarmingly low. Worse, just about 2,00,000 ATMs were operational across the country and most of them were located in urban centres. What complicated the situation was that within days of demonetization the government and the RBI realized that their efforts at remonetizing the economy had hit an unexpected roadblock. The new currency notes, with new specifications, size and security features, required the ATMs to be recalibrated—a cumbersome exercise that took about a couple of weeks at least. Thus, the intensity of disruption got worse.
The task of remonetization at hand was not easy. With about 17 billion pieces of currency notes of Rs 500 value and another 6 billion pieces of currency notes of Rs 1000 value to be replaced in quick time, the capacity constraints at the currency printing presses in the country proved a big hurdle. Already, the four currency note printing presses were overstretched and importing currency notes was considered risky and not feasible at short notice. In the wake of long queues of customers outside banks, waiting to withdraw a specified amount of new currency notes or deposit their old currency notes, serious questions over the wisdom of the move were being raised.
One such question pertained to the size of the fake currencies, which was one of the targets of demonetization. The government had estimated that the size of fake currency notes in circulation was about Rs 400 crore. But as K.C. Chakraborty, former deputy governor of the RBI, said, the attempt to reject an entire bag of rice, which may have some stones or other contaminated foreign products, is an exaggerated response, where the consequences would be far worse than the benefits. A bigger question was that if data showed that only a small part of India’s black money (estimated only 23 per cent of India’s GDP) resided in cash and the bulk of it was in the form of gold, land and real estate, was demonetization’s drive against black money misdirected?
Half-way into the fifty-day period when the annulled currency notes could be exchanged, the government changed its narrative on the purpose of demonetization. In addition to fighting black money, corruption and fake currency used in terrorist activities, the government argued that demonetization was a tool for pushing India into a cashless economy. Digitization of payments was a new focus area and new electronic payment companies were encouraged to launch digital wallets and incentives were rolled out to encourage more transactions to take place through the electronic mode without using cash. Digital India—a government-run scheme to promote the use of information technology for delivery of services to citizens—was being used as an instrument for popularizing digital transactions.
Admittedly, the government and the RBI were a bit slow in responding to the disruptive impact of demonetization on the availability of cash in the economy and the
pace of economic activity. After about a fortnight or so, the government machinery swung into action to reduce the adverse impact of demonetization on people. Queues began getting shorter outside banks and ATMs after the third week of demonetization. More ATMs got recalibrated and they could now dispense new currency notes. The restrictions on withdrawal of money from bank accounts were also considerably eased after some time. Guidelines for use of the annulled currency notes in many public utilities like petrol pumps, government hospitals, chemist shops, milk suppliers and mobile phone recharging outlets were relaxed to relieve the pain of demonetization.
But the relief announced for farmers, traders and small business establishments was inadequate. Thanks to the continuing shortage of cash, farmers experienced great difficulty in buying seeds and fertilizers. The government’s response was partial as farmers were allowed to use the annulled notes only for purchasing seeds from state-owned companies. Many farmers who relied on buying seeds from private companies suffered in a big way and acres of their fields went uncultivated in the coming rabi season. Small businesses and traders, too, decided to down shutters as there was no cash in the system and the currency replacement pace was too tardy to compensate for their loss.
Demonetization was later justified by the government as a drive towards digitization, but ironically its actual impact was that the move deepened the digital divide in the economy. This was because achieving digitization through a sudden decision like demonetization meant that there was no proper and advance planning. One of the sectors that gained from demonetization was mobile banking and electronic payments. With access to cash getting severely limited, the only recourse for people to buy and sell goods and services of necessity was payments through digital wallet companies which saw a spurt in their usage and popularity.
For the next couple of days, major national newspapers carried full-page advertisements of Paytm, India’s largest payment wallet company, to congratulate Modi on taking the boldest decision in the financial history of independent India. The advertisements carried the picture of Modi and the message in the advertisement was: ‘Pay with Paytm to more than 15 crore people and businesses. Join the revolution. Ab ATM nahin, #PaytmKaro.’
Did Paytm have an inkling of the Modi government’s demonetization move, which would give it a big business opportunity? Opposition political leaders suspected such a nexus. Delhi Chief Minister and Aam Aadmi Party convener, Arvind Kejriwal tweeted: ‘Paytm biggest beneficiary of PM’s announcement. Next day PM appears in its ads. What’s the deal, Mr PM?’ While these were only tweets and could not establish any nexus, the numbers told their own story. Paytm conceded that within hours of the announcement of demonetization, its wallet business grew by 25 per cent, though its growth slowed down over the next few months when cash returned to the system with remonetization.
Given the long queues and the disruption caused to the pace of economic activity, demonetization raised many other questions. Was the government aware of the state of its banking infrastructure and capacity in currency note printing presses? Was there advance planning to ensure that the ATMs were recalibrated well in time before the announcement of demonetization? Did anybody in the government point out that demonetization would target only the stock of black money held in cash and would not prevent the generation of black money or unaccounted income?
A more disturbing question was whether there was a political motive behind demonetization. With his task of fulfilling the promise of development and jobs becoming more difficult, Modi may have opted for a move that would have greater immediate salience and recognition as a seemingly bold action against black money.
Politically, therefore, demonetization might have worked in favour of Modi and his party, the BJP. As many as five state Assemblies were due to go to the polls in 2017, one of them being Uttar Pradesh, a state that the BJP was very keen to wrest from the incumbent party, the Samajwadi Party of Mulayam Singh Yadav. For Modi’s political opponents, demonetization was a big setback. The bulk of India’s electoral funding by political parties has mostly been in cash and demonetization flushed out cash from the coffers of many Opposition political parties. Did it help the BJP and did the party apparatus know of demonetization in advance to take advantage of that knowledge? There are no easy answers to such questions. But the election results in Uttar Pradesh held in early 2017 showed a thumping victory for the BJP.
The Shock to the Economy
The disruption that demonetization caused to the Indian economy is unquestionable. Economic growth slowed in the subsequent quarters. From 5.5 per cent and 6.4 per cent GDP growth in the last two years of the Manmohan Singh government (2012–13 and 2013–14), the Indian economy had revived with growth numbers at 7.4 per cent in 2014–15 and 8 per cent in 2015–16. The economy seemed set for take-off. Indeed, provisional GDP had grown by 8.1 per cent in the April–June period of 2016 and stayed at 7.6 per cent for the July–September period of the same year. And then demonetization of 8 November 2016 took the toll of the economy.
Provisional estimates on national income, released on 31 May 2018,9 showed that GDP growth for the three quarters after demonetization had decelerated—from 6.8 per cent in October–December 2016 to 6.1 per cent in the January–March period of 2017 to and further down to 5.6 per cent in the April–June period of 2017. It was only from the second quarter (July–September) of 2017–18 that economic growth began recovering. But the adverse impact of demonetization on growth was unmistakable. And going by the same set of May 2018 data, the annual GDP growth in 2016–17 had dropped to 7.1 per cent, compared to 8.1 per cent in 2015–16. In 2017–18, the growth further dropped to 6.7 per cent. Former chief economic adviser Arvind Subramanian expressed his surprise, after quitting the job he held for about four years, that the actual impact of demonetization was less than what he had originally feared. He admitted that it was a draconian measure, but it was a puzzle as to why the impact on growth was less than anticipated.
The Economic Survey for 2016–17, written by Subramanian and presented to Parliament in February 2017, also noted that ‘growth slowed as demonetization reduced demand (cash, private wealth), supply (reduced liquidity and working capital, and disrupted supply chains) and increased uncertainty’. The Survey also concluded that cash-intensive sectors like agriculture, real estate and jewellery were affected the most. But on the long-term effect of demonetization, the Survey forecast a scenario that was broadly how the growth scenario panned out. It said that demonetization could be beneficial for growth in the long run if formalization increased and corruption fell. Many economists like Prof. Arun Kumar of Jawaharlal Nehru University were of the view that such an analysis was erroneous as in the succeeding years the investment rate declined, the employment rate fell and even output growth decelerated, creating conditions that were similar to an economic slowdown. Demonetization, in his view, could not be a panacea for growth since the unorganized sector, a large chunk of the economy, had taken a big hit.
Irrespective of such analysis, however, the government’s assessment of demonetization acquired a completely new narrative when it released the first revised national income data for 2017–18 on 31 January 2019.10 The Central Statistics Office, entrusted with the task of releasing national income data, revised its growth estimates for 2015–16, 2016–17 and 2017–18. Against the earlier estimates of 8.1 per cent, 7.1 per cent and 6.7 per cent, respectively, for these three years, the revised estimates showed them at 8 per cent for 2015–16, 8.2 per cent for 2016–17 and 7.2 per cent for 2017–18. In other words, the revised GDP numbers showed that demonetization did not have any adverse impact on growth. Quite to the contrary, growth increased in the year demonetization took place. Economic growth for 2017–18, a year after demonetization, however, dipped to 7.2 per cent, according to these revised numbers. And for 2018–19, two years after demonetization, the growth in GDP slowed down further to 6.8 per cent.
The revised numbers may have changed the official narrative on the impact of dem
onetization on growth, but the entire exercise raised many questions on the authenticity of the revised data and the basis on which the increased growth numbers have been calculated. Arvind Subramanian, who was earlier surprised over why growth did not suffer as much as the disruption that was caused by demonetization, would have been even more surprised with the higher growth numbers. It is possible that the official GDP numbers, even after accounting for some overestimation, did not adequately capture the impact of demonetization on the unorganized sector and agriculture. And the output data on agriculture may not have fully captured the extent of farming distress as a result of demonetization. In June 2019, a research paper, published by Arvind Subramanian at the Center for International Development at Harvard University, raised more doubts on India’s GDP data by claiming that the country’s annual economic growth in the 2011–17 period was 2.5 percentage points lower than the official estimate of 7 per cent. According to the study by Subramanian, who quit the Indian government in June 2018, economic growth in the demonetization year of 2016–17 was actually 5.7 per cent, compared to the official estimate of 8.2 per cent.
Popular narrative, anecdotal evidence and even some surveys, however, continue to indicate that demonetization did indeed have an adverse impact on growth and jobs. Mahesh Vyas of the Centre for Monitoring Indian Economy (CMIE) released in July 2017 the findings of his survey that showed that 1.5 million jobs were lost in the four months of January–April 2017, compared to the previous four months, which included the demonetization period.11 This claim was challenged by Chief Statistician T.C.A. Anant by pointing out statistical flaws in the comparisons made by Vyas.12 Vyas returned to this subject a year later in September 2018 to claim that the impact of demonetization on job losses was even more at 3.5 million, adversely affecting the job participation rate for youths.13 In December 2018, the All India Manufacturers’ Organization or AIMO released the report of a survey, based on a sample of responses from 34,700 traders and small/medium enterprises. It claimed that over 3.5 million jobs were lost in the previous four and a half years largely on account of demonetization and the GST.14 The PHD Chamber of Commerce and Industry released a report in 2017 that admitted to an adverse impact of demonetization on economic growth.15 Analysis by researchers at the Bengaluru-based Azim Premji University, made available in its report ‘State of Working India, 2019’ concluded that five million workers had lost their jobs between 2016 and 2018, a period coinciding with demonetization.16
The Rise of Goliath Page 36