RBI's Report on Demonetisation

What is the issue?

RBI has said in its annual report that over 99% of the demonetised currency in November 2016 was returned back.
The new report has highlighted the futility of the whole demonetisation drive.

What are the highlights?

99.3% of the Rs 500 and Rs 1000 notes that were withdrawn from circulation were returned back.
Post demonetisation, the RBI spent nearly Rs 8,000 cr in 2016-17 on printing new notes.
This is notably more than double the amount spent in the previous year.
The value of banknotes in circulation increased by 37.7% over the year from demonetisation.
Also, compared to previous year, there is substantial increase in counterfeit notes of almost all denominations.

Why is demonetisation unjustifiable?

Objective - Demonetisation targeted those who had hoarded ill-gotten wealth in cash.
If these had been returned at a higher tax rate, the government would receive the taxes.
If not, it was expected that 15-20% of the cash in use as 'black' money would not return.
This amount was estimated to be in the tune of Rs 4-5 lakh crore.
So if not returned, it would count as a windfall gain on the RBI’s balance sheet.
Because, unreturned money would mean a reduction in the RBI’s liabilities by that amount.
So the plan was to transfer this resultant surplus from the RBI to the Centre.

This was, in fact, the principal reason for the whole demonetisation exercise.
Now that over 99% has retuned to the system, the basic objective has not materialised.

Black money - Many converted the unaccounted money into legal tender.
Unintendedly, the demonetisation drive itself became a tool for making white the black.
Also, given the logistical difficulties in penalising all of them, the whole purpose gets defeated.
Corruption - It was claimed that the drive would root out and bring to light the corrupt rich.
This was, in fact, the reason why there was less public agitations, despite the difficulties.
But having not fulfilled this promise, demonetisation has had no political benefits as well.
Savings - Demonetisation seems to have had a problematic effect on household savings pattern.
Household savings includes the savings of small unregistered enterprises as well.
These units were some of the hard hit by demonetisation.
But the household savings figure is at a multi-year high of over 11% of gross national disposable income.
In fact, households are holding far more of their savings in cash than in the year prior to demonetisation.
So the attempt to financialise savings has, in fact, been set back.
Cash - The cash to GDP ratio has reached levels comparable to the period before demonetisation.
So the behavioural changes demonetisation brought in terms of holding cash were not as the government expected.
Impact - Clearly, the aims of demonetisation do not seem to have been met.
On the other hand, it has had many negative impacts, leading to

Had there been any benefits?

The benefits, if any, would be the increase in the number of income tax returns filed.
Demonetisation has also led to formalisation of economy and more tax collections.
But these could have been achieved by other policy measures too and not necessarily by demonetisation.
Besides, cashless modes of payment have become more common.
But financial savings in the form of currency have also risen, suggesting that people still value cash.

What is the way forward?

The government must not disown its biggest reform attempt.
It should neither try to sidestep parliamentary scrutiny of the outcomes of demonetisation.
Instead, it could focus on fixing the problems that people still face.
Transactions with Rs 2,000 notes in the absence of Rs 1,000 notes are difficult.
This is indeed a departure from the currency denomination principle.
As per this, every note should be twice or two and a half times its preceding denomination.
Besides this, the larger lesson that sudden shocks to the economy are less likely to yield intended policy objectives should be learnt.

Source: The Hindu, Business Standard, Economic Tim