The Narendra Modi government tried to kill cash. It ended up strangling the economy

Erm…thank you?
Erm…thank you?
Image: Reuters/Adnan Abidi
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A year ago, on Nov. 08, prime minister Narendra Modi’s announcement that Rs500 and Rs1,000 notes were going to be taken out of circulation overnight predictably led to utter chaos and mayhem. Not only a flustered public, even the government and India’s central bank were caught flatfooted. Some 74 notifications were issued in 50 days following the note-ban announcement, several involving an about-face on the previous announcements. And in the months that followed, about 1.5 million jobs were lost, business in several cash-intensive industries came to a screeching halt, and economic growth took a beating.

A year later, the jury is still out on whether demonetisation was worth it.

The Reserve Bank of India’s report revealing that about 99% of the demonetised notes had been returned further muddied the waters. This basically meant that the amount of black money in the system was far lower than previously estimated. The government, meanwhile, is out to convince everyone of the resounding success of this exercise, which was variously aimed at curbing black money in the system, improving the digital economy, and tamping down on terrorist funding. Its supporters are celebrating today as “anti-black money day,” while opposition parties call it ”dhokha divas“—a day of treachery.

As the debate rages on, this is how demonetisation has impacted the Indian economy and the country’s banking system:

For one, the note ban sent the economy into a tailspin. Even though the government has been trying to argue otherwise, several institutions, including the Wold Bank, have cut India’s growth forecast for this year. This slowdown may have to do with factors other than demonetisation, too, but the withdrawal of high-value notes did hit hard.

The cash ban also took a toll on industrial production, which measures India’s factory output. Small and medium enterprises bore the burnt, as these firms relied heavily on cash. A year on, many are still struggling to get back on their feet.

As the economy slowed down, jobs disappeared. Some estimates suggest that about 1.5 million jobs were lost in the aftermath of demonetisation between January and April this year. The labour participation rate (LPR), which shows the share of the population that is employed or willing to work and looking for jobs, also crashed in the wake of demonetisation. And it still hasn’t recovered fully.

Unsurprisingly, a sluggish economy and vanishing jobs did nothing to help consumer sentiment in India, which has gone on a bit of a roller-coaster ride since November last year. Below is the consumer sentiments index, which is based on a survey of about 42,000 households every month.

But there’s some good news.

Bank deposits have swelled since Nov. 08 last year as more and more Indians poured their money into the formal economy. It was one of the primary objectives of the currency ban exercise, according to the government, helping to slowly dismantle India’s large shadow economy.

The government has repeatedly emphasised that demonetisation has helped expand India’s digital economy. Bankers claim that the growth in digital transactions has doubled after the currency ban. And data from the RBI does reflect strong growth in plastic money—i.e the number of credit cards, debit cards, and point of sales (PoS) terminals in circulation.

The government also claims that there has been an increase in the number of people that have come into the tax net, but the final numbers from the Central Board of Direct Taxes are still awaited. Meanwhile, there has been a crackdown on shell companies—bogus entities set up to launder money and evade taxes—with the income tax department taking action against 1,150 of these firms.

The Modi government appears convinced that it’s done a great job. In a Facebook post yesterday (Nov. 07), finance minister Arun Jaitley described demonetisation as a “watershed moment in the history of (the) Indian economy.” That it may well be, but for the better or worse?