Did gains justify pain? Just wait

It now seems that Rs 14.97 lakh crores, or almost 97 per cent of the Rs 500 and Rs 1,000 notes “demonetised” by the Narendra Modi government, are now in the banks. On November 8, when he made the announcement, Mr Modi listed the three objectives for removing Rs 15.40 lakh crores from the system were to filter out the “black”, counterfeit and terrorist cash from the economy. This was undeniably a laudable objective, but what did it fetch in return must be a question that needs to be answered.

Sources in the government seemed to believe that about Rs 4-5 lakh crores would not be deposited back as they would be money with dubious antecedents. This would then be the RBI’s bonus, which could be used to refinance the non-performing assets (NPAs) burdened PSU banks. But this is not to be, and most of the cash outside, in flow or stock, has been deposited. So what was said to be the unsaid expectation is now best left unsaid.

But this doesn’t mean that the three main objectives stated by Mr Modi remain unrealised. Quite clearly there was a good deal of tax-evaded income, counterfeit notes and terrorist funds in the system. Only counterfeit cash would have been filtered out in this first filtration. The tax-evaded incomes will now be searched out and large deposits from the usual suspects and unexpected sources will be scanned with diligence, both for the nation’s as well as the tax collector’s benefit. How much will fetch the exchequer is not clear, but we can safely assume it will be a tidy sum.

Last year, the RBI recorded filtering out about Rs 29 crores of counterfeit notes. But not all counterfeit go back to the banks, though in theory at some stage or the other they will have to. How much could this be? We have often heard of a figure of about Rs 20,000 crores of locally manufactured and Pakistani counterfeits in circulation. If it is in the flow these notes will sooner or later be intercepted at the final stage of their life when they come to the RBI for their obsequies. But a good part will also be in stock and we will never know how much will end up in the Ganga, like it was shown on TV on November 9.

To be sure there is huge tax evasion in our system. Even if the National Institute for Public Finance and Policy (NIPFP), the ministry of finance’s in-house think tank, estimation of a parallel economy equal to about 68 per cent of the GDP is not accepted and the figure of 20-25 per cent often cited by the multilateral agencies like the IMF and other authorities is accepted, we are looking at a parallel economy of about Rs 30 lakh crores. This implies about Rs 10 lakh crores of lost taxes.

The demonetisation exercise would not fetch even a small fraction of it, largely because most of the undeclared income undergoes metamorphosis into property, gold and foreign holdings leaving only about four to five per cent within the cash system. So at the IMF end we are looking for about Rs 1-1.5 lakh crores at least and at the NIPFP end we are looking for about Rs 3-4.5 lakh crores at least. The tax gains thus could at best be between Rs 50,000 crores and Rs 1.5 lakh crores.

Now we hear murmurs of expectations of about Rs 4 lakh crores, which if so suggests that the NIPFP estimates are closer to the reality? After imposing penalties (30 per cent + 30 per cent) this should fetch the government about Rs 2.4 lakh crores as taxation.

But remember this is for the most part of it a one-time exercise. All our past experiences show we revert to past practices and habits. But there are only so many demonetisations one can have in a lifetime. Frequent demonetisations will only diminish the credibility of the rupee and the RBI. With currency no longer linked to gold, its value is only in its credibility and no government should keep risking this.

Against this one-time gain of at best about Rs 2.4 lakh crores, what did we lose? The loss due to the unprecedented drop in production and income to the economy this year is now widely accepted by economists to be around two per cent of GDP. This is almost `3 lakh crores. The cost of printing replacement notes is expected to be Rs 40-50,000 crores.

There are huge human costs implicit too. India has a workforce of close to 450 million. Of these only seven per cent are in the organised sector. Out of these 31 million about 24 million are employed by the state or state-owned enterprises. Of the vast reservoir of over 415 million employed in the unorganised sector about half are engaged in the farm sector, another 10 per cent each in construction, small-scale manufacture and retail.

These are mostly daily wage workers and mostly earning less than the officially decreed minimum wages. The average daily wage in India is Rs 272, which means that it is essential to have a good part of that for a typical family to have to escape starvation every day. Just visualise the cold hearths in these homes and children going to bed cold and hungry. At least 22 crores of daily workers have suffered loss of work. We will have to await this bill.

Millions of farmers, too, have lost crops and produce due to the sudden drought of cash, which has impeded both sowing and harvesting. Farmers and the retail trade, which sells perishables like fruits and vegetables, have suffered huge losses due to the abrupt compression of demand induced by the demonetisation. The motorbike industry has for long been the bellwether of rural prosperity. Year-on-year sales at Hero MotoCorp, the market leader and the world’s largest two-wheeler producer, slid by more than a third in December. According to the research group Nielsen, fast-moving consumer goods, usually a reliable growth sector, retrenched by 1-1.5 per cent in November have been hit harder.

Data released by the Centre for Monitoring the Indian Economy (CMIE) shows investment proposals amounting to only Rs 1.25 lakh crores in the October-December quarter, as compared with an average of Rs 2.36 lakh crores worth of new investments seen per quarter in the preceding nine quarters that the Narendra Modi government has been in power.

While 227 new investment proposals worth Rs 8,800 crores were announced during the quarter till November 8, only 177 investment proposals worth Rs 43,700 crores came in between November 9 and December 31.

The huge post-demonetisation fall in investment is clearly apparent. The big question is whether the slowdown of investment is temporary or long-term? It can be plausibly argued that local investment will be back but one cannot say the same about foreign direct investment. Often foreign investors look at several location options simultaneously and once a choice is made that investment has very simply gone forever.

Quite clearly the losses outweigh the gains. And did it achieve anything? Huge volumes of new currency notes have again been accumulating with individuals and corporations. Bureaucratic and political corruption is back as before. The only palpable gain seems to be a stop of high-quality high-value counterfeits from Pakistani security presses. But that too will pick up in due course.

The topmost priority for the government now should be is to remonetise the economy fully. Unless remonetisation is complete, growth cannot be restored and employment cannot be generated.