Note: A shorter version of this piece was first published on The India Cable – a premium newsletter from The Wire & Galileo Ideas – and has been republished here. To subscribe to The India Cable, click here.
Demonetisation continues to cast its long shadow on Modinomics. The Reserve Bank of India has reported an unprecedented rise in currency held by public. It has grown a whopping 57% — from Rs. 17.5 trillion on Nov 4 ,2016 to Rs 28 trillion on Oct 8, 2021.
Consequently, the cash to GDP ratio in India is now at 14.5 %, the highest since independence. It is also easily one of the highest among major economies.
One of the stated objectives before the government demonetised 86% of all currency on 8, November 2016, was to reduce cash component in the economy and give a boost to digital payments. In the immediate aftermath of demonetisation. the cash component did come down from about 12% of GDP to 7.5% of GDP but it did not stabilise at this level.
The cash economy started rising steadily in subsequent years and it surged in the post pandemic period when there was a rush for cash.
It is also true that the current peak of cash to GDP ratio partly reflects the shrinkage in GDP after the pandemic. However, it seems likely that even if the GDP recovers, the currency with the public will not go down meaningfully because the cash culture will dominate the vast informal sector.
One big policy miscalculation by Modi government was in thinking that digital payments must grow at the cost of cash. What we have seen is a simultaneous growth in both the cash economy and digital payments. RBI data also shows a big rise in payments via UPI, credit cards & debit cards. RBI’s digital payment index which stood at 100 in 2018 as base year has risen to 270 now. This is an impressive growth of nearly 200%.
So both cash and digital payments are rising and this is a lesson for policy makers who imagined all cash was shady and that digital must necessarily dent the cash economy. The vast informal economy always sustained itself on cash. India has over 90% households living on a monthly income of less than Rs 15,000. Such small incomes are largely earned and spent in cash. To forcibly push this part of the economy to digital made little sense.
The bulk of the real black economy, it was always evident, resided in real estate and gold. That part was never addressed effectively by the Modi government which chose to attack the currency stock alone. Even today property transactions in most parts of the country are being conducted substantially in black. The GST system was supposed to track and capture all transactions in the value chain but evidence suggests that in many products the full chain of value added is being executed outside the GST framework. Little wonder the actual GST collections have stagnated in the range of Rs.95,000 crore to Rs. 1,10,000 crore a month for 5 years since 2017 when the new tax was implemented.
Normally GST growth should be in line with nominal GDP growth. This means GST revenues should have grown at least by 10 to 11% every year and shown a cumulative growth of over 60% in 5 years. But GST collections don’t show any sign of such growth by next year when the new tax regime will complete 5 years after its implementation in 2017.
But GST collection over 5 years has broadly stagnated and not lived upto its promise.
GST is also a form of digitisation of multiple value chains in the economy. The fact that substantial parts of economic activity still exist outside it requires a fresh examination. Official narrative after demonetisation was that tax to GDP ratio will soar as a large number of new tax payers will be captured by the system. The tax to GDP ratio had actually declined marginally even before the pandemic hit the economy.
Does anyone remember what happened to the thousands of cases where notices were sent to depositors of currency totaling several lakh crores after demonetisation. If these were new tax payers captured by the system then why did the tax to GDP ratio not rise in the subsequent years? Many questions remain unanswered till today.
Overall, it is evident that demonetisation has caused severe and lasting damage to the economy which is yet to be documented simply because the Modi government has chosen to see it purely from an ideological prism. So facts cannot be allowed to come in the way of the pre-determined conclusion that demonetisation could only benefit the economy.
It is instructive to note that in 2017 most major world economies saw an uptick in GDP growth but India was an outlier among a minority of countries which saw a decline in growth.
So whether it was curbing black money, reducing cash in the system or raising tax to GDP ratio the facts don’t stack up in favour of the Modi government.
