Impact of Demonetisation: What Does the RBI Annual Report Say?

It was a fine evening in November 2016 and I was walking back home from work. I received an SMS cryptically asking me to tune into the PM’s broadcast that night. I plugged in my earphones and heard what everyone in India would find out in the next 30 mins - Rs 500 and Rs 1000 notes were now worthless. Thus began a saga that lasted a few months - old notes were to be deposited, new notes printed and distributed, and the economy was to get a reboot. While people shout at each other on the 9 pm news about alleged Urban Naxals and pass judgments while the Courts are yet to pronounce theirs, objective discussions on costs and benefits of demonetisation have stayed off the airwaves.

 

RBI's Annual Report has finally given us some numbers to look at and analyze how the costs and benefits of demonetisation compare.

 

Why Demonetisation?

 

A few reasons were (in the order they were shared with the public)

 

  1. Black Money: The idea being that money hoarded illegally would be flushed out of the system - since the government was going to keep a track on deposits into the banking system and use that information to find people who now had money in the banking system disproportionate to their known sources of income.
  2. Counterfeit Currency: A) Old notes were worthless, so any cash hoarded by terrorists/criminals would now be worthless B) Counterfeiters would also now have to rework their infrastructure to copy the new notes, and in a best case scenario, not be able to counterfeit at all.
  3. Digital Payments: The retrospective notion that forcing people to adopt digital methods of payments would reduce the amount of cash in the economy, increase the traceability, and improve financial inclusion.

 

All in all,

 

It was supposed to be a short-term shock to the economy which would provide long-term benefits.

 

Demonetisation is so 2016. Why Are We Talking About It Again?

 

Because the Reserve Bank of India finally released its Annual Report last week detailing how much of the cash in the system actually came back. So finally, we have some objective numbers with which to evaluate the impact of demonetisation.

 

What Does the RBI Report Say?

 

1. Did the amount of black money in the system reduce? 99.3% of the 15 lakh crore which was in circulation in November 2016 is now in the RBIs vaults. So two things could have happened.

 

 

2. Counterfeit currency: Overall detection of fake notes in 2017-18 was 31% lower than the previous year. Detection of Rs 500 and Rs 1000 notes has decreased by around 50%. But the new Rs 500 notes are still being counterfeited. Also, the Rs 2000 note is now the pick for counterfeiters. The RBI report says that  only 638 pieces of fake Rs 2,000 notes were detected in 2016-17, but in 2017-18, 17,929 pieces (worth Rs 360 million) were detected.

 

3. Digital payments: Overall digital payments have increased massively since November 2016. In 2017-18, digital payment volume rose by 29%. But does this also mean households now prefer digital over cash? Not really. Household preference for cash: In November 2016, around Rs 18 lakh crore was the amount of currency in circulation, out of which around 86% was demonetised. Today, around Rs 18 lakh crore of currency is still in circulation! So even though digital payment volume has increased, people still have a preference for cash.

 

What Was the Impact?

 

We all faced the micro impact, but a sharp drop in GDP (~1%) was a predominant economic impact - much of India’s industrial sector runs in the unorganized sector where lack of cash constrained production and productivity. In addition, the RBI spent around Rs 13,000 crore to print the new notes and transport it across the country (whereas only around Rs 10,000 crore of the banned currency did not return into the system). So based on these costs, it does seem that demonetisation did not achieve its objectives.

 

However, there are some long term impacts which are yet to be quantified - notably the effect of demonetisation on formalization of the economy i.e. more traceability of cash. better accounting, and higher tax collections. We have yet to see how that pans out.

 

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