120 days after demonetization


V Pattabhi Ram

A full 120 days after Narendra Modi sprung on a surprised nation his version of financial carpet-bombing (not my words, but the words of the Supreme Court) it’s time to take a look at the fallout.

Surprisingly, the central bank is not reeling out the numbers as they should be doing, bringing into open the question of the independence of the RBI. It would not have been thus if rock star Raghuram Rajan had been in the hot seat.  Let’s glean in the figures from different sources to get a perspective of what has happened.

Net cost of demonetization

Four days before the dramatic announcement, on November 4, the amount of money in circulation was about Rs 17.54 trillion. Of this Rs 15.40 trillion was demonetized. According to reports, Rs. 14.97 trillion has come back to the banking system. This number translates into a gain of Rs 0.43 trillion to the government. Remember, the original estimate was Rs 3 trillion. Of the Rs 14.97 received, the government has reissued only Rs 9.2 trillion. The government may choose to issue the balance Rs 5.77 trillion or may let other forms of money like credit card etc., cover that sum. That would mean a transition of Rs 5.77 trillion to the digital economy.

According to CMIE, the cost of carrying out the demonetization exercise, including the opportunity cost of waiting in queues, as of 31st Dec is Rs 1.28 trillion. Looked at in the backdrop of a Rs 0.43 trillion gain, the net loss of demonetization is Rs 0.83 trillion. This loss, of course, does not consider the benefit that may flow in due to change in the climate towards the generation of black money.

The government has put out that the growth in Q3 is 7%, a number got after downgrading the base figure! Without the downgrade, the growth rate would have slipped to 6% and been in line with original estimates. Also, we must remember that the GDP does not capture the informal sector, which is where demonetization had played havoc.

The story of the shadow economy

One of the avowed objectives of demonetization is the elimination of black money. Interestingly, the government of India does not have with it an estimate of the shadow economy. We will have to rely on external information and back of the envelope calculations.

As per a World Bank report of 2007, the value of the parallel economy is 23% of India’s GDP. Let’s assume that in the last 10 years, this number has inched to 25%. India’s GDP by the last count was $2.25 trillion. Taking an average exchange rate of Rs 67, this translates into Rs 150 trillion. At a 25% estimate, the value of the black market is Rs 37.5 trillion. Reports indicate that India’s cash component of the black market is 5%-6%. Taking the top number of 6%, we are looking at cash black in India of Rs 2.25 trillion. This black cash amount, or a little more than it, was what the government expected would not come back, and thought it could pocket. In the end, the sum turned out to be just Rs 0.43 trillion.

Freak out the fake money

The second objective of demonetization was the elimination of fake money. According to a government-sponsored study carried out by the ISI, Calcutta, the value of fake money (aka counterfeit) currency is Rs 400 crore. Some estimates place it at Rs 5000 crore. With the total currency upwards of 17 trillion, fake money is a mere 0.023% of the total money. We don’t know how much of this is eliminated following demonetization.

Since counting machines can spot fake currency, one hopes that whatever money the banks was good currency. Incidentally, the story that the new Rs 2000 note is fake proof has proved to be just that – a false story. These currencies have been counterfeited and that too at such short time when usually it takes five years to fake a new currency. Statistics show that there are 250 per million currency notes as fake and that the banks can spot only 16 of them.

Black money abroad

Cash black money in India was a low-lying fruit. The larger sums are lying in gold and real estate. Much more is lying abroad. Some computations are in order.

The BJP, at its election rallies, talked about placing Rs 15 lac in every citizen’s bank account. At a population of 120 crores, this translates into a whopping 1800 trillion. At the then ruling rate of Rs 58/dollar, the amount is $31 trillion. Even if we assume that the BJP was talking about a family of 5, the size of the black market is Rs 360 lac crore. Shouldn’t we be attacking that instead of attacking Rs 2.25 lac crore?

If we want to root out corruption, we must reduce the high incidence of tax. At 33% direct taxes are high, and at 30% indirect taxes on restaurant bills are usurious. We need to improve our personal discipline (see our civic sense including traffic jams, for proof), and we must adhere to a swift and impartial criminal justice system. Minus all that we will only be scratching the surface.


About Pattabhi Ram

A chartered accountant by profession, a writer by passion and a teacher by accidental choice.
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