Demonetization, NDA, BJP

Friday, 14 December 2018



Demonetisation and its success

Sumanta Deb | November 22, 2017 20:24 hrs

The first anniversary of demonetisation recently brought into focus the way this government has embarked on a massive drive to “formalize” the economy – one of the key transformational agenda. In this context, let me examine one of the levers that is being used to achieve this - Demonetisation.

Why did Modi resort to demonetisation? Well, during NDA 1 (1999-2004), the economy created over 60 million jobs, according to NSSO data, as real GDP grew by 5.5% annually. In contrast, though the economy grew by 8.4% annually in the first six years of the UPA government, only 2.7 million jobs were created (NSSO data again). Inflation was higher and the external sector deficit touched $100 billion, compared to the NDA- 1’s $20 billion surplus. What explains this dichotomy under UPA – much higher GDP growth but negligible job growth? High asset price inflation replacing production as the prime growth parameter! 

In UPA’s first six years, prices of stock and gold jumped three times or 60% annually. Property prices doubled every two-three years. This led to “investment bias.” Urban middle classes channelized most savings into real estate. I, for example, have low liquid assets such as bank deposits but fairly high real estate holdings (for a salaried tax payer). In cities like Bangalore and Gurgaon, land prices rose by over 10 times. Asset inflation in six years was three times the annual nominal GDP growth. On hindsight, economists feel this is not the result but the cause of the UPA’s “high growth.” For instance, 3-BHK apartments in Bangalore priced at Rs. 25 lakhs in 2003 rose to over Rs. 1 crore in 2012! Arriving at the real growth rate is like peeling off multiple layers of an onion – deduct the non-asset price inflation from nominal growth to know the real growth. However, asset price rise (such as real estate) is seen as wealth and prosperity and is added to GDP.

Why target the 500/1,000 rupee notes? The reason is the absence of monitoring of high value notes (HVN) due to the informal, cash-is-king nature of our economy. During 2004-10, average money supply grew annually by 18% (15.3% under the NDA); however asset prices rose by several multiples of it. The asset inflation can be explained not by the moderate increase in money supply but by the rising levels of unmonitored HVNs – this made cash deals easy. In 1999, the cash with the public was 9.4% of nominal GDP which rose to 13% by 2008, whereas it should have come down due to rising bank and digital payments. And more seriously, HVNs with the public rose from 34% to 79% between 2004 and 2010. This complete absence of monitoring of HVNs led to increase in gold and land prices through cash deals and stock prices through instruments such as Participatory Notes (PNs). In essence, these were hawala transfers from India that came back into the stock markets through the Mauritius route. In just 3 years from 2004-07, PNs rose by over Rs 3 lakh crores!

The bigger agendum: expand the scope of the formal economy - Two of the biggest transformational moves of this government were Jan Dhan Yojana (JDY) bank accounts and Direct Benefit Transfer (DBT) of government benefits. Both were aimed at sucking out cash from the informal economy and channelizing it through the banking system, in effect, “formalizing” the economy. As of August 2017, there are 295 million accounts having about $10 billion in deposits all because of JDY. Similarly, savings due to DBT during the period 2014-16 had touched Rs. 50,000 crores and is expected to rise further in the coming years as a total of 533 central schemes in 64 ministries will be brought under DBT. Demonetisation similarly has led to huge gains in expanding the scope of the formal economy. Sample this - a 25% increase in the number of individual IT payers and increase in advance tax collections by about 40%. In the long term, it implies that the sources and rate of generation of black money will be severely impacted. Already, we have 20% less cash in the economy, over 37,000 shell firms are being targeted and digital payments have increased by over 70%. Demonetisation has also led to more than 1 crore workers being added to EPF and ESIC. 

The adverse impact on the real estate sector is in line with the very thinking that prompted demonetisation in the first place – “inflated” asset prices fuelled by cash deals were creating a mirage of high GDP growth which was not reflected in job-growth data. HVNs outside the banking system took refuge in stocks, gold and real estate. If the HVNs had been within the banking system, it would have multiplied through the fractional reserve model, reduced the inflation and interest, and funded the starved small-and-medium enterprises. One of the key gains of demonetisation is that it brought back all the cash into the banking system, increased banks’ lendable resources, formalised significant chunks of our economy, gave “birth” to lakhs of tax payers and enabled a sudden, one-time detoxification of our economy.

Welcome to the formalized Indian economy emanating from the success of demonetisation. The introduction of GST (my next article) takes this process of formalizing the economy further.

Sumanta Deb, a self professed “bhakt” is a Management Consultant by profession. He is currently based in Bangalore.

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