Evaluating the critics of note ban
Most claims against it are untenable; note ban is more than a one-time step jump
Last week has seen a contentious debate on demonetisation replay itself. Predictably, critics have gone on to make several untenable claims. The present article by ARVIND PANAGARIYA challenges 3 of them
Last week has seen a contentious debate on demonetisation replay itself. Predictably, critics have gone on to make several untenable claims. The present article challenges three of them. Claim 1: With nearly all of the highdenomination notes returned to the banking system, the primary objective of demonetisation — extinguishing unaccounted cash — has been wholly defeated.
This claim is false on two counts. First, the primary objective of demonetisation was combating corruption, not extinguishing unaccounted cash. The latter was seen as the mechanism through which demonetisation would attack corruption. Second, demonetisation did successfully attack corruption, though not by extinguishing unaccounted cash as originally expected but through three alternative mechanisms.
First, every ~500 and ~1,000 note that has returned to the banking system now has the name of an individual or a company attached to it. Modern-day data mining techniques allow us to identify which of the notes are clean and which ones are potentially tainted. Once the government identifies the latter, it can go after their owners.
Already, the Income Tax (IT) Department has identified 1.77 million suspicious bank accounts with ~3.68 lakh crore in deposits that do not match the deposit holders’ respective tax profiles. Notices are already being sent to some 70,000 entities that deposited over ~50 lakh each in cash in bank accounts but did not file tax returns or respond to the IT Department advisories. Many more notices will be issued in the months ahead.
In parallel, the Ministry of Corporate Affairs (MCA) has de-registered 224,000 companies, which conducted no business during the last two years or longer and could provide no satisfactory explanation for it. Many of these companies have 100 or more bank accounts and have deposited and withdrawn large sums after demonetisation. These companies can no longer operate their bank accounts. The MCA has also disqualified appointments of nearly 309,000 directors who failed to file financial statements or annual returns for three consecutive years.
The second avenue through which demonetisation has directly expunged unaccounted wealth is real estate. Critics have argued that demonetisation was the wrong instrument to combat corruption because the bulk of the black wealth was held in assets such as real estate, not cash. But these critics forget that unaccounted cash is what is used to acquire real estate. Unsurprisingly, an attack on unaccounted cash struck at the heart of this black wealth by cutting real estate prices by a quarter. Black wealth held in real estate thus fell by a quarter in a single stroke. Moreover, today, those looking for a safe haven for their ill-gotten cash think twice before investing it in this asset.
Finally, demonetisation and followup actions have sent a strong signal to all those accumulating unaccounted wealth that the Prime Minister will not hesitate to take any political risk when it comes to combating corruption. It is no surprise that the number of taxpayers and formalisation of transactions through digitisation and other means have experienced a significant jump. If the government continues on its current path, I have no doubt that this change will prove to be a shift in the trend rather than a one-time, step jump. Claim 2: With demonetisation, India has lost two per cent of gross domestic product (GDP).
Most, if not all, analysts including those in the government had expected that by temporarily wiping out 86 per cent of the cash in circulation, demonetisation would have some adverse impact on GDP. Some analysts had, of course, predicted a loss of several percentage points of GDP. In the event, nearly all were surprised by the GDP estimate for 2016-17.
Nevertheless, the estimate of two per cent GDP loss due to demonetisation has resurfaced. Simple analysis demonstrates the fragility of this claim. Growth during 2015-16 had been eight per cent. Informed analysts attribute about one percentage point of this growth to a onetime gain from the sharp reduction in oil price. If we accept this proposition, absent demonetisation, growth in 201617 would have been seven per cent. With the actual growth at 7.1 per cent, demonetisation would seem to have had no negative effect on growth. Even if we make the unrealistic assumption that the oil price decline made zero contribution to the growth rate in 2015-16, the negative effect of demonetisation would be maximally 0.9 percentage points. Claim 3: Demonetisation has led to a loss of 1.5 million jobs.
The source of this claim, accepted uncritically by some prominent critics, is the Centre for Monitoring Indian Economy (CMIE). The CMIE started counting the employed and unemployed as part of its household survey beginning in January 2016. Mahesh Vyas, CEO of CMIE, claims that according to this survey the number of individuals employed during SeptemberDecember 2016 being 406.5 million and those employed during January-April 2017 being 405 million, demonetisation has destroyed 1.5 million jobs.
The problem with this inference is that employment is subject to seasonal variation. To control for this variation, we must compare the employment figure of 405 million for January-April 2017 to that for the corresponding period in 2016. It turns out that the number of those employed during January-April 2016 was 401 million. Therefore, if we follow Vyas (something I do not recommend) and credit demonetisation with the entire change in employment between the two periods, we would conclude that it created four million jobs instead of destroying 1.5 million of them.