High costs, meagre gains

Far from curbing black money and corruption, demonetisation has disrupted the economy

ON NOVEMBER 8, Prime Minister Narendra Modi announced his ambitious demonetisation policy initiative to attack the scourges of corruption, black money and fake currency. He also spoke eloquently in his December 31 address about the need for purifying the nation of these scourges. The desirability of this policy goal is wellunderstood and incontrovertible. How effective has demonetisation, as a policy, been in achieving its stated goals? How efficiently has it been implemented?

In terms of effectiveness, the move undoubtedly prevents further circulation of existing counterfeit currency in the two demonetised denominations (Rs 500 and Rs 1,000). However, it doesn’t necessarily eradicate the problem since counterfeiters will be hard at work trying to replicate the new notes, which, by all existing reports, are no less prone to counterfeiting. More importantly, the size of this problem was small to start with (around 0.025 per cent of all notes in circulation, according to recent Indian Statistical Institute estimates). The move also doesn’t do anything to punish the originators of fake money.

How effective has demonetisation been in dealing with black money and corruption? As pointed out by many, both black money and corruption are flow concepts. The move does nothing directly to the flow creation of black money and corruption, other than through its signaling of possible future moves.

Black wealth is a stock that reflects all past creation of black money, cash being just one of several ways of holding it. If 90 per cent of the demonetised cash is returned to banks, back-of-the-envelope calculations suggest that the demonetisation will likely net about two per cent of the black wealth stock or one per cent of GDP in government revenues. The revenue gain could be a bit higher if the income tax department successfully performs the Herculean task of levying penalties on those who laundered their black wealth held in cash by depositing it in banks. The Central Board of Direct Taxes, with its