Demonetisation: Review of Outcomes

Demonetisation came under media scrutiny recently, when RBI’s annual report gave an almost complete picture of gains and losses from this policy adventure. It was thought that demonetisation would break the vicious black money cycle and, if followed by changes in the tax regime, would end the perverted cycle of black money-creation in many sectors. But it did not happen. The scheme was announced as an extremely bold and risky move but it was followed by a poor rollout and implementation. Within first week of the decision, it was clear that government was printing wrong denomination notes (why Rs. 2000?) and those notes were of wrong size {it took long to recalibrate the ATM machines}. Government failed in remonetisation of economy immediately.  Longer the remonetisation took; more the government had to be lax in rules regarding exchange of money. Soon it was apparent that the scheme was not implemented to achieve its objectives.

Here is a brief review of various gains and losses from demonetisation.

Impact on Black Money

The RBI report has unambiguously shown that only Rs. 16,000 crore, equivalent to 0.1% of GDP failed to come back to the RBI.

Rs. 16000 crore is 1.03% of the value of notes banned in November 2016. Even this amount is not all black money. Out of this, Rs. 3500 crore is held with Nepali citizens in the form of old currency notes as RBI had delayed allowing Nepali citizens to return their old notes. Around Rs. 100 crore is also with Bhutanese people. Further, a small fraction of old currency notes may also be with PIOs, NRIs and some other unknown Indians who could not – for legitimate reasons, deposit it to banks in time. Thus, we can assume that this figure of Rs. 16000 crore would further shrink to some 12500 crore. Thus, only on the basis of this figure it can be inferred that demonetisation helped flush out just 0.80 per cent of the high-denomination notes then in circulation.

However, following are some of the positive developments on black money front:

  • 15497 crore of undisclosed income admitted in 2016-17, which is 38% higher than 2015-16.
  • 13716 crore undisclosed income was detected during searches in 2016-17, up 41% from 2015-16.
  • Advance tax by non-corporate during fiscal up by 42%
  • Three Lakh shell companies were detected and 2.1 lakh of these were de-registered.
  • SEBI has delisted some 450 suspicious companies and the demat accounts of these have been frozen.

The government claims success of demonetization on the basis of above list of positive developments. Nevertheless, in November 2016, it was expected that RBI would get windfall gains from its extinguished liability of currency notes that would not come back to system. This idea has fallen flat. Instead, the cost of new currency printing has left RBI in net loss – thus bringing the government dividends from RBI to almost half.

PMGKY and Operation Clean Money

To curb the black money, the government launched one scheme (Pradhanmantri Gharib Kalyan Yojana) and two operations {Operation Clean Money phase-I and Phase-II}.


Prior to demonetization, the Income Declaration Scheme (IDS) was launched between June and September 2016. In this scheme, government collected Rs. 12,700 crore tax from people disclosing undisclosed income of Rs 67,382 crore. After demonetisation, PMGKY was launched for voluntary disclosure of unaccounted income for a payment of 49.9 per cent tax, surcharge and penalty. Also, a mandatory deposit of 25 per cent of the black money was to be made in a zero-interest bearing account for four years.

Under this scheme, black money worth Rs. 4900 crore was disclosed by some 21000 people by the time it closed on March 31, 2017. From this, government has collected a tax of around Rs. 2451 crore. Like any other black money scheme, the response to this scheme was also not good. It was worst than IDS because of very high penalty and a sense of tax terror among people.

Less Cash Economy

The significance and domination of cash in Indian economy is mind-boggling. In 2015, a report by PwC had pegged India’s cash transactions at 98 % of total consumer transactions in value terms; and around 68 % in volume terms. This amount was much higher than the comparable economies and was one of the factors that led the government to give a blow to cash economy.

The progress towards less-cash economy in the aftermath of demonetization can be enumerated in following points:

  • Around 21% reduction in currency in circulation
  • Entire circulation of money is now having address and is no more anonymous
  • There was a rise in suspicious transactions which led Income Tax department to start probe.
  • Total value of digital payments with pre-paid instruments rose from Rs. 48800 crore in 2015-16 to Rs. 83800 crore in 2016-17.
  • In 2016-17, NEFT handled transaction of Rs. 120 lakh crore up from 83 Lakh crore in previous year.

However, the country was not prepared for such knee-jerk action because of less penetration of debit / credit cards, less number of ATMs and PoS terminals etc. Thus, the government also concluded that digital transactions in India can best play role of parallel mechanism, not a substitute for cash transactions.

Tax Base

Demonetization has resulted in some increased tax base. As per government data, E-returns of individual tax payers filed till August 5 has rose to 2.79 crore from 2.2 crore last year. This amount to an increase of 57 lakh returns, clicking a growth of over 25%.

Implications of Agriculture

The government claimed decrease in stone pelting in Kashmir; and reduced terror activities. All these claims are very subjective as we see gradual rise of these in recent months. Government was able to detect 2.56 Lakh pieces of fake currency notes of Rs. 1000, which is also much lower than expected. Its impacts were largely negative on all industries except those highly based on digital transaction. It led to disruption of unorganized supply chains that are dependent on cash transactions. The most hit sectors were agriculture and small unorganized retail businesses. The agrarian economy of country is mostly cash based, so this move gave hardest blow to farm sector. The poor and illiterate farmers needed immediate loans to purchase seeds and due to lack of financial inclusion, were exploited by moneylenders. The wholesale prices of most commodities fell and this became one of the factors behind recent farmers agitation in several parts of the country.

Lessons for the Government and Way Forward

As envisaged by the government, demonetisation relied on a surprise element to flush out the black money, fake currency notes, and increase formalization of economy in one master stroke. It was a hugely disruptive move but was not managed well. The ill-management was worsened by frequent change of rules governing demonetisation. Cumulatively, it intensified a slowdown in the economy; hurt jobs; undermined agricultural trade; caused lots of inconvenience to people. In short term, it has led to more unintended consequences. It is quite possible that in long term it may result in substantial growth in the direct tax base; switch in the financial holdings of households from cash to bank deposits; increased use of digital payments; and so on. However, whether the long term benefits will be greater than short term costs, it is yet to be seen.

At the same time, the policy gave a clear signal to tax evaders that tax compliance would be prioritised. Surely, demonetisation widened the tax base and it is estimated that it added 5.4 Lakh taxpayers. Much more work is needed to realise all potential benefits.

Question for UPSC Mains:
Every government policy has intended as well as unintended consequences. To what extent, the unintended consequences of demonetisation have overshadowed the intended goals? Critically discuss.