Demonetisation and its contents

It was about both politics and economics. It is an acknowledged political success and early ‘returns’ indicate an economic success story as well.

Today is the first anniversary of an unprecedented and bold political and economic experiment — demonetisation (DM). Nobel laureates are cited to suggest that this was an uncalled for, unneeded, and unnecessary experiment — one with magnificent costs and precious little benefits. Most economists, left and right, have argued that DM was a costly and ineffective exercise. Given this convergence, some have declared that there is no debate on the efficacy of DM — an economic version of “Jab miya bibi raazi to kya karega kazi”. Impeccable logic, which can only be proved wrong by empirics.

As far back as November 19, 11 days after D-day, in an article in this paper, ‘Demonetisation — Big Bang or Big Thud’, I argued that increased tax compliance was the most important metric to judge the success or failure of DM. Curiously, but not at all surprisingly, political anchors who want to berate DM will mention everything in their fertile imagination to pronounce DM as demonic, but will not utter a single word about tax compliance. Fake news and flaky analysis was discovered in India considerably earlier than that in the US on D-day 2016.

Let us now talk evidence. The table documents various aspects of the Indian economy pre- and post DM. The post-DM period is April to September 2017; the pre-DM period is the same period last year. Some data (for example, CMIE data on employment) are only available till August, and for such data the comparison is with January-August last year.

As many have noted, the GDP growth slowdown happened well before November 2016. After hitting a high of 10.3 per cent for two consecutive quarters, 2015Q4 and 2016Q1, industrial growth, as measured by GDP accounts, was reduced to nearly half the rate (5.9 per cent) by September 2016. If one looks at the industrial growth and credit growth numbers in the accompanying table, they paint a very sorry, and sad, picture of the economy. Industry, which accounts for nearly 30 per cent of GDP, has been crawling for quite some time now. This crawl has been accelerated, and encouraged, by the RBI/MPC which has allowed real policy rates to rise from 1.1 per cent in December 2016 to 3 per cent in September 2017, and headed higher. Unless you are living in a pre-historic cave (like several members of the political Opposition who are the only ones cheering this inexplicable RBI policy), most people agree that interest rates affect demand, and hence, production. My plea to all those commenting on the growth slowdown caused by DM: Spare a tear for the countless poor and rich who have been made considerably poorer by a high interest rate policy. And note that during the year the MPC has been in operation, CPI inflation has averaged 3.1 per cent.

A favourite reasoning of the Opposition opinionatti is that DM failed because all the cash got returned to the system. In my view, it is very positive that all the cash got returned because now the black money can be identified as black. This is up to the tax authorities and a legitimate legal process is underway. Only if the income tax authorities are with the anti-corruption programme will DM be a grand success. Everyone knows that the Indian tax authorities have been accomplices in tax evasion. If they change, India will change for the better, faster.

Data for this fiscal year (April to September) suggests quite a large increase in tax compliance. Tax compliance is composed of two parts — new taxpayers and old taxpayers evading tax. If old taxpayers are now, post DM, paying significantly more, then DM might just have been the most creative and bold move to reduce corruption. (Tangentially, and this is to be discussed on another day, tax rates, like interest rates, should not be too high for reasons of both equity and efficiency).

In its post-DM budget in February, the finance ministry had projected nominal GDP growth of 11.8 per cent, and direct tax collection (personal income and corporate taxes) to increase by 15.6 per cent. Unfortunately, and helped by the ultra-tight monetary policy, nominal y-o-y GDP growth (GVA growth at basic prices) during April-June 2017 was only 7.9 per cent, one of the six lowest on record (since 1996). Even with this low, low income growth, direct tax revenues have increased at a 13.5 per cent pace, very close to the targeted 15.6 per cent. This close correspondence is only possible because of a large increase in tax compliance.

This is just one measure of the large increase in tax compliance that has already been observed. There is more to come, and don’t be surprised if India, because of DM, ends up with more direct tax revenue this fiscal year than it had planned for.

Another knee-jerk criticism of DM is the “fact” that cash is king, again! The jugad ingenuity of the badmash Indian is back, and DM or not, corruption always pays in India. Look, we are using 90 per cent as much cash as we did before, phir aapne demon se kaun sa teer maara? Arrey bhai, look again. According to the trend, we are using about 20 per cent cash than before, or at a minimum, 10 per cent less cash. And the effects of a move to less cash (and therefore less corruption and less tax evasion) is not over.

Yet another piece of “evidence” offered by the critics is the “fact” that after first increasing at a rapid rate (say in January 2017), the month-on-month increase has fallen. What is relevant is the y-o-y increase not the m-o-m increase; the y-o-y is also, in 2017, parallel to the logic of before and after DM. In 2016, before DM, cash transactions (withdrawal from ATMs) were increasing at a healthy 16 per cent rate; post DM, cash withdrawals are 8 per cent lower. Total digital payments were increasing at a solid 24 per cent pace before DM; now they are increasing at a 40 per cent pace.

Let me end with two strikingly puzzling aspects about the Indian economy, pre- and post-DM. First, is the pattern of real wage growth in rural India. Real agricultural wages (Ministry of Labour nominal wage minus rural CPI inflation) grew at 0.1 per cent in 2016 (January-July) and a robust 4.9 per cent in 2017; non-agricultural rural wages show the same pattern — a 1.3 per cent decline in 2016 and a 3.4 per cent increase in 2017.

The second puzzle is the pattern of employment and unemployment in India. The only recent available employment data for India is produced by a private data company, CMIE. Based on the data, a report came out in mid-July arguing that “1.5 million jobs were lost in the first four months of 2017”. This report was picked up as evidence that DM had surely not worked. It has been brandished about, Mark Antony-like (the will, the will), by the Opposition economists and politicians.

The headline, and analysis, are misleading. What the author had done was to compare the change in employment between September-December 2016 and January-March 2017. This comparison, and analysis, was definitely not kosher, that is, it did not account for seasonality in employment. Fortunately, the CMIE data (posted on their website) allows one to compare like with like, that is, employment (and unemployment etc.) between January-August 2016 (pre DM) and January-August 2017 (post DM).

The results are (pleasantly) shocking. Employment actually increased at a healthy rate post-DM — for the population aged 15-24, employment increased by 7 million, and for the age group 25-64, a healthy 12.7 million, or a rate of growth of 3.7 per cent, the highest over the last 35 years (previous years, NSS data).

These are interesting times for the Indian economy. Lots of change, political and economic. Look before you leap to conclusions. Haste makes waste. Demonetisation was not a one year affair; but even 365 days later, there is precious little evidence to term it a failure — and considerable evidence to conclude that it was a radically successful policy.