Does the RBI Report Give the Lie to Demonetisation, as the Media Would Have Us Believe?

The Criticism

After the publication of the RBI Annual Accounts for 2016-17, a spate of articles and opinions has surfaced in the media claiming that the Reserve Bank’s report belies the government’s expectations of the demonetisation exercise. Some opposition leaders went to the extent of calling the entire process a “scam”, a “sham”, etc, along the same lines. Some of examples of these articles are “Demonetisation: 10 figures that underline impact of PM Modi’s note ban” and “Shame on RBI which ‘recommended’ demonetisation: Chidambaram”, published in The Indian Express; “Demonetisation: Nearly 99% of Scrapped Notes Came Back into System” published in The Wire; or an article like “Opposition slams govt, says RBI data prove note ban was sham”, published in Business Standard.

Most of these articles pounce on the RBI’s announcement that nearly 99% (98.96%, to be exact) of the demonetised Rs 500 ad Rs 1,000 notes were deposited or exchanged, thereby the currency value coming back into the system. Thus, their focus is on notes worth Rs 15.28 lakh crore being deposited out of the total value of Rs 15.44 lakh crore in Rs 500 and Rs 1,000 notes that were in circulation, and only Rs 16,000 crore not returning to the system. Moreover, the RBI spent Rs 7,965 crore, or about half of this Rs 16,000 gain, to print new notes. The implication of these facts, as interpreted by the media, is that not much was gained by demonetisation and what little was gained was mostly wasted.

The articles go on to argue that given the reported hardships caused to the general public by the exercise and the larger disruption caused to the economy, the government’s justifications for demonetisation do not hold water any more. Where the government had allegedly expected a huge amount of currency – apparently Rs 2-3 lakh crore as per The Wire – to not return to the system, only about 1% has not done so. How then do the arguments about curbing black money, counterfeit currency and terrorism still stand as justifications for demonetisation, the articles ask. Then, as article like “Demonetisation: As money flowed back in, how goalposts were shifted”, published by The Indian Express goes on to argue that the government has constantly shifted the goalposts as its stated reasons for demonetisation kept being shown up.

Let us, then, look at the facts behind and post demonetisation to examine if this criticism itself holds up.

The Facts

  1. The first misconception about demonetisation, which the type of articles mentioned above seems to stem from, is the consideration of the success or failure of the exercise based on the amount of money returned to the system. It was never the stated objective of demonetisation to magically convert black money into white once the former was deposited into banks. Nor did the government intend to destroy valid currency in the hands of the public. If that were so, would there be a timeline for depositing the demonetised notes? Or the facilities put in place for exchanging the notes, the relaxations offered, or even the Pradhan Mantri Garib Kalyan Yojana (PMGKY), which allows for deposition with a penalty?On the other hand, the fact that such a large percentage of the money returned allows for a detailed investigation into and examination of the cash deposited. Moreover, the government never claimed or announced that a significant proportion of the notes in circulation would not come back. This analysis based on a single metric, as done by most commentators and news articles, is logically unsound.
  2. In fact, efforts were made to ensure currency entered the mainstream post-demonetisation. Just as this has helped in formalisation, it has also helped in detecting anomalous transactions. The state would not only collect penalty and tax on the unaccounted money, but also bring those involved into the financial mainstream.
  3. Next, let us quickly dispense with Former Finance Minister P. Chidambaram’s claim that “RBI ‘gained’ Rs 16000 crore, but ‘lost’ Rs 21000 crore in printing new notes!”.This is outright incorrect. Paragraph VIII.12 on Page 129 of the RBI report clearly states: “The total expenditure incurred on security printing stood at Rs 79.65 billion [Rs 7,965 crore] for the current year (July 2016 – June 2017) as against Rs 34.2 billion [Rs 3,420 crore approximately] during 2015-16.” (Translation into crore added)
  4. Let us next look at the criticism levelled at the Prime Minister for saying in his Independence Day speech that of Rs 3 lakh crore of “black money” had come back into the system.In his speech, the PM had said “…about Rs 3 lakh crores that had never come into the banking system before, has been brought into the system after the demonetisation”. Let us note the difference in diction.The RBI report from August 11, 2017, shows that excess deposits accruing to the system due to demonetisation was in the range of Rs 2.8-4.3 lakh crore. The report also says that aggregate deposits grew by 14.5% y-o-y from November 11 to December 30, 2016, as against 10.3% during the corresponding period of 2015. This indicates a 4.2 percentage point excess deposit growth due to demonetisation. In nominal terms, excess deposits worked out to Rs 3.8 lakh crore.
  5. Demonetisation was implemented with the intention of adding identities to the cash holdings in the economy. With the return of Rs 15.28 lakh crore, almost the entire cash holding of the Indian economy now has an address. Nevertheless, questions have also been raised about the success on detecting counterfeit currency, and thus of this aspect of demonetisation as well. Let us look at Table VIII.8 of the Annual Report below:

The table makes it explicitly clear that there was a large increase in the detection of fake notes of the Rs 500 and Rs 1,000 denominations.

Here is what the report itself says: “During 2016-17, 762,072 pieces of counterfeit notes were detected in the banking system, of which 95.7 per cent were detected by commercial banks… Detection of counterfeit notes was 20.4 per cent higher than the previous year. Barring Rs 100, the detection of counterfeit notes increased across denominations – notably, Rs 500 and Rs 1,000 — during 2016-17…”

A similar increase in seen also in the number of suspicious transaction reports filed, as seen in Table VIII.9 of the RBI report:

As we can see, the number of Suspicious Transaction Reports filed by banks during 2016-17 went up from 61,361 in 2015-16 to 3,61,214; the increase for financial institutions is from 40,333 to 94,836, and for intermediaries registered with SEBI, the increase is from 4,579 to 16,953.

6. A specifically important objective of demonetisation was making the economy less cash-defined and thus reducing the black money in the system. The reduction of currency in circulation, more than 21% from the base scenario, shows that this intended objective has been met.  As our Data Story “Demonetisation – A Success for Digital Payments” makes it amply clear, demonetisation has left no doubt about its positive impact on the cashless economy. Let us look at Table VIII.1 from the RBI report:

As we can see from the table above, banknotes in circulation declined by 20.2% over the year to Rs 13.1 lakh crore in March 2017. This is clear evidence of the economy going more and more cashless. Paragraph I.20 from the RBI report is significant to understand where currency in circulation stands:

“Notwithstanding the rapid remonetisation process, currency demand appears to have attained a new normal (currently around 87 per cent of the pre-demonetisation peak) in view of the sharp increase in electronic modes of payments since demonetisation. Indeed, year-on-year growth rates of the total volume of retail electronic payments, that had averaged around 37 per cent during April to October 2016, shot up to nearly 70 per cent in November and then further to as much as 123 per cent in December 2016; in subsequent months, the growth rates have moderated but remain high. There appears to be a structural break in the volume and value of retail electronic payments, coinciding with the onset of demonetisation and the special measures put in place to promote digital payments…”

A final observation in this regard may be made with the citation of Paragraph II.3.4: “As remonetisation gathered pace, CIC moved up week after week and reached 74.3 per cent of the peak by the end of the financial year. At end-March 2017, CIC amounted to 8.8 per cent of GDP, down from 12.2 per cent in the previous year. At this level, India’s currency to GDP ratio compares well with a host of advanced and emerging market economies (such as Germany, France, Italy, Thailand and Malaysia).”

Currency with the public as on August 4, 2017, as per RBI, was Rs 14,75,400 crore. This was a reduction of Rs 1,89,200 crore on a y-o-y basis. Last year, an increase of Rs 2,37,850 crore was noted (y-o-y). Currency in circulation as on August 18, 2017, is Rs.15.71 lakh crore. Thus, without restrictions, currency use has shrunk post-demonetisation. While this shows that the push towards cashless or less cash is succeeding, it also demonstrates that hoarding of money not accounted for is on a visible decline. Let us look at Table II.4 as well, showing the monetary aggregates:

7. Other important outcomes of demonetisation would also appear to be the widening of the tax base, which has medium to long-term benefits (For details, please read: Taxpayer Numbers Post-Demonetisation: Explained in Plain Words & Simple Graphics). Besides, demonetisation has led to the detection of about 3 lakh suspect shell companies. About 2.1 lakh of these companies have been de-registered. The amount coming back into the system also means banks have more liquidity today. By adding greater levels of formalisation, demonetisation has also brought about related benefits to those denied of social security benefits, and so on.

In conclusion, it should be pointed out to analysts and news outlets that instead of lazy punditry, they had better use real metrics and approach the issue of demonetisation from a holistic perspective.

  • The True Picture