Indian Prime Minister Narendra Modi's strategy mystifies economists on both the left and the right. Photo: Reuters

The much-awaited release of data on demonetization by the Reserve Bank of India (RBI) has belied the Narendra Modi government’s claims that it would restrict ‘black money’ (laundered money/horded notes) as well as arrest corruption.

The RBI’s annual report released on Wednesday stated that 99% of de-notified Rs500 (US$7.82) and Rs1,000 (US$15.65) banknotes have returned to the system between the demonetization decision on November 8 last year and June 30 of this year.

The figure will likely touch 100% if ‘pipeline’ demonetized collections – banned banknotes with Nepali banks, Indian cooperative banks from Nov. 8-12, tax seizures or legal penalties –  are also taken into account.

The return of most de-notified notes shows the federal government vastly overestimated black money in circulation and probably helped people convert black money into ‘white’ (legitimate).

What is intriguing is how Prime Minister Modi kept moving the goal posts while defending demonetization. Three weeks into the exercise, he changed the narrative from a war against black money, corruption and counterfeit currency to a ‘cashless’ or ‘less-cash’ economy at par with developed nations.

On New Year’s Eve 2017, weeks before the crucial Uttar Pradesh (UP) assembly elections, Modi changed the narrative into a battle between the rich and poor by saying excess cash was causing inflation and black-marketing, therefore, hurting the poor.

This narrative found an echo in Parliament where he underlined the need to empower the poor by acting tough against those who are cheating the banking system. He called it a battle with people and the government on one side and a group of political leaders on the other.

The move impressed UP voters and helped Modi’s Bharatiya Janata Party (BJP) win by a landslide in elections held between February and March this year.

Soon after RBI released the report on collected demonetized currency, Opposition parties wanted Modi to tender an apology for what they viewed as the colossal failure of the note ban program which caused so much hardship for common people.

They cited the following arguments against demonetization:

  • It led to financial chaos and loss of lives.
  • The government’s claims about curbing black money, terror funding and counterfeit currency proved to be false.
  • Instead of curbing money laundering, it helped convert black money to white.
  • GDP growth fell to 6.1% in the fourth quarter of 2016-17 from 7% in the preceding quarter.

The report came as a big blow to economists such as Bibek Debroy and Jagdish Bhagwati who viewed demonetization as a bold step with long-term benefits. In December last year, Bhagwati had argued in a published article that a large chunk of the banned currency would not return, justifying the move to destroy nearly 86% of India’s cash overnight.

Finance Minister Arun Jaitley’s argument that the success of demonetisation should not to be linked to surplus money staying out of the system has also been criticized by Opposition parties as well as economists.

Demonetization has also negatively affected the economy as GDP shrunk to 5.7% for March t0 June 2017. GDP was at 7.9% for the corresponding period last year. Incidentally, GDP is being calculated with a new method was introduced by the Modi government two years ago. With the earlier method, GDP would have been even lower, according to several economists.

However, the government has claimed that demonetization has led to increased tax compliance and digital transaction. The 27% rise in personal income tax returns shows people are completing transactions with legitimate money. However, this claim has also been challenged by experts who point out that the period for calculating this data has not been specified.

Demonetization has helped identify more people with black money, but no official data has been released to buttress this claim. The income tax department is now planning to expand its indirect and direct tax base.

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