The publication of Reserve Bank of India’s (RBI’s) annual report has rekindled the debate on the costs and benefits of demonetisation. The fact that more than 98% of the invalidated high value notes came back to the banking system is widely used as evidence supporting the view that demonetisation has failed to curb the black money menace. Supporters of demonetisation cite facts such as a close to 20% decline in currency in circulation, increase in the number of tax payers and identification of large number of shell companies to claim that demonetisation has succeeded.

In this context, it is critical to emphasize that demonetisation was a unique event, and hence, drawing inferences based on theory, armchair analysis or even short-term data, could lead to misleading conclusions.

The danger of jumping to immediate conclusions can be easily illustrated using the latest numbers released by the RBI and the data relating to composition of post-demonetisation deposits presented by the finance minister during the course of his budget presentation. Based on recent RBI data, it is reasonable to infer that the government did not realize any short-term windfall gain due to demonetisation. But to say that demonetisation has completely failed to have an impact on black money too is premature. Consider the two data points presented by the finance minister: 147,000 individuals deposited close to a whopping Rs5.03 trillion, which works out close to one-third of the total currency recalled and an average of Rs3.4 crore per person. The next 10 million depositors deposited another Rs5 trillion.

In other words, a tiny fraction of the population accounted for close to two-thirds of all deposits. It is hard to believe that people stored up to Rs3 crore of tax-paid money in cash for liquidity or transaction purposes.

Interestingly, less than Rs30,000 crore was deposited in Pradhan Mantri Jan-Dhan Yojana Accounts. Finally, close to 50% of the money that came into the banking system has not moved out even after nine months, leading to an unprecedented close to 90 basis points (one basis point is one-hundredth of a percentage point) increase in financial savings to GDP (gross domestic product) ratio and a significant reduction in interest rates.

Given the above numbers, it is clear that the popular narrative that people with large piles of cash escaped completely by depositing money in benami accounts and withdrawing it later is not entirely true. If the numbers presented in budget speech are any guide, such people seem to have deposited the unaccounted cash and decided to take on the risk of being scrutinized by the income tax department. Not surprisingly, the income tax department has issued a large number of notices asking questions about the source of income.

At this stage, it is also important to understand that issuing notice is not conviction. Given the clogged court system, it is possible that the people who have deposited large piles of cash either drag these cases for an unreasonably long period of time or escape completely by exploiting loopholes in law. In such a situation, even in the long run, there may not be any increase in revenue collection. In fact, black money hoarders may get a feeling of invincibility and continue their old style of doing things with renewed vigour.

On the other hand, it is also possible that the income tax department establishes that a large part of these deposits represent black money and recovers tax. In fact, there is a real possibility of tax department learning about other sources of income of the depositor which were hidden from the department hitherto. If recent identification of shell companies is any guide, unearthing of other hidden sources of income cannot be fully ruled out. In such a situation, the revenue recovered could be significantly higher than even the demonetised currency deposits.

Similarly, multiple possibilities exist with respect to other impacts of demonetisation. It remains to be seen whether developments such as a spike in digital transactions, use of bank accounts, increase in tax base, increase in savings in financial instruments, among others, will sustain in the medium and long term. Initial trends are definitely positive. For instance, Jan-Dhan accounts have retained close to two-thirds of deposits made during demonetisation.

My experience of studying the debt-waiver programme of 2008 makes me extremely sceptical of drawing conclusions based on short-term data. In fact, in June-July 2008, agricultural credit did get a boost with more than 40 million farmers having a clean balance sheet. There is reason to believe that the waiver programme helped the government of the day in their re-election bid in 2009. However, negative effects of the waiver started manifesting in the medium and long term. A number of careful studies conducted by many scholars around the world have unambiguously documented that the 2008 waiver led to increased moral hazard and reduction in formal credit to small farmers. The fact that on the ground the situation of farmers did not improve substantially even after the close to Rs1 trillion waiver and farmers are once again demanding waivers corroborates the findings of these studies.

The bottom line of this article is easily summarized. Serious researchers need to be extremely careful and consider reasonably long-term data before reaching any conclusion about unprecedented policy events such as demonetisation. This becomes even more important when there are other related moving parts such as goods and services tax (GST), clean-up of the banking system, real estate sector reform and others going on at the same time. It is better to wait a bit longer than reach wrong conclusions in haste.

Prasanna Tantri is senior associate director, Centre For Analytical Finance, Indian School of Business.

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