“THE ROAD to hell is paved with good intentions” is an aphorism that has been variously attributed to Geoffrey Chaucer, the Cistercian abbot Saint Bernard of Clairvaux, Samuel Johnson et al. but was perhaps said first by an English theologian, John Ray.

If one feels compelled to give the benefit of the doubt to the star protagonist of demonetisation, which began at around 8 p.m. on November 8 last year, one may take refuge in this good old aphorism. On the other hand, if one is less charitable, is a stickler for facts, is not sold on fairy tales and flights of fancy, and would rather follow empirical evidence, there is clinching and sobering evidence that Indians were led up the garden path by the Narendra Modi government.

This effort is merely aimed at inquiring into the various supplementary claims that were trotted out by the government and how prepared the kitchen cabinet (assuming there was one) of the Prime Minister was to decree invalidation of 86 per cent of the cash in the economy at a stroke and then control the fallout.

There is no need to belabour the point that even after the passage of a whole year the Indian economy is yet to recover from the shock of demonetisation. Demonetisation, which its progenitor claimed was the first shot fired from his armoury against the triple evils of black money, counterfeit currency and terrorism, underwent a swift metamorphosis into an initiative towards making India a digital economy and promoting a cashless way of life.

Meticulous planning or a grandiose gesture?



While there were unsubstantiated claims that demonetisation had been undertaken after many months of minute planning, the figures available from the government’s own published sources prove that whoever initiated it, whether singly or jointly, had miserably failed to consider the capabilities of the remonetisation system and, more importantly, its limitations. Especially, when they decided to withdraw the legal tender status of the Rs.500 and Rs.1,000 currency notes amounting to Rs.15.44 lakh crore, which comprised 86 per cent of the total Rs.17.977 lakh crore currency in circulation (CIC) on that day.

How much of actual planning went into taking this momentous and fateful decision is moot. It looks like an impulsive, if not ill-considered, decision based on back-of-the-envelope calculations, if that, and as a we-will-make-the-rules-as-we-go-along game.

Let us sift through the evidence. The CIC increased from Rs.13.715 lakh crore on May 23, 2014, to Rs.17.977 lakh crore on November 4, 2016 (an increase of 31 per cent), during the tenure of the present government, that is, a few days before demonetisation. The Reserve Bank of India (RBI), in a response to an application made under the Right to Information (RTI) Act, has revealed that as on November 8, 2016, it was in possession of Rs.20.512 lakh crore worth of Rs.500 and Rs.1,000 notes. If demonetisation was a considered decision, it is baffling why the RBI took on an additional inventory of Rs.5.072 lakh crore worth of Rs.500 and Rs.1,000 notes over and above the Rs.15.44 lakh crore of the same in circulation if they were to be rendered invalid soon. Instead, the RBI should have increased the inventory of lower denomination notes, which would have ameliorated the pain caused by paucity of change for the new Rs.2,000 note. This points to a mindless, wanton waste of public money.

The same RTI response further shows that the RBI held 2,473.20 million Rs.2,000 notes worth Rs.4.946 lakh crore as on November 8, 2016, to replace the demonetised currency or Specified Bank Notes (SBNs) worth Rs.15.44 lakh crore, leaving a huge gap of around Rs.10.5 lakh crore. Although the Prime Minister had pleaded for a mere 50 days to complete the remonetisation, as on January 6, that is, after 57 days, the replacement currency printed and circulated was a meagre Rs.1.497 lakh crore, apart from the Rs.2,000 notes already freshly in circulation. The RBI, thus, was able to remonetise only 41.7 per cent of the SBNs within the promised time. To further prove the lack of forethought, the printing of the new Rs.500 note commenced only on November 23, a few weeks after demonetisation.

It is not as if the capacity of Indian mints was unknown to those who went on this adventure. The Nashik press’ capacity is 5,800 million notes a year and that of Dewas in Madhya Pradesh is 2,620 million a year while the Mysore and Salboni presses of the Bharatiya Reserve Bank Note Mudran Private Limited together can print 16,000 million a year if run on double shifts. In short, all the four presses put together have a capacity of 66.90 million notes a day. One must believe that despite having all this information and rudimentary arithmetical knowledge that would have given the Prime Minister the actual number of days required for remonetisation, his declaration that everything would be back to normal in 50 days was nothing but wilful prevarication.

Limitations of financial system in rural India



Cash is the only medium available for transactions for the majority of Indians, and India’s is an incredibly cash-based economy; other alternatives are virtually non-existent for the vast majority. When the government extinguished 86 per cent of the CIC at a stroke, it was aware of the poor penetration of banks in rural India and the lack of digital payment options. It knew that 69 per cent of the Indian population was from the country’s six lakh villages; only 48,768 bank branches (i.e., 35 per cent, or one bank per 12 villages) out of a total of 1,39,240 bank branches serviced this 69 per cent, which meant an average of fewer than six bank branches per one lakh rural population, and only 40,480 ATMs (18 per cent) of the country’s 2,19,637 ATMs were in rural areas. It also knew these limitations would militate against quick remonetisation in rural areas and that the distress there would be worse than in the urban centres. Yet, the public was misled and callously given false assurances.

Lack of infrastructure to support digital economy



When the government had to put up with currency-printing blues coupled with logistics bottlenecks that hampered effective remonetisation, the rhetoric about the fight against tax evasion and black money suddenly shifted to transforming India into a cashless economy. A study by the Boston Consulting Group and Google (July 2016) clearly indicated that in 2015, 78 per cent of all consumer payments were in cash and only 22 per cent were non-cash transactions, showing the preponderance of cash in the Indian economy. A shift of this magnitude from cash to digital money should have been preceded by imparting digital and financial literacy to the millions of technologically challenged people in the country, setting up effective and robust cyber-defence capabilities and creating seamless, always-available infrastructure.

Yet, when the government decided to transform an unsuspecting and unprepared India into a cashless economy, the situation on the ground was like this: Only 34.8 per cent of Indians, mostly urban, have access to the Internet; only 68.27 per cent of rural households have a mobile phone connection and, even there, some States lag behind. For instance, it is as low as 28.58 per cent in Chhattisgarh, 33.58 per cent in Odisha and 44.18 per cent in Arunachal Pradesh.

But the government forged ahead with spending millions of rupees on pushing Digital India when it knew that little of the prerequisites for a digital economy existed. In hindsight, it would seem this sudden epiphany to make India cashless was out of compulsion to divert attention as the days required for remonetisation had been grossly underestimated.

That the RBI came out with more than 66 notifications and announcements in the first 50 days after demonetisation, including several revisions and rollbacks, was evidence enough that there was simply no plan. It took a week for the RBI to wake up to the reality that the new notes required both software tweaks and hardware recalibrations at ATMs; a task force to address this issue was formed only on November 14, 2016.

After a press release on December 13 confirmed that the total SBNs received as on December 10 was Rs.12.44 lakh crore, the RBI clammed up and refused to divulge the amount of SBNs received thereafter, citing risible excuses such as that the SBN counting and recounting was going on. In fact, it still seems to be going on! Finally, the RBI’s annual report published on August 30, 2017, revealed that 99 per cent of the SBNs had indeed been received. But by then, the RBI’s reputation had been tarnished, possibly beyond repair. As Rs.15.28 lakh crore out of Rs.15.44 lakh crore of the SBNs had been returned as on June 30, 2017, dreams of windfall gains evaporated. The expenditure on note-printing in 2016-17 was Rs.7,965 crore, more than double the 2015-16 figure of Rs.3,421 crore. The surplus transferred to the government by the RBI nosedived from Rs.65,876 crore in 2015-16 to Rs.30,659 crore in 2016-17.

Scorecard



When the dramatic announcement was made on the night of November 8 in a nationwide televised address, the stated objectives were snuffing out 1) unaccounted money held in cash; 2) counterfeit currency, which was purportedly the source of financing for terrorists; and 3) therefore, terrorism itself.

We shall first examine how far these objectives were met before moving on to the objectives that came as an afterthought as the original objectives retreated in the face of massive outrage.

Black money



The government is in possession of enough reports addressing the prevalence, menace and forms of black money. One such report, titled “Measures to Tackle Black Money in India and Abroad” (2012) by the Chairman of the Central Board of Direct Taxes (CBDT), unequivocally states that demonetisation will not be able to contain the black money menace:

“One common demand from the public is that high denomination currency notes, particularly Rs.1,000 and Rs.500, should be demonetised. In this connection, it is observed that demonetisation may not be a solution for tackling black money or economy, which is largely held in the form of benami properties, bullion and jewellery, etc. Further, demonetisation will only increase the cost, as more currency notes may have to be printed for disbursing the same amount. It may also have an adverse impact on the banking system, mainly logistic issues, i.e. handling and cash transportation may become difficult and may also cause inconvenience to the general public as the disbursal or payments of wages/salaries to the workers will become difficult.”

The government authorities are also aware that most of the black money generated is invested in businesses, stocks, real estate, benami accounts, etc., and only a small fraction is kept as cash. According to data from income tax raids, this is limited to less than 6 per cent of the total black money in the economy.

For instance, it was stated in Parliament on August 1 that between November 2016 and March 2017, a total of Rs.18,529 crore of unaccounted wealth was detected through search and seizure (Rs.11,634) and surveys (Rs.6,895). In this, the seized cash component was only Rs.1,003 crore (5.4 per cent of the total Rs.18,529 crore). The CBDT classifies seizure accounts for currency and ornaments as one unit. Hence, the actual proportion of cash in these seizures will be lower than even Rs.1,003 crore, which is a tiny fraction compared with the demonetised currency of Rs.15.44 lakh crore. The undisclosed income from search and seizure in previous years clearly proves that demonetisation failed to unearth any remarkable amounts of black money.

Fake currency



In a study in partnership with the National Investigation Agency, the Indian Statistical Institute estimated that around Rs.400 crore of fake Indian currency notes (FICN) is in circulation. But this report does not call for radical steps such as demonetisation to flush out FICN. The data (2011-15) show that law enforcement agencies have been seizing Rs.25-Rs.45 crore of FICN annually. Another Rs.30 crore of FICN gets detected in the banking system on an average annually, according to recent records of the RBI. It is another fact that India has substantially low FICN per CIC compared with the United States, the United Kingdom and Europe. The RBI’s annual report of 2016-17 shows that the total FICN detected is Rs.43.5 crore. Although this is higher than the Rs.29.6 crore detected in the previous year, the amount is insignificant in relation with the CIC of around Rs.17.977 lakh crore.

Despite the claims of the government that the post-demonetisation notes have added security features, banks detected hundreds of FICN of the new Rs.2,000 and Rs.500 notes within a couple of weeks of their introduction. Law enforcement agencies also seized a substantial amount of counterfeit notes of these denominations. Demonetisation, therefore, did not contain, let alone stop, counterfeiting of Indian currency.

Terrorism



How effective could demonetisation have been as a one-time initiative to choke terror funding? If the government had thought things through, it would have known that demonetisation would have been, at best, a temporary blip, and once remonetisation happened, cash would become available to terrorists too. It would not be difficult for terrorist outfits, which have channels to move money digitally and which use front companies, to procure new or counterfeit currency. Although demonetisation apparently did crimp terrorist activities for a few months, cross-border terrorism and Maoist insurgencies resurfaced again after the hiatus.

It is also a myth that removing cash and moving to a “cashless society” creates a “terrorism-free society”. Belgium and France, which are in the first and second places on the list of cashless societies in the world, were also victims of indigenous and trans-border terrorism. The Charlie Hebdo attack in Paris in January 2015 is an unfortunate example. France did not detect that the terrorists involved in the attack had bought their weapons from Brussels. Nor did Belgian agencies know that Molenbeek, a small 5.8-square kilometre area in their country, was the Islamic State’s busiest terror incubation centre in the world.

All the evidence points to the conclusion that none of the originally stated objectives were met by demonetisation. No black money worth all the misery the Indian public was put to was found. On the contrary, as most critics of demonetisation suspect, large caches of black money and counterfeit money got laundered since possibly more than 99 per cent of the SBNs have reached the RBI. The government’s claims that the money is now in the system, is traceable, and its holders can be prosecuted sounds logical, but the large number of cases (some nearly two lakh suspect accounts according to figures given by the government), the lack of matching manpower, and the poor record so far in prosecuting such cases all suggest that identification of black money and the final tax collection from such accounts will never reach the fancy figures floated by even the so-called economists rooting for demonetisation.

Growth of Digital Transactions



If we examine the growth in digital transactions in recent months, the Unified Payments Interface (UPI) recorded a growth of 74 per cent, that is, from a Rs.2,391 crore monthly transaction amount in March 2017 to Rs.4,157 crore in August 2017. But if we consider the total retail electronic clearing, we can see there was no dramatic jump in digital volumes; instead, it almost follows the same growth trajectory of previous years. If we consider the total retail electronic payments of Rs.13,98,809 crore in August 2017, the share of the UPI is less than 0.3 per cent. Here is another interesting data set: while Indians withdrew Rs.2,19,165 crore of cash using debit cards from ATMs in August 2016, it touched Rs.2,35,196 crore in August 2017. As cash returned to the system, the apparent surge in digital transactions after demonetisation appears to have evaporated.

Cash-GDP ratio



Another narrative was that the objective of demonetisation was to bring down the high currency-to-GDP (gross domestic product) ratio. The government claimed that the cash-GDP ratio of 12.2 per cent in March 2016 witnessed a drastic reduction to 8.8 per cent in March 2017. But the CIC increased from Rs.13.353 lakh crore on March 31, 2017, to Rs.16.465 lakh crore on October 20, a jump of 23.3 per cent within the past seven months. When computing the CIC-GDP ratio, it is always the nominal GDP that is considered. If we account for the fact that the GDP at current prices (nominal GDP) is growing at 9.3 per cent, the present currency-GDP ratio has already crossed the 10 per cent mark. When the GDP is slipping, this will reflect in a higher CIC-GDP ratio further down the line.

Increase in tax base



The government claimed that demonetisation resulted in widening the tax base and bringing a record number of taxpayers into the tax net. To substantiate its claims, at various times the government released contradictory figures of 56 lakh, 5.4 lakh, 91 lakh and 33 lakh as the number of new taxpayers since demonetisation, without revealing the base figures over which these accretions are claimed. None of this stands up to scrutiny.

The annual report 2016-17 of the Ministry of Finance sets the actual number of new taxpayers for FY 2014-15 at 78.38 lakh and for FY 2015-16 at 99.98 lakh. That means there was a year-on-year growth of 27.6 per cent in new taxpayers between 2014-15 and 2015-16. The government disclosed in Parliament on August 4, 2017, that 1.26 crore new taxpayers were added to the tax base in FY 2016-17. So, the year-on-year growth for 2016-17 is only 26 per cent compared with a 27.6 per cent jump in 2015-16. Thus, despite the alleged impetus of demonetisation, the tax base grew at a lower rate than in the previous year.

One year after the then awestruck Indian public was hit by demonetisation, it is clear that the decision was taken without any forethought, let alone detailed, step-by-step planning. It all seems to have stemmed from megalomania, a need to make grand gestures, to play to the gallery, to show intrepidity, or even to test the limit of one’s powers to make decisions on a whim unchallenged. The government did not take institutions into its confidence. It was not that the government was not forewarned. Among other people, Raghuram Rajan, before his exit, would have resisted, which perhaps hastened his exit from the RBI.

Now, when the inventory is taken, what we have are economic growth that has been stymied and pushed into decline; distress among the rural population, which is yet to recover from the blow; devastation in cash-dependent sectors of the economy; blots on the independence and integrity of institutions such as the RBI; unchallenged opacity in decision-making that bodes ill for the nation’s future; no dramatic growth in the tax base or tax collections; no tangible gains of any sort; and possibly long-term and as yet unplumbed damage to the economy.

Was it only good intentions that paved the road to this hell? Or was it a mixture of chutzpah and hubris?

James Wilson, a civil engineer and avid blogger, works for the Inter State Water Advisory Committee of the Government of Kerala.