It is time for a mea culpa on demonetisation. This writer has been largely positive on the medium-to-long-term benefits of notebandi, as opposed to its short-term downsides, including a fall in gross domestic product (GDP) growth rates for one or two quarters. Now, and especially after the farmer agitations for loan waivers, I believe that the negative side of the ledger on demonetisation (DeMo) is larger than the positive. It has failed.

The critics have been right for the wrong reasons. They did not have a better crystal ball on DeMo’s side-effects than the optimists; but they did have a deeper animus against the Narendra Modi government that the optimists, including me, did not have. Thus, they were faster to pick up the negative signals than the rest of us.

The bottom line on DeMo, seven months after Modi announced that he was withdrawing the legal tender status of Rs 500 and Rs 1,000 notes from 8 November, is that the costs are outweighing the benefits. And the rising demand for fiscally ruinous farm loan waivers surely has a direct link to DeMo. Maybe loan waivers would have happened anyway in the run-up to 2019, but it is equally clear that DeMo has emptied many mandis of cash, and the demand for ready harvested crops has collapsed in many parts of the country, as Harish Damodaran notes in his column in The Indian Express.

Damodaran admits he was wrong in assuming that DeMo would impact farm production – which did not happen – but the damage came later. He writes: “Where demonetisation did have an impact, however, was in the prices received during harvest: Potatoes in Farrukhabad, Uttar Pradesh, fetched below Rs 350 per quintal this February, compared to Rs 600 or more last year. The same goes for rabi onions in Lasalgaon, Maharashtra, that traded at an average of Rs 450 per quintal in May, as against Rs 750-800 and Rs 1,200 in the same month of the preceding two years. Farmers, likewise, sold tomatoes at Kolar, Karnataka, in early May for Rs 300-400 per quintal, down from Rs 1,500-1,600 a year ago. When was the last time we saw all three – potatoes, onions and tomatoes – wholesaling at less than Rs 5/kg, and even retail prices within Rs 20/kg? And this, in peak summer! The above “fire sale” – the evocative term used by the Reserve Bank of India (RBI) in its latest bimonthly monetary policy review statement – has been repeated across a range of other crops too: Garlic and methi (fenugreek) seed prices at Mandsaur – the district in Madhya Pradesh’s Malwa region that’s become synonymous with the ongoing farmer unrest – averaged Rs 3,400 and Rs 3,100-3,200 per quintal in April, whereas these ruled at over Rs 4,100 and Rs 4,700-4,800 respectively during the same time last year. Farmers in Nashik, which has also witnessed large-scale street action, along with the rest of Western Maharashtra, had to dump Sonaka grapes at about Rs 12/kg in March, having sold the same green seedless variety for Rs 45 or so last year.”

I have quoted Damodaran at some length here because it details the damage done to the farmer, who epitomises the informal part of the economy like no one else. While all critics said that the informal economy was hurt the most by DeMo, now we know how that happened.

In late November 2016, the Centre for Monitoring Indian Economy (CMIE) had estimated the loss to the economy and various players at Rs 1.28 lakh crore. Since then we have had more data on GDP losses in the two quarters immediately affected by DeMo. If we assume that at least 0.5 per cent of the GDP drop was due to DeMo, the CMIE loss figure would at least double.

But now we have the unstoppable juggernaut of farm loan waivers: UP (Rs 36,000 crore-plus), Maharashtra (Rs 30,000 crore-plus), and Chhattisgarh (Rs 3,200 crore of interest waivers) have already taken the loss to state exchequers close to Rs 70,000 crore, and we haven’t even begun. Bank of America-Merrill Lynch estimates that the total size of loan waivers could hit Rs 2.57 lakh crore by 2019. They note in a research report: “We grow more confident of our call that farm loan waivers will spread across states after Maharashtra followed Uttar Pradesh in waiving farm loans on Saturday (10 June). This begs the question, how much of farm loans will eventually get waived? $40 billion, or 2 per cent of GDP, in our view, in the run-up to the 2019 general elections. This covers bank loans to farmers with up to five acres of land.”

Even if we assume that only half the waivers are directly due to the DeMo impact, we are talking of a tripling of the figure first put out by CMIE – at the very least, with most costs yet to show up. This means the DeMo damage could be in the region of Rs 3.5-4 lakh crore at the minimum. Since the wildest estimate of gains from black money not coming back to the banking system do not exceed this latest ballpark estimate of loss, it is clear why DeMo has failed its cost-benefits test.

It can also now be clearly said that DeMo was the last straw that broke the farmer’s back, leading to a cascade of farmer protests and political demands for loan waivers. DeMo will damage the fisc like nothing else before this. Two consecutive droughts did not do as much damage as DeMo. All the fiscal prudence shown by the Modi government in the last three years will be washed away now in one huge burst of state government populism.

Here’s a counter-factual: if the UP elections, which happened before farm produce started coming to the markets, had taken place in June and not February-March, would the BJP still have won its big majority? In retrospect, the loan waiver may well have been the political sweetener offered well in advance to prevent farmer worries from boiling over into the ballot box.

So, mea culpa, once again.

The other bits of evidence that support the claim that DeMo did more damage than good are already in the public domain – or assumed to be.

One, the fact that even five-and-a-half months after the demonetisation window for old notes closed on 31 December we don’t know how much money has come back to the system tells its own story. The total value of Rs 500 and Rs 1,000 notes outstanding on 8 November was Rs 15.44 lakh crore. If the deposits have hit this number or even exceeded it, it would mean not only a major embarrassment for the government, but also the RBI. It would imply that fake notes got exchanged for new notes. I had raised this possibility in early December, but didn’t press it when some bankers assured me that they had mechanisms to detect fake notes. But I should have pressed the point: in the rush to clear queues, it is unlikely that cashiers were doing anything more than just count notes. Now that the notes are in, it will be impossible for anyone to link any specific bundle of fake notes with any particular depositor. DeMo may also have validated some fake notes, possibly with the connivance of bankers.

Two, there is not much evidence that tax collections have spiked due to DeMo or even that the tax base in expanding. The poor collections under the Pradhan Mantri Garib Kalyan Yojana indicate that no big disclosure of black money was witnessed, and even if we assume that a large chunk of the deposits made during November and December may have been unaccounted money, the government will have to unleash a tsunami of tax terrorism that will surely be counter-productive. The need of the hour is to bring normality to economic activity. The last thing we need, as we stand on the threshold of the implementation of the goods and services tax (GST), is an unchecked taxman let loose on unwary taxpayers when GST is likely to create its own fiscal chaos and disruption.

Third, it is clear that nationalised banks played a key role in implementing notebandi. But the fall in interest rates following large inflows into the banking system will constitute only a pyrrhic victory unless credit demand picks up – of which there is little sign. While rates can be cut, credit growth is muted. And with loads of bad loans to resolve, banks have had more costs piled onto them due to DeMo. This can hardly be good for them.

Fourth, perhaps the one big gain from DeMo is the still rising trend in digital payments. But this gain in intangible, and benefits will come only over the long term. Moreover, while DeMo made non-cash modes of payment necessary and vital, the popularisation of digital payment modes could have been done even without the disruption of notebandi. DeMo at best provided the government an opportunity to make necessity the normal mode of payment.

Fifth, even the implementation of DeMo could have been better thought out. With hindsight, one can say that the best way to demonetise would have been to limit it to the Rs 1,000 note, and then withdrawing the old Rs 500 notes in stages – by not returning those notes that came back to banks as part of normal cash deposit operations. The disruption was maximised precisely because this two-stage approach was not adopted.

The lessons the Modi government needs to learn from this costly experiment gone wrong are the following:

#1: Don’t rely on economic charlatans and a small group of babus in the Prime Minister’s Office (PMO) and the advisers brought over from Gujarat when taking big decisions like DeMo or even GST. Modi needs to widen the circle of experts in his government, even if he chooses not to finally listen to their advice. This is one redeeming feature of Indira Gandhi, who too had a strong PMO, that Modi could now seek to rectify.

#2: Empower more ministers, and make it a point to regularly listen to your own chief ministers who may have ears closer to the ground than the PMO. Shivraj Singh Chauhan and Vasundhara Raje could well have told Modi what may be a problem with DeMo, but this kind of political feedback loop does not seem to exist in the Modi government.

#3: A white paper on the larger effects of DeMo and the lessons learnt is important. While it may not show the government in good light, it will at least demonstrate that it is learning lessons from the misadventure. To brazen it out – pretending DeMo was not a failure – is the worst thing that can happen to a leader who is clearly one of the best India has produced in a long time.

#4: The damage on loan waivers has been done, but nothing stops Modi from holding a special parliament session and creating a multi-state group of chief ministers to recommend how to fix farming without waivers in future, and also to agree on a code that no politician or state government will henceforth demand a waiver except in exceptional circumstances, and that too on a selective basis.

In the past, Modi has proved he is a good learner from defeat. After Delhi and Bihar, he recovered quickly to win in Assam and UP. But DeMo is his ultimate test. If he learns from this, his next two years may still be his best.

Leadership is most needed when the country is down. Right now, banks, farmers, small and big businesses are all down – though not out. The economy will not recover easily without great economic and political leadership. Modi’s second term depends on him getting the economics right, and not just the politics.

It is great to be thought of as a bold leader who can take tough decisions to break the back of black money. But it is not so great to go about it in a hamhanded way and breaking the back of the Indian economy in the process.

Good politics begins with accepting that DeMo did not work. Hiding the truth can hurt Modi more than acknowledging it – directly or indirectly.