India’s Demonetisation Experiment: Lessons for future policies

Article by, Sibin Sabu – MACE 2010-14 (Mechanical)
Demonetisation will go down as a landmark decision in the history of independent India and serve as a useful guide to countries across the globe in their monetary experiments to counter black money.
In this article, I raise a few questions pertinent to the policy discourse in India.

Stakeholder involvement

Unlike GST, the inputs of several relevant stakeholders were not solicited in demonetization’s policy design. Most legislators were not privy to this decision until moments before the announcement – understandably so, because the move would fail if any of them were in possession of black money or leaked the news to those possessing it. Even when the Cabinet was informed about the decision moments before making the announcement public, its members were not allowed to carry their mobile phone to the meeting. The intent was to ensure utmost secrecy so that the corrupt could be caught off-guard.

The very fact that the inputs of those elected to represent the public could not be solicited due to concerns of ‘trust’, should perturb us – yet, strangely it does not.

A friend remarked that when elected representatives take office and secrecy but are yet not involved in decision making, it seems to be an acknowledgment of their lack of integrity. It is even more disturbing that there was hardly any dissent from those kept out of the loop that they should have been consulted in the decision-making process – because it gives the impression that they acknowledge concerns over corruption to be real.

It is necessary to take measures to address concerns over the integrity of those elected to power so that their involvement in critical policy decisions not be affected. Greater stakeholder involvement would have helped the government to be better prepared for consequences of demonetization while also identifying and preventing ways in which black money could be converted to white money. Perhaps, the government may even have decided not to implement demonetization and would have looked at other alternatives. ‘DeMon’ will go down as a reminder of how effective a policy could have been, had relevant stakeholders been engaged.

Reward intent or outcome

Once the decision was taken, it seems reasonable that the government would have kept track of it to see if it yielded intended benefits. Some reports suggest that RBI was aware at least by April that 98.8% of the demonetized notes had returned to the system. But, an announcement in this regard was not made public until August.

If the central government had to admit that much of the withdrawn currency had returned to the system sooner, it may not have been able to capitalize on the perceived gains of the demonetization policy in elections in states like Uttar Pradesh. The intent of the policy is likely to have played a role in helping the ruling party win elections conducted immediately after demonetization.

At present, there seems to be a blind faith in the effectiveness of policies made with good intent. Once a policy gets through the intent filter and persuades us on its potential benefits, we presume that the intended benefits materialize and do not place enough emphasis on measuring the actual outcome. Our systems and culture seem to assess and reward the intent of a policy more than its outcome.

Consequently, there is little focus on gathering data to gauge whether policies created with good intent such as caste and gender-based reservation or rail travel subsidy are effective as envisioned. This is evident from the lack of emphasis on a sound evaluation mechanism which provides room for policymakers to get away with poorly designed policies.

It enables policymakers to carry out any experiment by advertising its intent and claim success even in the absence of a good outcome. Some critics argue that demonetization was intended for political gains and not for any economic benefit as it would enable the ruling government to shed the criticism of being ‘suit boot ki sarkar’. This argument gains some credibility as the government decided to overrule the RBI’s concern that the costs could be higher compared to the benefits.

A systematic and structured approach to policy design with emphasis on the outcome can prevent such exploitation. It is important that policy evaluation is given as much importance as policy formulation. A shift in this mindset can enable a change to outcome-oriented policies.

A grave miscalculation

The initially stated objectives of demonetization were modified to stay in sync with any positive consequences – intended or unintended – reported to arise from it. As per the initial proclamation by the Prime Minister, its intent was to curb black money and terrorism financing. It later metamorphosed into increasing digitization, formalization and widening of tax base.

Raghuram Rajan believes that the loss to the GDP on account of demonetization is approaching Rs.2.5 lakh crore. He also feels that the decision may have resulted in a situation where the government ends up paying interest to those who deposited black money back into the banks. He estimates that the RBI will be paying them around Rs.24,000 Cr each year as interest. Reports suggest that the cost of printing new currency costs was around Rs.15,000 Cr. Thus, the total short-term costs to our economy might be around Rs.3 lakh crore.

Interestingly, the government had anticipated that at least Rs.3 lakh crore of black money would not return to the system so that the incurred costs could be offset. But, it turned out to be a gross miscalculation and just about 0.16 lakh crore is yet to return. The government probably overestimated its capability to prevent black money being pumped back into the system and (or) underestimated the ability of the corrupt in putting their dodgy cash back into the system. This could have been avoided had inputs of more stakeholders was collected.

These figures seem to indicate that demonetization has probably failed as far as countering black money is concerned while also contributing to derailing the Indian economy. However, it might still result in net positive gain due to (unintended) long-term benefits in formalization and digitization of the economy.

Would other measures succeed?

It must also be worrying that even the strongest measure by the government to tackle black money seems to have become futile. If the ingenious minds found a way to counter demonetization, they may as well be able to circumvent other policies adopted to tackle black money.

While it is clear that concerns over the corruption of elected representatives a pivotal root-cause for some of the disastrous consequences of demonetization, no measure seems to have been adopted to change the status-quo. It is important to examine how legislators stand to benefit if they help those holding black money. Initiatives to ensure transparency in election financing and stringent monitoring of wealth accumulated by those in power are few steps that can be taken in this direction.

Nonetheless, the move could be considered as a strong signal by the government that it will not tolerate black money and that it is willing to take strong measures against it. This perception, coupled with stringent law enforcement and greater involvement of stakeholders could help the government successfully combat the menace of black money.


Sabu | Founding member, McGrath Centre for Policy Research, XLRI Jamshedpur

This article originally appeared in the Quint. A version of this article had been published in The Huffington Post and Qrius

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