THE GIST of Editorial for UPSC Exams : 4 September 2018 (What the RBI data on demonetization tells us)

What the RBI data on demonetization tells us

Mains Paper: 3 | Economic Development
Prelims level: Demonetisation
Mains level: What are the RBI data tell us about demonetisation?

Introduction

• The Reserve Bank of India’s (RBI’s) annual report confirmed that ₹15.3 trillion of the demonetized currency in November 2016, i.e. 99.3%, is back in the banking system.
• What does it mean when only ₹107 billion, or 0.7% worth of the old notes, were not returned?

What tell us RBI data

•   A significant share of the old notes were held by tax evaders and criminals who, in the interest of avoiding legal scrutiny, would eat their losses and not exchange their currency for the new notes in circulation.
•   The RBI would reduce its liabilities because of the unreturned notes and the Indian government would receive a revenue windfall.
•   This one-time dividend to all Indians would be paid for by participants in the underground economy, who would be effectively taxed at a 100% rate on their illicit wealth.
•   In November 2016, experts and government officials made wildly optimistic predictions that 10-30% of the notes would remain unreturned.
•   That 99.3% of the currency came back could mean one of three things.
•   First, while there really was 10-40% black money in the economy, tax evaders and criminals never held this wealth in cash holdings;

Looking for the other indicators

•   They were adept at laundering before demonetization through shell companies, tax havens abroad, and Swiss bank accounts.
•   As they never held black money in cash, there was no problem in returning their old notes to the RBI through deposits.
•   The other possibility is that Indians did hold large amount of black money in cash, but they are so adept at reacting to draconian state policies that in a mere 60 days.
•   They displayed extraordinary entrepreneurship and managed to launder their money and deposit it in banks.
•   This could have been done through shell companies, foreign accounts, deposits in Jan Dhan accounts, sending the money to Nepal to launder and return to India, or paying temple trusts/cooperative banks/political parties/middlemen a small premium to launder the money.
•   A third, highly unlikely, scenario is that there really isn’t much black money in India, in cash or even otherwise, and the law-abiding, punctual citizens returned the old notes in time.
•   While this makes Indians flexible and adaptable, and helps them grow and prosper in a hostile environment,
•   It also means that unless rules are very well designed and enforced, very few policy measures will have the intended outcome.
•   There is so little trust in the state among Indians and there is so much adeptness at bypassing state enforcement that even well-designed schemes are hard to execute and demonetization was a highly flawed idea to begin with.
•   Everyone is aware of and has borne the enormous costs imposed by demonetization.
•   However, there is another long-term effect one needs to think about—some of the new tricks Indians learnt to launder money as a result of demonetization.

Way forward

•   A huge cost borne because of the way India functions is that this kind of unproductive entrepreneurship, which spends so much resource in simply circumventing the state, could have been used productively to unleash more innovation and growth.
•   The entrepreneurial talent is unfortunately trapped navigating regulatory roadblocks.
•   This unproductive entrepreneurship has helped India survive demonetization and also shackled growth.