Modi@3: Demonetisation Hasn’t Sealed BJP’s Fate, But Raised Stakes
Demonetisation may have worked for BJP electorally, but the real benefits are yet to be seen.
In the midst of rising din of the culture wars, it is easy to forget that the 2014 Lok Sabha elections had a focus on economics that is perhaps unprecedented in our electoral history. One party won absolute majority for the first time in more than three decades, largely on the strength of the message that it can deliver achhe din. The 2019 verdict will turn on the fulfilment of this promise, in reality and perception, more than anything else.
Was Demonetisation BJP’s Brahmastra?
- Though the recent GDP growth estimate of 7 percent is beyond expectations, yet the methodology has been controversial.
- Larger tax base seems to be an obvious benefit of note ban, but at 11.43 percent, it is still below international standards.
- Digital transactions got a boost, but it would be long before India proclaims itself to be a cashless society.
- It’s too early to predict if demonetisation has helped to curb bad loan crisis of banks.
NDA-2 Dashed People’s Expectations
While ordinary voters flocked to the BJP in 2014 expecting results, the party also attracted a section of the intelligentsia who yearned for a different direction in policy, one that relied more on unleashing the power of markets to lift people out of poverty, and less on the redistributive welfare schemes like MGNREGA that are UPA’s legacy. Supporters cheered and opponents feared that Modi’s BJP will be an Indian edition of America’s Republican Party or Britain’s Tories.
Nothing like that happened in the first two years. The government pretty much followed UPA’s script, often under new nomenclature, brought a slew of schemes along with an energy, hype and publicity which the moribund grand old party could never muster.
Murmurs kept arising from some quarters that “big bang reforms” were missing. Arun Shourie, driven in part, no doubt by the pique of being left out in the cold, put it succinctly: this government is just UPA plus a cow.
Big Bang in the form of Demonetisation
The big bang came in year three, in the form of demonetisation, and the sound was heard in every corner of the country.
The funny thing is that this completely unexpected step was not pulled out of the wish list of reforms that was trotted out by the government’s academic and intellectual supporters – change labour laws, take an axe to regulatory hurdles for business, replace leaky in kind welfare benefits by cash transfers, embrace private sector competition to public health and education, heavily disinvest in PSUs, and so on.
Instead, it latched on to an unorthodox idea, apparently borrowed from an obscure think tank in Pune that hails more from the tradition of swadeshi economics than Chicago economics.
Too Early to Call it a Dud
How has demonetisation turned out? There will be a lot of spin based on factoids emerging now and then, but the truth is, just like the French Revolution, it is too early to tell. The discussion is taking place in a near data vacuum, and many of the claimed benefits are supposed to arise in the long-term anyway.
Critics of demonetisation talked about a potentially large contraction in GDP in the short run in response to the liquidity shock. Early GDP growth estimate of 7 percent for the December quarter has surpassed even the more optimistic predictions.
Several points need to be kept in mind: the new GDP series calculated since 2014, based on a new methodology, has been controversial, revised estimates that will be available later, based on more data, may yet paint a different picture, and the statistical machinery of national income accounts are ill-equipped to measure output in the informal sector, which was hit hardest by demonetisation.
But it is possible that practices like trust credit allowed economic activity to continue and absorbed the shock better than most people thought possible.
No Evidence of Benefits of ‘Notebandi’
While the government and its supporters may feel vindicated that the economic cost looks low by early estimates, there is not yet any solid evidence of large benefits. In fact, the government’s message regarding what gains it expects and why, has been quite fuzzy.
The most obvious benefit to be expected is an expanded tax base and a bump to the tax-GDP ratio of 17 percent, which is quite low by international standards. A recent news item that 9.1 million new income tax filings have happened in the current fiscal year has, of course, been grist for the mill.
What ultimately matters, though, is not the number of tax filers, but how much extra revenue comes in, and what part of it will ‘stick’ in the long run. In the post-demonetisation budget presented in February, the government’s own estimate of revenue growth is a modest 12 percent in nominal terms. If it expects a real bonanza, then it is holding its cards close to its chest.
Reasons for substantially greater tax compliance are hard to find. According to RBI’s latest figures, the currency in circulation is back to nearly Rs 15 lakh crore, which is not too far below the Rs 18 lakh crore that existed on the eve of demonetisation.
Perhaps there could be a healthy one-time windfall? The government reported that a third of the returned cash came in deposits of Rs 80 lakh or more, but how much of this can be assessed as taxable is anybody’s guess. The only plausible argument is that demonetisation sent a strong signal that the government is serious about cracking down on black money, which will straighten out many wrongdoers. That is speculative and the jury is very much out.
The other oft-claimed benefit is that demonetisation mobilised savings lying under the mattress and has recapitalised banks that were reeling under pressure of the NPA problem. Since a lot of the deposits was money people ordinarily needed for cash transactions, much of it won’t stick once the dust settles. We don’t have reliable estimates yet how much bank deposits have grown.
At any rate, the primary purpose of financial inclusion, to my mind, is not so much to mobilise small savings as to create small loans and insurance for the poor at affordable rates.
Commercial banks serve businesses and the middle class with their deposits. The informal moneylenders and microfinance organisations who serve the poor were badly crippled by demonetisation and may at best be hobbling back into shape. Credit and insurance benefits to Jan Dhan Yojana account holders has been modest so far.
There is still considerable debating room about the ultimate effects of demonetisation, but whatever they are, the government will make a serious mistake to think it can serve as a miracle pill. From a dip in UPA’s already sluggish job creation rate to the severe NPA problem in banks that has crippled credit growth and private investment for several quarters, there are plenty of storm clouds on the horizon.
Recent election results show that the voters have suffered the pains of demonetisation with surprising equanimity. But this almost certainly has to do with increased rather than fulfilled expectations. Demonetisation hasn’t sealed the game for BJP. It has only raised the stakes.
(The writer is Associate Professor, Delhi School of Economics. He can be reached @prkghosh. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)
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