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Was Demonetization Triggered By Sudden Surge In Cash or FICN?

“In his book, Glimpses of Indian Economic Policy: an Insider’s View, Patel writes that when the then finance minister HM Patel told him about the step, he asserted that steps like these rarely have striking results”* IG Patel was the RBI Governor when India underwent demonetization in 1978. Lately high cash in economy and surge in FICN has been put as possible drivers for sudden decision to demonetize the economy in late 2016. Especially, since the original driver ‘Black Money’ seems to have failed (as rightly predicted by IG Patel in 1978 only), it is necessary to see whether there was any sudden surge in either cash density (cash %age of GDP) or FICN (Fake Indian Currency Notes) circulation that could have triggered this decision at top level.

In our first analysis let us see how ‘currency in circulation’ (Re Billion) moved wrt GDP (Re Billion). For this we mapped the data from 1978-79 to 2016-17. The first impression we get is that truly the cash economy has perhaps moved at a faster rate than the GDP. The near exponential growth since 2001-02 is quite evident from the chart. We used GDP at Market price and also rationalized the 2011-12 to 2016-17 GDP data to ensure comparability with previous years as the baseline was changed in 2011-12.

Secondly, let us look specifically at ‘Cash As %age to GDP’ to see whether there was any sudden surge in last couple of years. Truly in FY1516, the %age increased to 11.8% from 11.3% in FY1516. But then if we go back a few years, it had actually peaked at 12.3% in 2009-10 and then gradually has been in decline.  Post demonetization, it was at 8.5% at end of FY1617 but true impact can be judged at end of FY1718.

Thirdly, let us look at FICN history based on what was detected at commercial banks and RBI. For this we look from 2011-12 data. What we observe, is that FICN (by value) as %age of ‘Coins & Notes In Circulation (By Value)’ had actually taken a dip in FY1516. Interestingly post demonetization, FICN detected increased by more than 45% by value and 20% by volume compared to FY1516. This significant increase in detection is probably due to huge cash inflow into banking system due to demonetization.

Also quite understandably, the fake notes are in higher denominations.

To conclude, we see evidences of higher density of cash in FY1516 but not so similar trigger from FICN perspective. Higher presence of cash is also an indication of high prevalence of a informal economy, potential tax avoidance and money laundering. Hence GST, digitalization of transaction, elimination of duplicate PAN, mandatory usage of banking transactions for any high value transaction etc. are right steps to control the revenue leakage for the Government, restrict misuse of money for ulterior motives and strangulate shadow economy.

While all this are surely in right direction, what possibly did not work as desired is Demonetization and neither the compelling needs for it is well understood. May be IG Patel was 2nd time right. Black money is probably more kept in ‘asset format’ (gold, land etc.) rather than cash format so that benefit of appreciation of value is realized and secondly jugaad/ implementation ineffectiveness killed whatever remaining of that black money (in cash) could have been blocked out from the system through demonetization

Source:

*https://www.thequint.com/news/india/rs-500-1000-notes-scrapped-narendra-modi-a-look-back-at-1977-when-notes-were-scrapped-demonetization-black-money-rbi

RBI Annual reports (FY1617, FY1314)

RBI Handbook on Statistics (FY1617)

Featured Image: Taken from an Indian express article http://indianexpress.com/about/fake-indian-currency-notes/

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