A feature of these times is what has been called the “war on cash” It’s proponents argue for it on two main grounds. The first is that cash and in particular large denomination banks notes are used by criminals (especially by organised crime) and terrorists and so eliminating such notes would be part of the various wars against them. Others make the case that we may need to cut interest-rates even further when the next recession arrives which means that even more countries will experience negative interest-rates and that they will go even more negative for those that already have them. Cash is a barrier to this because it provides 0%. Who would have thought that 0% would be attractive? It is of course as Prince would say A Sign O’ The Times.
Of course interest-rates were supposed to go up in a recovery but Michael Saunders of the Bank of England has opened more than one can of worms with this in his speech this morning.
It is fully 10 years since the MPC last tightened monetary policy
If we go back to early November last year this happened.
Government of India vide their Notification no. 2652 dated November 8, 2016 have withdrawn the Legal Tender status of ` 500 and ` 1,000 denominations of banknotes of the Mahatma Gandhi Series issued by the Reserve Bank of India till November 8, 2016.
What was called Demonetisation was publicised as an effort to cut corruption. crime and also terrorism and there was a day to consider it as November 9th was a bank holiday. Also as I pointed out on November 11th it was suggested that it would provide an economic boost.
I hope that they have success in that and also that the official claims of a 1.5% increase in GDP as a result turn out to be true.
There were official claims that around 3 lakh crore or 20% of the currency would not come back and therefore a significant cost would be imposed on the criminal and terrorist worlds.Actually I note that the Financial Times is reporting that there were even more inflated claims.
At the time, government officials had suggested that as much as one-third of India’s outstanding currency would be purged from the economy — as the wealthy abandoned or destroyed it, rather than admit to their hoardings — reducing central bank liabilities and creating a government windfall.
Not everyone was convinced that it would be that easy including The Times of India.
Firstly, gone are the days when people hoarded wealth in gunny bags full of banknotes. In today’s world, there are refined ways of laundering money or stashing it away in benami properties, offshore bank accounts and foreign currency. Only the small fish keep their ill-gotten wealth in currency and the impact on black money will therefore be very limited in this exercise.
What happened next?
As I pointed out on the 26th of November the initial economic effects were negative and some of them were quite strong.
The automobile industry, which accounts for 7.1% of the GDP, is witnessing a fall in stock prices of up to 12% since the demonetisation. Himanshu Sharma, auto analyst at Centrum Broking, said two-wheeler sales can get affected by 40- 45%. The impact on cars is less, since most of them are bought on loan, but it could still be 10-12%……..Things aren’t any better with pharmaceutical companies, as sales of medicines have plunged almost 15%.
If we move to overall economic output we see that it in fact slowed. The annual rate of economic growth fell to 6.1% in the first quarter of this year so we can say that it showed no signs of the economic boost promised. As to how much demonetisation contributed to the fall we can say that there were downward effects but as ever it is hard to be precise.
What happened to the cash?
Yesterday the Reserve Bank of India gave its annual report and here is The Times of India on the subject.
The Reserve Bank of India (RBI) on Wednesday said that Rs 15.28 lakh crore –or 99% of the Rs 15.44 lakh crore demonetised by withdrawal of Rs 500 and Rs 1000 notes on November 8, 2016 –has been deposited with banks.
So the promises and suggestions of a large windfall gain for the government via the central bank have turned out not to be true. Seignorage is usually a theoretical number but in this instance it became reality except as we looked at above it was expected to be much more than this. Also according to the RBI there were costs in doing this.
Expenditure on Security Printing and Distribution
VIII.12 The total expenditure incurred on security printing stood at `79.65 billion for the current year (July 2016 – June 2017) as against `34.2 billion
More fake notes were uncovered than usual ( 345% up on the previous year) but considering what was taking place the number remained low especially if the rumours about how many fake bank notes there are in India have any basis in fact. As some of the returned bank notes have not been counted yet could we see the number of notes climb to say 101%?
According to The Times of India the official response is as follows.
The finance ministry said the five main objects of demonetisation were: -Flushing out black money -Eliminating fake currency – Ending financing of terrorism and left-wing extremism – Converting the non-formal economy into a formal economy to expand the tax base and employment — Giving a big boost to digitisation of payments to make India a less cash economy
Well I suppose the last bit is probably true but this bit is pretty woeful if we note the government’s previous rhetoric.
The finance ministry said in a statement that the government had in fact expected the bulk of the cash to be returned to become effectively usable currency.
Although no doubt you can define “bulk” in a variety of ways.
Let me completely support efforts to reduce organised crime and terrorism with the only caveat being that care is needed how you define that. After all an area pretty much ignored by Demonetisation is that a clear example of what many would consider organised crime in recent times has involved the banks. For obvious reasons it is hard to get accurate estimates but it seems likely that “banking crime” exceeds “cash crime”.
Returning to the Indian experience there were clear stoppages in the economy and I speculated on the 11th of November last year on who it would hit the most.
I remember watching the excellent BBC 4 documentaries on the Indian railway system and the ( often poor) black market sellers on the trains saw arrest as simply a cost of business. Will this be the same? Also there is the issue of whether it will all just start up again with the new 2000 Rupee notes.
Also let us remind ourselves that India now has more 2000 Rupee notes which surely will only make the stated objectives harder to achieve. The timeline we now know also perhaps provides insight into the resignation of the previous RBI Governor Raghuram Rajan..
On the other side of the balance sheet then if this claim from the Finance Ministry is true maybe there will be a gain going forwards.
Advance collections of personal income tax showed a growth of 41.79% on August 5 over the corresponding year-earlier period. Personal income tax under self-assessment grew 34.25%.
Having mentioned the Indian railways it reminds me of the impact the Monsoon season has on the ( Monsoon Railway if you have not seen it) and that it has been severe this year. My sympathies to those affected.
Me on Core Finance TV