On 8 November 2016, Prime Minister Narendra Modi announced that higher denomination currency notes of Rs 500 and Rs 1,000 would be recalled. The aim of this sudden policy shock, we were told, was to curb money laundering. Subsequently, the goal posts of demonetisation kept shifting—from curbing black money to that of transitioning India into a cashless economy—and continues to shift even today, two years after the event. And now finance minister Arun Jaitley has told us that the policy shock was introduced with an aim of formalising the economy.
A better route to formalise the economy would have been to widen the ambit of the labour laws so as to include more workers under its purview.
If the intention was to formalise the economy, demonetisation should have been the least preferred route, given the colossal hardships faced by the poor, the old, and the small entrepreneurs of India—the 'informal' self-employed Indians. This is in addition to the more than 100 lives believed to have been lost as an effect of demonetisation.
A better route to formalise the economy would have been to widen the ambit of the labour laws so as to include more workers under its purview. For instance, the government could begin by recognising the contributions of domestic workers as 'work'. In addition, more 'formal' jobs ought to be created. Both these measures have positive multiplier effects on the economy, rather than the negative multiplier effects occasioned by the demonetisation route. Indeed, structural problems require structural solutions; and perhaps this is why two years after demonetisation, currency is an even more significant part of household savings.
Who was hit by demonetisation?
Small households and consequently the labour-intensive sectors have been the most affected. The agricultural sector, which provides most Indians with employment, has been adversely hit. In fact, the rural farm sector has been doubly hit because agricultural prices have fallen relative to non-agricultural prices in addition to losing employment and income.
Such negative shocks get transmitted across the economy in a multiplicative manner. This is because of the structural interdependence present in the economy—both the manufacturing and services sectors depend on agriculture both directly and indirectly (the dependence of the service sector on agriculture is more indirect—via the food consumption of those employed in this sector).
The loss of employment, besides the quantifiable effects on income and consumption, also causes severe psychological distress, which is very difficult to quantify
On the basis of the regular household surveys conducted by the Centre for Monitoring Indian Economy (CMIE), we know that India faced losses in employment: about 1.5 million jobs were lost in the first four months of 2017. From a macro perspective, it is perhaps easy to classify this as a short-term shock to the economy. Moreover, sectoral losses need not show up in aggregate measures like the Gross Domestic Product (GDP); for instance, if the extent of positive growth of service sector is greater than the negative growth of the agricultural sector, GDP will still show a positive growth rate.
The loss of employment, besides the quantifiable effects on income and consumption, also causes severe psychological distress, which is very difficult to quantify, and more so because the pains from demonetisation were rationalised as a necessary evil for a greater good.
Short-term shocks often have long-term consequences, or in economics parlance, this is captured by the concept of hysteresis. Our policymakers must take cognisance of this very important economic fact. For an economy, loss in employment implies that the potential of the economy is reduced, and hence its actual growth in the subsequent periods. As noted already, the farm sector and small entrepreneurs have been adversely affected by demonetisation. Without doubt, the potential of these sectors have been reduced. According to data published by the World Bank based on ILO estimates, 79% of total employment in India consisted of the self-employed as of 2017. Thus, the biggest losers from demonetisation are the small entrepreneurs (or self-employed workers) and those working in agriculture.
Fintech companies benefited from the note ban
Which class or sector has benefited the most from demonetisation? In the move to 'digitise' and 'formalise' the economy, the largest beneficiaries of this policy shock has been the fintech companies, of which Paytm is perhaps the most well-known. To put it differently, the largest beneficiaries of demonetisation appear to be this new class of entrepreneurs who are able to bundle 'finance' and 'technology'—thus the name fintech.
According to the recently published RBI Annual Report 2017-18, as a percentage of total retail payments, the use of electronic clearing has decreased to 28.7% in 2017-18 from 46% in 2015-16. Over the same two-year period, the percentage of prepaid payment instruments increased to 0.5% from 0.3%. To get a closer picture, let us look at the use of prepaid instruments (mainly supplied by the fintech companies) as a percentage of total card payments in terms of both value and volume; in terms of value, it now stands at 13.34% as opposed to 10.89% in 2015-16 and in terms of volume, it now stands at 42.14% as opposed to 27.63% two years ago. The fintech sector has been a direct beneficiary of demonetisation.
In fact, the Forbes profile of Vijay Shekhar Sharma, the founder of Paytm, states that he has been 'one of the biggest beneficiaries of India's demonetisation'. Sharma, in 2017, ranked 99 in Forbes list of Indian billionaires. In 2018, riding on the rise of prepaid money, he rose up the ranks to 74. A well-thought-out regulatory framework is urgently needed for prepaid money.
The biggest losers and gainers occupy the opposite ends of India's highly unequal income distribution. Thus, demonetisation has resulted in the socialisation of costs by the poor and the privatisation of benefits by the few.
The author is Assistant Professor of Economics at the School of Liberal Studies, Azim Premji University. This is a revised version of his presentation as part of a panel discussion on demonetisation organised by the Bengaluru Collective on 8 November 2018. The author thanks Anjana Thampi for her useful inputs.