Demonetisation Punished Those Who Didn’t Do Any Wrong: An Interview with Arun Kumar

Courtesy Arun Kumar
13 November, 2017

On 8 November 2016, in an unexpected late-evening message on television, Prime Minister Narendra Modi announced the government’s decision to pull notes of theRs1,000 and Rs 500 denominations from circulation. The aim of this demonetisation, he said, was to “fight against corruption, black money, fake notes and terrorism.” Arun Kumar, an eminent economist who formerly taught at the Centre for Economic Studies and Planning at Jawaharlal Nehru University, has been amongst the strongest critics of the move. Kumar noted that the move would not tackle the issue of black money, as it does not impede the generation of black income. On 10 November, Kedar Nagarajan, a web reporter at The Caravan, met the economist to discuss the outcomes of the policy decision. Kumar discussed the scheme’s impact on economic growth, employment and on the shift towards a cashless economy.

Kedar Nagarajan: What has been the broad impact of demonetisation on the economy?

Arun Kumar: It has not fulfilled the three promises it was supposed to have, which were to tackle the black economy, counterfeit currency and terrorism. None of those have been affected because, as I have said, the black economy comprises two parts: black income and black wealth.

In the case of black wealth, there’s a portfolio of assets, and cash is less than 1 percent of the portfolio of assets. It could not tackle even 1 percent of the black wealth because nearly 99 percent of the cash has come back [according to the Reserve Bank of India’s annual report]. As far as black income is concerned, demonetisation is not designed to tackle the process by which black income is generated. In other words, the black economy has not been impacted by demonetisation.

Its main impact has been on the white economy, which consists of the organised and the unorganised sector. The organised sector can work with credit cards, debit cards and mobile transfers, but the unorganised sector relies entirely on cash. We must realise that cash is not something that we consume, but it is what we use to ensure the circulation of incomes. When transactions do not take place, incomes stop. It is the unorganised sector—which is 45 percent of the GDP and [along with the self-employed sector] 93 percent of the country’s workforce—that was impacted negatively. This also impacts the organised sector. The discretionary demand in the organised sector got postponed. The impact of this was that the capacity utilisation [the extent to which an economy employs its productive capacity] in the organised sector went down. When that happens, investment declines as well. This has a long-term impact. What was marketed as a short-term inconvenience actually has a long-term impact due to the decline in demand, decline in investment and decline in the growth rate. It got converted into a recessionary type phase. Because the demand fell, especially in the unorganised sector, this fall in demand meant capacity utilisation went down. RBI data shows that capacity utilisation has been hovering between 70–75 percent, which is very low. Investment declined, and that leads to a long-term slowdown in growth, because investment is what propels growth. Employment went down, that’s why demand went down.

This was supported by the fact that credit offtake [or credit growth] from banks was at an all-time low. In the month of August this year, it became negative, which has never happened before. The government data does not show this decline because they do not regularly collect data from the unorganised sector, except once every three years. Therefore, in the interim it is assumed that the unorganised sector is growing at the same rate as the organised sector.

That was true till 7 November last year, but after that the unorganised sector collapsed. All the surveys at that point of time show that the organised sector was hit between 50–80 percent. The Punjab, Haryana, Delhi Chamber of Commerce and Industry, All India Manufacturers Organisation, State Bank of India—all of their surveys showed a big hit[on the unorganised sector]. Employment went down in the unorganised sector as a result and impacted the rural economy severely, and that explains why the demand for [jobs under] MNREGA [Mahatma Gandhi Natural Rural Employment Guarantee Act] shot up. All this suggests, that when the unorganised sector was hit, the rate of growth fell 15 percent, and didn’t increase 6–7 percent. For the year as a whole the growth went down to 1 percent. This is what we are facing: a loss of about 7-percent growth in the economy, which means about Rs 10.5 lakh crore output in a Rs 150 lakh crore economy. This does not even take into account the numerous social inconveniences that the policy caused.

KN: In “Demonetisation: Exorcising the Demon,” a recently released report, you write that there needs to be gradual progress to a cashless economy. Do you think that demonetisation was a catalyst for that shift?

AK: No, there was anyway a move towards a cashless economy. Now, the government has shifted the goal posts and said that demonetisation has accelerated this. Of course, for a time it did do that, because people began to use Paytm and Bhim because they did not have cash. But, as soon as cash began to return, people began to revert to cash. Using less cash is a matter of habit. Financial literacy is not currently high enough to expect that demonetisation in and of itself will make this transition [to cashless economy]. Finally, the infrastructure itself is not enough. You require point-of-sale machines everywhere—India has among the lowest [number of] point-of-sale machines compared to the size of the population, and this is true of ATMs as well. You also require reliable cyber security and regulation. All these companies that make electronic transfers possible, need to be regulated for the amount they charge, otherwise they will run away with making higher charges indiscriminately. If you want to promote a cashless economy, then you should not charge so much for the use of ATMs, because if you do that, people will revert back to cash. This is a process that is independent of demonetisation for which an economy needs to prepare.

KN: Was there and will there be any impact on election expenditure as a result of demonetisation?

AK: Election expenditure and campaign financing is not linked with demonetisation. People think that a lot of black money is used in elections, but my own estimates from the 1998 elections and the elections after say that 0.1 percent of the GDP is being used on elections. One of the conspiracy theories [regarding demonetisation] was that this was done to prevent the opposition from using black money in the Uttar Pradesh elections, but I do not think that that happened. They had a great number of rallies and they continued they spent as they were spending. Even when cash is short, you can convert assets into new cash.

KN: Did demonetisation impact the number of taxpayers in the country?

AK: The government says that there were 91 lakh new tax-filers [during the financial year 2016–17] and that 18 lakh people were to be issued notices [from the Income Tax department, to clarify large cash deposits after demonetisation]. Now the question is how many of them are going to declare significant income from the 91 lakh and how many from the 18 lakh are going to be caught for their black income?

The bulk of the cash that is there in the economy is with businesses and not with households. Businesses need this cash for their activities. Suppose there is a petrol pump that collects Rs 20 lakh a day and they deposit that amount every day, then in 50 days they have deposited Rs 10 crore. Similarly, there will be travel agents and telephone companies depositing high sums. Depositing high sums does not mean that the money is black—you have to prove that the source is black. The income-tax department will have to investigate such people and that is a time consuming process, because it is not going to happen automatically. Suppose there is a person from the real-estate sector, now they have been suffering losses for four to five years now, so they would have recorded deposited sums in their books as cash in hand. Therefore, they would legitimise this cash.

Very often what happens is that large number of people who file returns, many do not declare very large incomes. Data is there for 2012–13: out of the 52 million people in the tax net, only 17 million people paid effective taxes. The rest either declared very low incomes and paid zero tax, or they paid less than Rs 20,000 tax. There is evidence in the economic survey [of 2016–17] that suggests that after demonetisation, those who filed returns only declared Rs 10,000 crore of income on which they only collected Rs 3000 crore of taxes. Now compared to a total direct tax collection of Rs 7.5 lakh crore, this is 0.003 percent. Other evidence is that, if these people were declaring a lot of income and filing taxes, then our fiscal deficit would not have shot up to 91 percent by the month of August.

KN: In the same report, you mentioned the possibility that demonetisation could have allowed for windfall gain—the coming back of all the income into the banks. Could you elaborate?

AK: It was expected that Rs 3-4 lakh crore may not come back, that’s what the attorney general said in the Supreme Court when the case came up in November. Then they thought that that Rs 3.4 lakh crore would be a windfall for the RBI, which would be passed on to the budget. But now that 99 percent of the currency has come back, that windfall is not going to come. They [referring to the government] have turned the situation around by saying that now that the money has come back, we’ll be able to track people that have deposited money. But as I said, even though 18 lakh notes have been issued, how much of [the amount in question] would be black or white—that would be very difficult to prove. Businesses have a large number of ways of hiding funds. The problem is this policy impacted a large number of people who never generated black [income], and they couldn’t catch the people who did generate black [income]. It’s sort of punishing those who didn’t do any wrong.

KN: You have noted in the past that the black economy is the result of a triad—the corrupt politician, the corrupt businessman and the corrupt executive.

AK: If the black economy is 62 percent of the GDP—which is my latest estimate—it means that illegalities are there in 62 percent of economic activites. How can 62 percent of economic activities have illegalities unless it’s very systematic? It’s not anecdotal that one day I do [something illegal], the next day I don’t do it, or one month I do it and the next month I don’t.

How can illegalities become systematic? When the instrumentality of the state is a party to it—that is, the policy maker and the executive, where the executive consists of the bureaucracy, the police and the judiciary. The triad of the corrupt businessman, political class and executive where the executive consists of these three—it is this triad that runs the black economy. If one of the wings [of the triad] say that we don’t want the black economy—suppose the politician says I’m not going to take bribes, I want rules implemented—then it won’t survive. If the executive says the same, it won’t survive. If the businessman says that we are not going to bribe anymore, then also it won’t survive. In other words, it becomes a political issue, about how our politics will be able to tackle this triad.

KN: How long, by your estimates, is the impact of demonetisation on the economy likely to last?

AK: It all depends on how soon demand is revived. If demand is not revived in the unorganised sector, then we will continue to face this problem. You need to generate employment in the unorganised sector on a large scale. It won’t work if you only spend on the organised sector. The government is trying to recapitalise banks to lend, but they largely lend to the organised sector, and this sector has been facing a jobless growth because they don’t generate jobs because of the high technology they use. So take, for instance, that they are spending more on roads or railways—now a bullet-train project or the road project uses modern machinery. Earlier such a project would’ve had 100 people working, now you see 10 people working. Given the automation in projects like this, those are not going to generate large number of jobs. To generate large number of jobs, you have to spend a lot of money on things where employment is really the focus, like education, health, and rural infrastructure. And if you spend on rural infrastructure—jobs in the unorganised sector will go up, the purchasing power in rural areas will go up.

As newspaper reports recently showed, that production units are still closed down especially in the unorganised sector, and that revival has still not taken place. Then there was the double whammy of the GST. Unless we revive the unorganised sector, until then we will not be able to overcome the recession taking place in the economy.

KN: Do you think the move indicated a commitment to tackling the black economy?

AK: No. In this step, it was thought—and this was a mistake—that “black” [money] means cash. The government thought that the move would be a politically wise step because they would get Rs 3–4 lakh crore of surplus, and that could be distributed among the people. What you get is a Robin Hood image—I have taken from the bad guys and given to the poor people. The attempt was entirely to create this image, and the public believed it.

This interview has been edited and condensed.