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Explained: Has demonetisation worked?

Last updated on: January 05, 2017 22:31 IST

People queue up for money outside a bank

Prithviraj Hegde explains the first results of the demonetisation exercise in layman terms.

So we have the first clear indicator of what demonetisation has achieved.

According to reports, not confirmed by any official authority (why are we not surprised!), 94% of the demonetised currency has returned to the banks. (Rs 14.5 lakh crore out of 15.44 lakh crore that was in circulation before November 8).

Other reports (external link) say 97% or Rs 14.97 lakh crore of the money has returned to the banks.

The government's windfall then is a meagre 3% to 6% (depending on which report you believe). Not the 20% to 30% that was expected at the beginning of the exercise, that brought so much pain to 1.25 billion people across the country.

So has the demonetisation move failed?

There will be no quick answers. The success/failure of the exercise may take anything from a few months to a couple of years to unravel.

Why is 94% money returning to the banks not a surprise?

Let's try and answer this with a hypothetical situation.

Suppose I had, say, Rs 10 crore (Rs 100 million) of unaccounted money (in demonetised notes) as on November 8.

I would have panicked and scrambled for ways to get my money into the banks and probably even thought of forgoing a part of the money or paying tax plus 200% penalty on it (as was first announced).

But then the bumbling government kept changing the rules of the game on an almost daily basis.

It finally gave me an option to pay 50% tax on the unaccounted money (provided it is from a legitimate business and not from drugs/smuggling/terror etc).

The government would keep 25% interest free for four years. And I would have 25% of my money in white.

So from my original Rs 10 crore, I would get Rs 5 crore in white finally.

Then why on earth would I not return my money to the banks?

Are the banned notes that have returned to banks now white money?

No.

There are many, like the guy in the example above, that will declare that the money they have deposited in the banks is unaccounted for and pay the 50% tax and keep 25% in the Pradhan Mantri Garib Kalyan Yogana interest free for four years.

For us to know how much tax will be paid on the money returned to the banks will take many months or even years. And a humongous exercise for the tax officials (which is another story).

And with the government and the Reserve Bank of India cagey about giving us proper figures, it may take even longer for us to pry the information out of them.

Then there are guys who will brazen it out and not voluntarily declare their unaccounted money.

If caught, they will have to pay 85% taxes plus penalties. Details here.

But catching them will take some doing and also take time and money.

So has the demonetisation exercise worked, or no?

Like we said earlier, there are going to be no quick answers. But there are some straws in the wind that we can clutch for now.

  • There is not going to be a quick Rs 2 lakh crore to Rs 3.5 lakh crore windfall for the government (as some experts estimated).
  • The cost of demonetisation to the economy was estimated at Rs 1.28 lakh crore by the Centre for Monitoring the Indian Economy.
  • The government has already made about Rs 43,000 crore to Rs 90,000 crore, because that money did not return to the banking system.
  • Between Rs 14.5 lakh crore and Rs 14.97 lakh crore has returned to the banking system. So every single rupee in that has left a trail that can be picked up. There is basically no unaccounted money any longer.
  • Let's believe the experts for once and agree that 25% of the money pre-demonetisation was black. Between 3% and 6% of it has not returned to the system. So we can assume that 20% of the black money is now in the banks. That's about Rs 3 lakh crore (20% of nearly Rs 15 lakh crore that has returned). Even if the tax authorities manage to track all of that (a difficult if not impossible task), they can hope to gain a maximum of Rs 1.5 lakh crore. Plus some interest accrual to the PMGKY.
  • So the maximum the government can hope to gain from our 50-day pain is about Rs 1.9 lakh crore to Rs 2.4 lakh crore. (I am rounding off and simplifying the calculations).
  • Realistically, I think the figure will be closer to Rs 1 lakh crore to Rs 1.5 lakh crore. (My gut that is, no number-crunching here).
  • Fake currency has been wiped out, for now. Terror funding has stopped, for now. But both will resume once the banned currency notes are replaced and banks ease withdrawal norms. It's just a one time reset.

So is there anything to smile about now?

Sure there is!

After 50 days of scrambling for money and getting used to standing in lines again, the rush at banks and ATM is thinning out and people have started getting cash in their wallets.

And since the banks are flush with money, they have slashed interest rates on home, cars and personal loans.

If nothing, the drop in your EMIs is something to make your flash those your pearly whites :).

Prithviraj Hegde / Rediff.com