Demonetisation Review: More Currency Does Not Mean More Corruption

2 years since note ban, here’s what the numbers state.

The second anniversary of demonetisation is upon us. The best analysis of events like demonetisation happens in the years to come. By that time there is more data available.

There is also a clear distance from the event at hand to do a more dispassionate analysis on whether what was supposed to be achieved has been achieved or not.

In the press release dated 8 November 2016, and accompanying the decision to demonetise high denomination notes of Rs 500 and Rs 1,000, it was stated: “Use of high denomination notes for storage of unaccounted wealth has been evident from cash recoveries made by law enforcement agencies from time to time. High denomination notes are known to facilitate generation of black money. In this connection, it may be noted that while the total number of bank notes in circulation rose by 40% between 2011 and 2016, the increase in number of notes of Rs 500/- denomination was 76% and for Rs 1,000/- denomination was 109% during this period.”

The Demonetisation That Was

After stating this, Rs 500 and Rs 1,000 notes were withdraw, and new Rs 500 and Rs 2,000 notes were introduced. If it was easy to store black money in the form of Rs 1,000 notes, Rs 2,000 notes made it even more easier.

The Rs 2,000 note continues to be around.

In fact, the mandate of demonetisation was expanded in the ‘mann ki baat’ address that Prime Minister Narendra Modi gave to the nation on 27 November 2016, where he said: “The great task that the country wants to accomplish today is the realisation of our dream of a ‘Cashless Society’. It is true that a hundred percent cashless society is not possible. But why should India not make a beginning in creating a ‘less-cash society’? Once we embark on our journey to create a ‘less-cash society’, the goal of ‘cashless society’ will not remain very far.”

So, have we moved towards a less-cash society as the goal was? Let’s take a look at Figure 1, which basically plots the currency in circulation, from 30 September 2016 onwards, up until 19 October 2018, the latest data available.

Demonetisation Review

What does Figure 1 tell us? The currency in circulation as of 4 November 2016, four days before demonetisation was Rs 17.98 lakh crore. After demonetisation, as people started depositing the demonetised notes of Rs 500 and Rs 1,000 into their bank accounts, the currency in circulation started to fall. It fell to a low of Rs 8.98 lakh crore as of 6 January 2017. It has largely been rising since then.

As of 19 October 2018, the currency in circulation stood at Rs 19.68 lakh crore, around 9.5 percent higher than it was before demonetisation.

Of course, between then and now, the Indian economy has also grown, and we need to take that into account as well. The trouble is that, while the data on the currency in circulation comes out every week, the gross domestic product (GDP) of the Indian economy (or the size of the economy), is declared only once every three months.

Less Cash = Less Corruption? No!

What does Figure 2 tell us? It tells that between June 2012 and September 2016, the currency to GDP ratio varied between 11 percent and a little over 12 percent. Basically, looking at Figure 1, it is safe to say that the currency to GDP ratio of India, at most points of time, has been around 12 percent.

In the aftermath of demonetisation, it fell to 6.35 percent of the GDP as of end December 2016. It has been rising since then and as of the end of June 2018, stood at 11.30 percent. The ratio has constantly been rising since December 2016. Given that the GDP data is currently available only up to June, 2018, the currency to GDP ratio can be calculated only up until then.

This basically tells us that cash has been making its way back into the financial system, beating the original motive of demonetisation, which was to move the Indian economy towards less cash.

Also, as cash (or currency) has made its way back into the system, the economic growth which had fallen dramatically (especially of the non-government part of the economy) in the aftermath of demonetisation, has recovered. In the aftermath of demonetisation, as cash was taken out of the system, economic transactions collapsed.

As cash made its way back into the economy, economic transactions have recovered, and so has the economy. But the idea that less cash means less corruption is basically wrong.

Cash Circulation and Corruption

Let’s look at some data to understand this very important point. Let’s take the case of Nigeria, which had a currency to GDP ratio of 1.85 percent in 2016. It is by far a more corrupt country than India is, though it has significantly less cash than India does, given its economic size.

Or take the case of Brazil which had a currency to GDP ratio of 3.31 percent in 2016. It’s a country more or less as corrupt as India is. Or take the cases of Singapore, the Eurozone, Taiwan, Switzerland and Japan, with a currency to GDP ratio of 10.36 percent, 10.49 percent, 10.54 percent, 11.11 percent and 19.4 percent, respectively.

Each of these areas or countries had a currency to GDP ratio higher that of India in 2016. But none of these areas or countries is as corrupt as India is. This notion that a higher currency in circulation leads to more corruption and black money, is indeed a misleading one.

Global data shows that to us, very clearly. If there should be one learning from demonetisation two years on, this has to be it — more cash or more currency in the system — doesn’t necessarily mean more corruption or more black money. The problem clearly lies elsewhere.

(Vivek Kaul is the author of ‘India’s Big Government – The Intrusive State and How It is Hurting Us’ and ‘ Easy Money’. He can be reached @kaul_vivek ‏. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)