Of “Shaky” Demonetisation Statistics, Arun Jaitley and Black Money

We don’t live in a perfect world. And given this, governments like to showcase the positive impact of the decisions they make, all the time. Sometimes, they get very desperate in the process.

Take the case of the economic impact of demonetisation. Most data now coming out clearly shows that the decision did not have a positive impact on the Indian economy. It might have helped the Bhartiya Janata Party to win the Uttar Pradesh assembly elections, but that doesn’t necessarily make it a right decision on the economic front.

Nevertheless, the Modi government would like us to believe that demonetisation has helped the country on the economic front. Early last week the finance minister Arun Jaitley said that “more than 91 lakh people were added to the tax base due the result of the actions taken by the income tax department.”

It was later clarified that 91 lakh people were added to the tax base in 2016-2017(i.e. between April 1, 2016 and March 31, 2017). As per Jaitley’s statement 91 lakh individuals were added to the tax base post demonetisation, which is incorrect.

Meenakshi Goswami, Income Tax Commissioner and the official spokesperson of the Central Board for Direct Taxes (CBDT), told NDTV later in the week that91 lakh was the total number of new taxpayers enrolled in the financial year 2016-2017.”

Now this makes things interesting. On the face of it, the addition of 91 lakh individuals to the income tax base sounds like a huge number. But when we are talking about any increase or decrease, a number should never be viewed in isolation.

The trouble is that we don’t have long term data on this front because of a change in the definition of “tax base” and “new tax payer added during the year”. The annual report of the ministry of finance for 2015-2016 points out that new taxpayers “added during the year 2014-15 is 76,04,154”. This basically means that 76 lakh new taxpayers were added during 2014-2015. I couldn’t find any data for 2015-2016. Now compare the 91 lakh additions in 2016-2017 to 76 lakh additions in 2014-2015, and suddenly the number doesn’t seem too high, given that no demonetisation was carried out in 2014-2015.

Even if the government doesn’t do anything, taxpayers get added every year, especially when the minimum tax slab continues to remain the same. In 2014-2015, the minimum tax slab was Rs 2,50,000, which is where it continues to be. This basically means that inflation alone would have ensured that more people came into the tax bracket and thus increased the tax base.

Over and above this, as the economy grows and people earn more, more people come into the tax bracket.

Once we take these factors into account, the addition of 91 lakh taxpayers suddenly doesn’t sound much, especially taking into account the disruption that demonetisation caused through the length and the breadth of the country.

Further, Sushil Chandra, chairman of CBDT said that between November 2016 and March 2017, the search actions of the income tax department revealed an undisclosed income of Rs 16,398 crore. On the other hand, the surveys had led to a detection of Rs 6,746 crore during the same period.

Again, if we look at these numbers in isolation, they sound like a lot of money. But that doesn’t turn out to be the case if we look at numbers over a period of time. Take a look at Table 1. It shows the undisclosed income admitted to and detected during the search operations as well as surveys conducted by the income tax department over the last few years.

Table 1: Undisclosed income

Financial Year Number of groups searched Undisclosed income admitted (in Rs Crore) Number of surveys conducted Undisclosed income detected (in Rs Crore) Total undisclosed income (in Rs Crore)
2012-2013 422 10,291.61 4630 19,337.46 29,629.07
2013-2014 569 10,791.63 5327 90,390.71 1,01,182.34
2014-2015 545 10,288.05 5035 12,820.33 23,108.38
2015-16 445 11,066.24 4422 9,654.8 20,721.04
2016-17* 222 6,304.71 977 17,62.51 8,067.22

*Up to September 2016 in case of search numbers and August 2016 in case of survey numbers
Source: Ministry of Finance Annual Reports and the Press Information Bureau
The numbers for 2016-2017 are incomplete. But there is enough detail that lets us analyse the issue. Between April and September 2016, the total undisclosed income (or black money) admitted through search operations of the income tax department stood at Rs 6,304.71 crore. The undisclosed income detected through surveys conducted between April and August 2016 had stood at Rs 1,762.51 crore. If we add these numbers we get Rs 8,067.22 crore.

Between November 2016 and March 2017, the search actions of the income tax department revealed an undisclosed income of Rs 16,398 crore, as pointed out earlier. On the other hand, the surveys had led to a detection of Rs 6,746 crore during the same period. Adding both these numbers we get Rs 23,144 crore. Adding this to the earlier Rs 8,067.22 crore, we get around Rs 31, 211 crore.

This is the total undisclosed income identified by the income tax department during the course of 2016-2017. The number is incomplete because the information for the month of October 2016 is missing in case of search operations and information for the months of September-October 2016 is missing in case of survey operations.

Nonetheless, it is a good ballpark number to work with. Hence, the total amount of undisclosed income or black money identified by the income tax department in 2016-2017 stood at more than Rs 31,211 crore.

Is it such a big deal? Look at Table 1. The total amount in 2012-2013 had stood at Rs 29,629 crore. This amount hasn’t been adjusted for inflation. It is safe to say that in inflation adjusted terms more undisclosed income was identified by the income tax department in 2012-2013 than in 2016-2017. In 2013-2014, the number stood at Rs 1,01,182 crore, which is significantly more than 2016-2017. And it is worth remembering here that these numbers happened without demonetisation. In fact, as the numbers clearly show the efficacy of the income tax department when it comes to identification of black money has come down since 2014-2015.

To conclude, the rosy picture of demonetisation that the government is trying to paint, is really not true. The more data we look at the clearer this becomes.

Postscript: I recently did a podcast with the writer Amit Varma who is currently the editor of the Pragati magazine, on the Right to Education and how it has screwed up our education system. Most of what I spoke was based on my new book India’s Big Government—The Intrusive State and How It is Hurting Us. You can listen to the podcast here.

The column originally appeared in Equitymaster on May 22, 2017.

New IIP Shows Demonetisation Slowed Down Indian Manufacturing Growth Big Time

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India has a new Index of Industrial Production (IIP). It is bigger and according to economists who track such things, it is better than the previous one. The IIP basically gives growth estimates of three sectors-manufacturing, mining and electricity. The manufacturing sector forms more than three-fourths of the IIP.

The base year for the new IIP has been changed to 2011-2012 from the earlier 2004-2005. This has been done to capture the changes in the industrial sector that have happened over a period of time and “to also align it with the base year of other macroeconomic indicators like the Gross Domestic Product (GDP), Wholesale Price Index (WPI)”.

Like any other index, the IIP tracks various items that make for the manufacturing, mining and electricity sectors. These items need to be changed or relooked at from time to time in order to ensure that the IIP continues to maintain a representativeness of the manufacturing, mining and electricity sectors in particular and the industry as a whole in general.

The new IIP has a total of 809 items in the manufacturing sector. The earlier one had 620. While, the number of items which constitute the manufacturing part of IIP have gone up, 124 items have been removed as well. These include items like gutka, calculators and colour TV picture tubes. Items like cement clinkers, medical and surgical accessories, refined palm oil etc., have been added. Along similar lines, the electricity sector now includes data from the renewable energy sector as well.

Over and above this, there has been an increase in number of factories in panel for reporting data and closed ones have been removed. All in all, these steps have been taken in order to ensure that the new IIP is a better representation of industry than the old one was.

Given that, items that constitute IIP have change majorly, it is not surprising that the growth figures of IIP have changed as well. Take a look at Figure 1. It plots both the new IIP and the old IIP growth rates over the last half decade, April 2012 onwards.

Figure 1: 

One look at Figure 1 is enough to tell us that the old IIP and new IIP are different beasts altogether, though both are very volatile. Now take at data from March 2013. As per the old IIP series, the growth was at 3.5 per cent. The new IIP series puts the growth at 15.1 per cent. That’s how different the old and the new IIP are.

In fact, as per the new IIP, the industrial growth stood at 3.3 per cent in 2014-2015, the last year of the Congress led UPA government. As per the old IIP the growth had stood at – 0.1 per cent. Hence, we can conclude that the state of the industry in the last year of the Congress government wasn’t as bad as it seemed at that point of time. It’s just that the old IIP may have no longer remained a good representation of the Indian industry.

In fact, the new IIP shows that industrial growth picked up in 2016-2017, the last financial year. The growth stood at 5.1 per cent. As per the old IIP the industrial growth was at 0.6 per cent, during the course of the year. What this also tells us is that the two IIPs are as different as chalk and cheese.

There is an interesting trend that the new IIP catches on to in the manufacturing sector. Manufacturing makes up for 77.6 per cent of the new IIP as against the 75.5 per cent in the old one. Take a look at Table 1.

Table 1: Manufacturing Growth

Period Manufacturing Growth(in %)
Dec 2012 to Mar 2013 9.4
Dec 2013 to Mar 2014 3.7
Dec 2014 to Mar 2015 3.2
Dec 2015 to Mar 2016 4.9
Dec 2016 to Mar 2017 1.6

Source: Centre for Monitoring Indian Economy.

The manufacturing growth between December 2016 and March 2017 stood at 1.6 per cent. This has been the slowest in comparison to the same period in previous years. Why is this the case? The one word answer to this is demonetisation. The Modi government announced demonetisation of Rs 500 and Rs 1,000 notes on November 8, 2016, and sent the economy into a tailspin. The interesting thing is that the average manufacturing growth between April 2016 and October 2016 had stood at 6.9 per cent. This signalled the revival of the manufacturing sector after having grown by around 3 per cent in 2015-2016 and 3.8 per cent in 2013-2014.

Demonetisation managed to scuttle that revival in this growth. Also, it is worth pointing out here that the IIP data is collected from “entities in the organised sector units registered under the Factories Act, 1948”. This means that the unorganised sector is not covered. And as I have often written in the past, the impact of demonetisation on the unorganised sector has been far greater.

Up until now, the government has refused to admit that demonetisation has had a negative impact on the economy (Subscription Required). I guess it’s time it looked at the new IIP numbers to realise the obvious.

(The column was originally published in Equitymaster on May 16, 2017)

Is Reserve Bank of India a Subordinate Department of the Finance Ministry?

RBI-Logo_8

The Reserve Bank of India(RBI) released the latest monetary policy report on April 6, 2017. In this report, the RBI said that: “In Q4[January to March 2017], remonetisation progressed at an accelerated pace.” It also said: “To sum up, economic activity should recover in 2017- 18 on the back of the fast pace of remonetisation“.

Remonetisation essentially refers to the RBI printing currency and pumping it into the financial system, in order to replace the currency rendered useless by demonetisation. Notes of Rs 500 an Rs 1,000 denomination were demonetised on November 8, 2016. Since then the RBI has been replacing the demonetised notes with new notes of Rs 500, Rs 2,000 and notes of other denomination which continued to remain legal in the aftermath of demonetisation.

In the monetary policy report India’s central bank claims that the remonetisation has happened at an accelerated/fast pace between January and March 2017. The trouble is that its own data shows otherwise. Take a look at Figure 1. It shows the weekly rate of increase in currency in circulation from mid-January 2017 to mid-March 2017.

Figure 1:

As can be seen from Figure 1, the weekly increase in currency in circulation has been slowing down since early January. How is the weekly increase in currency in circulation obtained? The currency in circulation as on January 6, 2017, was at Rs 8,98,017 crore. This jumped to Rs 9,50,803 crore as on January 13, 2017. This meant an increase of Rs 52,786 crore or around 5.9 per cent (Rs 52,786 crore divided by Rs 8,98,017 crore). A similar calculation is carried out for every week since then. This is how the weekly increase in currency in circulation is calculated.

In fact, by the end of the March 2017, the weekly increase in currency in circulation was at a three-month low, since January 6, 2017. This explains why there has been a shortage in currency in the recent past, with the ATMs running out of money time and again.

In April 2017, the weekly increase in currency in circulation has recovered a little than in comparison to the past. Nevertheless, we need to remember that the total currency in circulation is still a long way away from where it was at the beginning of November 2016, before demonetisation happened.

On November 4, 2016, the total currency in circulation had stood at around Rs 17.98 lakh crore. On April 14, 2017, the latest data that is available from the RBI, the total was at Rs 13.9 lakh crore. The gap between then and now is still at 22.7 per cent. In the pieces that I wrote on demonetisation I had said that the total currency in replacement would be replaced by May 2017. But the pace at which the RBI is currently going, it seems it will take more time than that.

Also, the RBI in the monetary policy report claims that the remonetisation happened at an accelerated/fast pace. This as we can see from Figure 1 is clearly not the case. The rate of weekly increase in currency in circulation at the beginning of January was close to 6 per cent. By end of March this had dropped to 1.7 per cent.

Of course as any base gets bigger, its rate of increase is likely to fall. But in this case, it is worth remembering that we are still nearly 23 per cent down from where the currency in circulation was before demonetisation.

One argument that has been finding favour is that the government needs to bring down currency in circulation so that people move towards digital forms of payment. While there is no denying digital is good, it is not going to happen over a period of a few months. Human habits ingrained for decades don’t change that fast. And given that the government will need to maintain the currency in circulation where it was before demonetisation was carried out. Every economy needs a certain amount of money to function and given the recent currency shortage we are nowhere near that.

The question is why has the weekly rate of increase in currency in circulation slowed down. Are the RBI and the government printing presses not working three shifts a day, like they were doing earlier? Is there a shortage of paper and ink? This is something only the RBI or the government can answer. The funny thing is that the banking journalists covering the RBI as a beat, haven’t put this question to the central banker as yet.

And what explains the RBI’s statement saying that the process of remonetisation or the weekly increase in the currency in circulation, is happening at a fast/accelerated pace. Why is the RBI saying something which its own data does not bear out?

Since the beginning of demonetisation, the communication of the government has been to make it look like a success and that is understandable. A similar bug seems to have bit the RBI as well when it has used words like accelerated and fast, when the weekly increase in currency in circulation has actually slowed down.

This brings me to something that TT Krishnamachari (TTK), who was the finance minister of the country, between 1957-1958 and 1964 and 1964, once said about the RBI. As TCA Srinivasa Raghavan writes in Dialogue of the Deaf-The Government and the RBI: “TTK’s view, expressed forcefully… [was] that the RBI was no more than a ‘subordinate department of the finance ministry’.”

In the case of demonetisation, the RBI is clearly behaving like a subordinate department of the finance ministry. And that does not bear well for the Indian economy.

The column originally appeared on April 24, 2017, on Equitymaster

The Undependable GDP

On February 28, 2017, the ministry of statistics and programme implementation published the Gross Domestic Product(GDP) growth figure for the three-month period between October and December 2016.

During the period the Indian economy grew by 7 per cent. This took most economists by surprise because they were expecting demonetisation to pull down economic growth. On November 8, 2016, the Prime Minister Narendra Modi had announced that come midnight the notes of Rs 500 and Rs 1,000 denomination, would no longer be money. Hence, the GDP growth for the period October to December 2016 was expected to be lower.

In one go 86.4 per cent of the currency in circulation was rendered useless. As Alain de Botton writes in The News—A User’s Manual: “Like blood to a human, money is to the state the constantly circulating, life-giving medium.”

When money is taken out of an economy, it stops functioning given that economic transactions come to a standstill. In the Indian case, cash/currency is the major form of money given that a bulk of transactions happen in cash. As per a PwC report 98 per cent of consumer payments by volume happens in cash. The Economic Survey of 2016-2017 points out: “The Watal Committee has recently estimated that cash accounts for about 78 percent of all consumer payments.”

In this scenario where bulk of consumer transactions happen in cash, the Indian economy for the period October to December 2016, should have come to a standstill. But the government data suggests that it grew by 7 per cent.

This seems unbelievable. The private consumption expenditure has grown by 10.1 per cent, the second fastest since June 2011. This when the retail loan growth of banks during October to December 2016, grew by just 0.5 per cent. The manufacturing sector grew by 8.3 per cent when bank credit to industry contracted by 2.8 per cent. Hence, there is something that is clearly not right about India’s GDP data.

Some analysts and experts have suggested that data is being fudged to show the government in good light. I really don’t buy that given that there is no evidence of the same. Having said that, one reason why the impact of demonetisation hasn’t been seen in the GDP growth figure is because the GDP calculations do not capture the informal sector well enough.

This is primarily because small manufacturers and those in the retail trade do not maintain accounts. Hence, estimates of the informal sector need to be made using the formal sector indicators. As the Economic Survey points out: “It is clear that recorded GDP growth in the second half of financial year 2017 will understate the overall impact because the most affected parts of the economy—informal and cash based—are either not captured in the national income accounts or to the extent they are, their measurement is based on formal sector indicators.”

In simple English, this basically means that the size of the informal sector while calculating the GDP is assumed to be a certain size of the formal sector. The formal sector has not been affected much due demonetisation. Hence, to that extent the size of the informal sector has been overstated in the GDP. It is expected that more information coming in by next year will set this right. This basically means that the GDP growth is likely to be revised downwards as more data comes in.

But this lack of dependable GDP data and other economic data creates its own set of problems for policymakers in particular.

This is a point that former RBI governor D Subbarao makes in his book Who Moved my Interest Rate?. As he writes: “Our data on employment and wages, crucial to judging the health and dynamism of the economy, do not inspire confidence. Data on the index of industrial production(IIP) which gives an indication of the momentum of the industrial sector, are so volatile that no meaningful or reliable inference can be drawn. Data on the services sector activity, which has a share as high as 60 per cent in the GDP, are scanty.”

Further, this poor quality of data is frequently and significantly revised, making things even more difficult for policymakers. And this possibly led YV Reddy, Subbarao’s predecessor at the RBI, to quip: “Everywhere around the world, the future is uncertain; in India, even the past is uncertain.”

Long story short—sometime around this time next year, the GDP for October to December 2016, is likely to see a significant revision.

The column originally appeared in Daily News and Analysis (DNA) on March 9, 2017

And the Notebandi Lies Continue…

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010

One week back, the finance minister Arun Jaitley said in the Rajya Sabha: “At no point of time, not for a single day, was the currency inadequate.”

Every government needs to defend decisions it has taken. In that context Jaitley’s statement is hardly surprising. Nevertheless, it not only mocks the common man of this country but also tells us how disconnected our ruling politicians are with the realities of the day.

Jaitley was essentially talking about the situation that prevailed in the aftermath of demonetisation or notebandi, as it is more commonly referred to as.

If there was no currency shortage for even a single day, why did ATMs have such long lines for close to a month? Is Mr Jaitley saying that people just gathered there because they had nothing else to do?

If there was no currency shortage even for a day, why did the government place limits on ATM withdrawals? It was churlish of Jaitley to have said what he did, given that 86 per cent of the currency in circulation was demonetised, the midnight of November 8, 2016, onwards.

The advantage with making speeches is that nobody asks questions at the end of it. Nevertheless, the lack of empathy among the politicians does get registered.

That apart, let’s look at the currency in circulation data published by the Reserve Bank of India every week. Take a look at Figure 1.

 

Figure 1:

Figure 1 essentially shows the currency in circulation in the Indian economy in 2017. December 30, 2016, was the last date for depositing the Rs 500 and Rs 1,000 notes which had been demonetised. Hence, I have taken the currency in circulation numbers from January 6, 2017, onwards, which is a week later.

The currency under circulation has been going up since 2017. On November 4, 2016, four days before prime minister Narendra Modi, made the announcement to demonetise Rs 500 and Rs 1,000 notes, the total currency in circulation had stood at Rs 17.97 lakh crore. In comparison, on February 3, 2017, the total currency in circulation, the latest data available, stood at Rs 10.49 lakh crore.

Hence, the total currency in circulation as on February 3, 2017, was at 58.4 per cent of the level before monetisation was announced. Given this, it is not surprising that the currency shortage, even though it has eased, continues to persist. This goes against what the Economic Affairs Secretary Shaktikanta Das recently said about the remonetisation process being complete.

Take a look at Figure 2. It basically plots the total increase in currency in circulation every week since January 6, 2017.

Figure 2:For the week ending January 13, 2017, the total currency in circulation grew by Rs 52,780 crore. Thereafter, the increase in circulation has fallen quite dramatically. One explanation for this may lie in the fact that initially more Rs 2,000 notes were being printed and that has now been replaced with more Rs 500 notes being printed, which is what the financial system needs, given the shortage of change. But at the same time, it takes four Rs 500 notes to replace money worth Rs 2,000.

The larger point being that the financial system is still away from having an adequate amount of currency. This, as I have explained in the past, is primarily because of the limited currency printing capacity of the government of India and the Reserve Bank of India.

The average increase in currency between January 6 and February 3, 2017, comes to around Rs 37,778 crore. At this speed, it will take many more weeks, before the financial system gets to a level, where it has adequate currency.

The total currency in circulation had stood at Rs 17.97 lakh crore before demonetisation. As of February 3, 2017, the total currency in circulation stood at Rs 10.49 lakh crore. The difference between this and the total amount of currency in circulation before demonetisation stands at Rs 7.48 lakh crore (Rs 17.97 lakh crore minus Rs 10.49 lakh crore).

At the speed of introducing currency worth Rs 37,778 crore per week, it will take close to 20 weeks for the currency under circulation to reach the pre-demonetisation level. One logic that has been offered is that the government may choose not to replace the entire currency.

Even if the government chooses not to replace the entire currency, at Rs 37,778 crore per week, it will take many more weeks before the currency in circulation stabilises at an adequate level.

While, the economics of it, can get tricky, even if the government chooses to go up to Rs 16 lakh crore and not Rs 17.97 lakh crore, it will still take close to 15 weeks to get to the pre-demonetisation level. Of course, the time taken can come down if the speed of money printing can be increased.

Long story short—both Jaitley and Das are essentially lying to the country in saying what they are. And that is something worth remembering and talking about, dear reader.

The column was originally published on February 14, 2017, on Equitymaster

4 Things Modi Could Have Done Instead of Demonetisation

narendra_modi

The decision to demonetise Rs 500 and Rs 1,000 notes when it was first announced was to tackle black money and fake currency. As the ministry of finance press release accompanying the decision said: “High denomination notes are known to facilitate generation of black money”.

What the Modi government was essentially saying is that it is easier to store black money in the form of high denomination notes. Having demonetised Rs 500 and Rs 1,000 notes, the government decided to launch a Rs 2,000 note, going precisely against its own statement.

The assumption was that people had stored black money in their homes in the form of cash. And by demonetising Rs 500 and Rs 1,000 notes, these notes would be rendered useless. Holders of black money in the form of currency would deposit it into banks and post offices, for the fear of generating an audit trail. Demonetised currency can be deposited into banks and post offices up to December 30, 2016. This money will be credited into the bank account or the post office savings account.

Things haven’t turned out like that. By December 6, 2016, close to 75 per cent of the demonetised currency had already made it back into the banks. Government officials are now saying that they expect almost all the demonetised currency to come back to the banks.

What this essentially means is that those who had black money in the form of cash have managed to get it converted into currency which continues to be legal tender. The hope now is that the government will use information technology to identify people who have deposited their black money into banks, tax them and raise some money in the process.

To what extent this happens remains to be seen. Nevertheless, if the idea was to attack black money in India, there are four things that the Modi government could have done, instead of demonetising high denomination notes and disrupting the entire economy. This would have hit at the heart of the nexus between politicians and builders, which thrives on black money.

1) Stop cash donations to political parties: Currently, political parties need to declare a donation only if it is greater than Rs 20,000. In 2014-2015, 55 per cent of the donation of the national political parties came from those making donations of Rs 20,000 or lower. Hence, the details of these donors are unknown.

If citizens are expected to share their identity with the bank or the post office while depositing their demonetised notes, why should donors of political parties be allowed to hide behind an archaic law, is a question worth asking. This needs to change.

2) Political parties should be brought under Right to Information(RTI): This is currently not the case. If the political parties are brought under the ambit of RTI, they will have to function in a much more transparent way in comparison to what they do now. This would mean keeping proper records of where the funds to finance them are coming from.

3) Real estate should be brought under the Goods and Services Tax(GST): If real estate is brought under GST, builders if they want to claim input tax credit must request documentation from all the suppliers and the contractors that they work with. This will hopefully start cleaning up the real estate business as more and more builders will have to operate through legitimate means. Once they stop using cash in dealings with their suppliers, their proclivity to ask for cash from their customers will also go down.

4) Slash stamp duty rates on real estate transactions: This is one reason why the real estate sector is at the heart of black money. If stamp duties across states are reduced and brought to realistic level, the tendency of people to under-declare the value of real estate transactions will come down. Hence, the proportion of cash transactions will come down.

These four moves would have hit at the heart of the generation of black money. What the government chose to do instead was to demonetise Rs 500 and Rs 1,000 notes, and throw the entire country in a huge disarray.

The column originally appeared in Bangalore Mirror on December 14, 2016

 

Demonetisation is Dead — Long Live Demonetisation

rupee

When the Facts Change, I Change My Mind. What Do You Do, Sir? – often wrongly attributed to John Maynard Keynes.

In the press conference that followed today’s monetary policy, one data point and one clarification, has essentially made clear that Narendra Modi’s big demonetisation plan is not going the way it was expected to.

When the plan was announced a month back on November 8, the one big aim of the plan was to tackle black money along with fake currency notes. Black money is essentially money that has been earned through legitimate or illegitimate means, but on which taxes have not been paid.

As on November 8, 2016, 685.80 crore Rs 1,000 notes were in circulation. Over and above this, 1716.50 crore of Rs 500 notes were in circulation. The total value of demonetised notes amounted to Rs 15.44 lakh crore.

These notes were demonetised and suddenly had no value. These notes can be deposited in banks and post offices, up to December 30, 2016 and the money will be credited in the bank account or the post office savings account.

The Reserve Bank of India (RBI) in a press release dated November 28, 2016, had said that Rs 8,11,033 crore worth of demonetised notes had been deposited back with the banks. Over and above this, Rs 33,948 crore worth of demonetised notes were exchanged for new notes as well as notes that continued to be legal tender. Initially, notes of up to Rs 4,000 could be exchanged. This was increased to Rs 4,500. Then decreased to Rs 2,000 and finally done away with.

By value the demonetised notes of Rs 500 and Rs 1,000 formed more than 86 per cent of the currency in circulation. The hope was that a certain portion of this currency would be black money held in the form of cash. And this black money would not be deposited into banks, for the fear of generating an audit trail.

In the process, black money would be destroyed. QED.

This logic seemed flawless that almost everybody bought it initially, including yours truly. The belief was that almost 20 per cent of the high denomination notes are black money. (I am yet to figure out how experts writing on the issue arrived at this figure. But once they did, almost everyone seemed to use it).

The total value of the demonetised notes stood at Rs 15.44 lakh crore. Given this, 20 per cent of Rs 15.44 lakh crore worked out to around Rs 3 lakh crore. It was then said that this amount will not make it to the banks. The assumption was that those with black money will not manage to get their old demonetised notes exchanged for the new or the currently legal ones.

Thankfully, I did not fall for this totally. In the letter dated November 11, 2016 (Modi’s Next Shot on Black Money Should…) I had worked with the assumption that around one-third of the black money won’t get converted and hence, close to Rs 1.1 lakh crore of currency will get destroyed.

In fact, almost every other analyst and economist talked about close to Rs 3 lakh crore being destroyed. It was rather amateurish of them to assume that the Indian public won’t be able to convert their black money into white. There are various ways through which this has happened, which I will discuss in a separate piece.

As mentioned earlier up to November 27, 2016, Rs 8.11 lakh crore of demonetised notes had made it back to the banks. Since then, the RBI hasn’t put out any new data. Nevertheless, in the press conference that followed the monetary policy today, the deputy governor of RBI, R Gandhi, said that close to Rs 11.55 lakh crore of demonetised notes had made it back to the banks.

This means that around 75 per cent of the demonetised notes are already back with the banks. (Rs 11.55 lakh crore divided by Rs 15.44 lakh crore of demonetised notes). With 24 days still to go until December 30, the last day of depositing demonetised notes, chances are almost all the demonetised money will come back to the banks.

This is something that the Revenue Secretary Hasmukh Adhia told The Indian Express: “The government expects the entire money in circulation in the form of currency notes of Rs 500 and Rs 1,000 which have been scrapped to come back to the banking system.”

Given this, the question of black money being destroyed does not exist. What this means is that the black money in the system has been exchanged for new notes in various ways.

There is another angle here which was the subject of multiple WhatsApp forwards. And this is how it went. Every rupee out (except Re 1 notes) there in the financial system is essentially a liability for the RBI. (If you look at the Rs 100 note carefully, you will see the RBI governor saying, I promise to pay the bearer the sum of one hundred rupees, for example).

The hope was that with Rs 3 lakh crore not coming back to the banks, the liabilities of the RBI will shrink. To that extent, the asset side of the balance sheet of the RBI would also need to shrink and that would lead to the RBI giving the government a special dividend of Rs 3 lakh crore.

Other than being a subject of many WhatsApp forwards this was something that many economists also wrote about in their research reports. Those against this logic said that, just because the notes don’t land up with the banks, does not mean that the RBI’s liabilities come down.

Today at the press conference, the RBI governor Urjit Patel was asked about this and he said: “They still carry the RBI’s liability as long as only the legal tender characteristic is withdrawn.” This basically meant in simple English that the RBI balance sheet wasn’t going to shrink and there was no question of a special dividend.

So where does that leave the Modi government? Revenue Secretary explained this to The Indian Express when he said: “Do you think that by simply depositing money in the bank account makes black money into white? It doesn’t. It will become white when we charge taxes, when the Income Tax department can reach up to them by issuing a notice and questioning them.”

The question is how many people will the Income Tax department go after, given their limited resources. Also, is this the way a government should go about raising revenue, by disrupting the entire economy?

Further, many people who have put money into banks are prepared to litigate and take this to court. As noted journalist Sucheta Dalal recently wrote:Tax experts and retired income-tax commissioners have been confidently encouraging people to deposit their unaccounted money as this year’s income under Sections 68 and 69 of the Income-tax Act and get away by paying 30% tax. While there is a good chance that this may lead to litigation, case law from the two previous instances of currency demonetisation in India (1946 and 1978) may support this stand.”

All this brings us to the question whether demonetisation was really required? Will the tax that the government manages to collect through this effort, be more than enough to make up for the slowdown in economic growth that demonetisation is likely to cause?

Also, I really don’t like the idea of the income tax department being allowed a free run.

The column was originally published in Vivek Kaul’s Diary on December 7, 2016