In 2016, Indian Prime Minister Modi demonetized all of the nation’s ₹1000 and ₹500 banknotes. This was part of his odd war on counterfeiting and everybody else who might hold large amounts of dubiously earned, and not properly reported cash.
After suffering from a nine-month note shortage, enough new notes were printed to meet India’s demand for cash. But in the interim, what had happened to Indians’ demand for cash? Did their experience with demonetization lead them to hold less cash than before, or did they simply revert to their pre-demonetization habits and patterns?
We can call this a demonetization gap: the amount of currency that would have been held in wallets had Modi’s demonetization not occurred.
My quickest thought is after pouring thru all the many ways of expressing available data: supply of banknotes, cash in circulation, circulation of dif 20,500,1000 rupee denominations, money volume/velocity, Point of Sale purchases and new machine installation, usage and then jiggering in theories on black money, markets, gold/diamonds,
The answer is Modi and the demonetization had much too big of a blast radius. It has failed
The costs and disruptions of lost labor time, foregone transactions, and pushing old notes into the black market, is too great. In that way it is a model of demonetization that no country will ever use as its model.
Modi’s demonetization became a massive cash dragnet.
The tricky thing with cash is that it is simultaneously a vessel for tax evasion for a few cheats and also a vital monetary fluid for the many. Punishing the first group means that the second will also be hurt. If the costs incurred by the second group are too high, then the calculus behind the whole effort fails.
Back to minding the gap, let’s do some brief forensics on the evidence that the cancellation of ₹1000 and 500s has had an enduring effect on Indians’ behaviour surrounding cash.
To measure the gap, we need to compare the evolution of India’s cash supply to the path it would have taken in a world in which Modi’s demonetization never occurred. And, I have to make assumptions….
We know that the supply of rupee banknotes grew at an average rate of around 12.3% from 2011 to 2016, and on the eve of demonetization there were around ₹17.5 trillion in banknotes and coins in circulation.
Taking these numbers and extrapolating forward, November 2018’s cash-in-circulation count would have clocked in at around ₹21.5 trillion rupees had the demonetization not occurred.
But… in our actual world, the one where demonetization occurred, India’s cash count registers at just ₹19.5 trillion rupees.
So thanks to demonetization, Indians are holding around ₹2 trillion fewer paper rupees than they otherwise would have.
What sort of assumptions do we need to make in order for the demonetization gap to be zero?
To get from a currency stock of ₹17.5 trillion in November 2016 to ₹19.5 trillion by November 2018, we need to assume an absurdly low 6% growth rate for the stock of currency stock. So while you can quibble with the size of the gap, I think it’s undeniable that some sort of gap exists.
There are two potential explanations for why a demonetization gap exists…
1. Demonetization might have had a permanent effect on Indians’ taste for cash. Prior to demonetization, a money launderer might typically have built up an inventory of ₹100 lakh (US$135,0000) worth of banknotes before laundering them. But the demonetization frightened the launderer, so now the launderer launders the ill-gotten gains whenever they hold just ₹50 lakh worth of notes.
Or maybe a family that typically conducted most of their day-to-day transactions in cash opened a bank account during demonetization so that they could deposit their notes. And now they’ve fallen into the habit of paying for half their family expenses with cash, and the other half with debit cards.
These sorts of changes to transactions preferences would get expressed in the nation’s overall stock of notes by a reduction relative to trend.
2. Demonetization might have caused large and lasting damage to the informal sector of the Indian economy. With 85% of the nation’s money stuck suddenly came unusable, and so many businesses dependent on cash, these businesses may have been forced to go under. With informal production cratering, fewer banknotes would be required for transactions purpose than would otherwise be the case. Over the long term, however, one would expect these sectors to rebuild, any drag they had once placed on cash demand being removed.
If Indian’s taste for cash changed, how might these new tastes have manifested themselves? Did Indians swap cash for deposits in the regulated banking system or did they simply swap one form of anonymous “black money” for another (i.e. cash for gold, diamonds, real estate)?
The number of point-of-sale (POS) terminals installed has experienced a meteoric, one-time shot to the arm after the November 2016 demonetization announcement.
The value of POS transactions using debit and credit cards moved to a new and higher plateau.
Demonetization gave mobile wallet usage a quick shot to the arm, but it is difficult to determine if growth stayed above trend in 2017-18 or below. Given that mobile wallets are recent and started from a very low base, usage had already been growing very fast before demonetization.
Modi’s demonetization tried to lessen the blast radius by targeting users of large denomination ₹500 and ₹1000 notes while leaving users of the ₹10, ₹20, ₹50, ₹100, and ₹200 untouched. The motivation behind this was that presumably large tax cheats will concentrate their cash holdings in higher denomination notes, while regular note users will tend to concentrate in the lower denominations. But even with this filter in place, the ₹500 and ₹1000 were so widely held by Indians that the demonetization of these denominations forced a large proportion of the population to endure massive lineups for weeks. Retail trade ground to a halt.
Demonetization is too blunt of a tool to effectively solve the complicated inequities arising from cash-based tax evasion. So should Indians (and the rest of us too) simply live with these imperfections, accepting unfairness as an acceptable cost of maintaining cash systems?
After suffering from a nine-month note shortage, enough new notes were printed to meet India’s demand for cash. But in the interim, what had happened to Indians’ demand for cash? Did their experience with demonetization lead them to hold less cash than before, or did they simply revert to their pre-demonetization habits and patterns?
We can call this a demonetization gap: the amount of currency that would have been held in wallets had Modi’s demonetization not occurred.
My quickest thought is after pouring thru all the many ways of expressing available data: supply of banknotes, cash in circulation, circulation of dif 20,500,1000 rupee denominations, money volume/velocity, Point of Sale purchases and new machine installation, usage and then jiggering in theories on black money, markets, gold/diamonds,
The answer is Modi and the demonetization had much too big of a blast radius. It has failed
The costs and disruptions of lost labor time, foregone transactions, and pushing old notes into the black market, is too great. In that way it is a model of demonetization that no country will ever use as its model.
Modi’s demonetization became a massive cash dragnet.
The tricky thing with cash is that it is simultaneously a vessel for tax evasion for a few cheats and also a vital monetary fluid for the many. Punishing the first group means that the second will also be hurt. If the costs incurred by the second group are too high, then the calculus behind the whole effort fails.
Back to minding the gap, let’s do some brief forensics on the evidence that the cancellation of ₹1000 and 500s has had an enduring effect on Indians’ behaviour surrounding cash.
To measure the gap, we need to compare the evolution of India’s cash supply to the path it would have taken in a world in which Modi’s demonetization never occurred. And, I have to make assumptions….
We know that the supply of rupee banknotes grew at an average rate of around 12.3% from 2011 to 2016, and on the eve of demonetization there were around ₹17.5 trillion in banknotes and coins in circulation.
Taking these numbers and extrapolating forward, November 2018’s cash-in-circulation count would have clocked in at around ₹21.5 trillion rupees had the demonetization not occurred.
But… in our actual world, the one where demonetization occurred, India’s cash count registers at just ₹19.5 trillion rupees.
So thanks to demonetization, Indians are holding around ₹2 trillion fewer paper rupees than they otherwise would have.
What sort of assumptions do we need to make in order for the demonetization gap to be zero?
To get from a currency stock of ₹17.5 trillion in November 2016 to ₹19.5 trillion by November 2018, we need to assume an absurdly low 6% growth rate for the stock of currency stock. So while you can quibble with the size of the gap, I think it’s undeniable that some sort of gap exists.
There are two potential explanations for why a demonetization gap exists…
1. Demonetization might have had a permanent effect on Indians’ taste for cash. Prior to demonetization, a money launderer might typically have built up an inventory of ₹100 lakh (US$135,0000) worth of banknotes before laundering them. But the demonetization frightened the launderer, so now the launderer launders the ill-gotten gains whenever they hold just ₹50 lakh worth of notes.
Or maybe a family that typically conducted most of their day-to-day transactions in cash opened a bank account during demonetization so that they could deposit their notes. And now they’ve fallen into the habit of paying for half their family expenses with cash, and the other half with debit cards.
These sorts of changes to transactions preferences would get expressed in the nation’s overall stock of notes by a reduction relative to trend.
2. Demonetization might have caused large and lasting damage to the informal sector of the Indian economy. With 85% of the nation’s money stuck suddenly came unusable, and so many businesses dependent on cash, these businesses may have been forced to go under. With informal production cratering, fewer banknotes would be required for transactions purpose than would otherwise be the case. Over the long term, however, one would expect these sectors to rebuild, any drag they had once placed on cash demand being removed.
If Indian’s taste for cash changed, how might these new tastes have manifested themselves? Did Indians swap cash for deposits in the regulated banking system or did they simply swap one form of anonymous “black money” for another (i.e. cash for gold, diamonds, real estate)?
The number of point-of-sale (POS) terminals installed has experienced a meteoric, one-time shot to the arm after the November 2016 demonetization announcement.
The value of POS transactions using debit and credit cards moved to a new and higher plateau.
Demonetization gave mobile wallet usage a quick shot to the arm, but it is difficult to determine if growth stayed above trend in 2017-18 or below. Given that mobile wallets are recent and started from a very low base, usage had already been growing very fast before demonetization.
Modi’s demonetization tried to lessen the blast radius by targeting users of large denomination ₹500 and ₹1000 notes while leaving users of the ₹10, ₹20, ₹50, ₹100, and ₹200 untouched. The motivation behind this was that presumably large tax cheats will concentrate their cash holdings in higher denomination notes, while regular note users will tend to concentrate in the lower denominations. But even with this filter in place, the ₹500 and ₹1000 were so widely held by Indians that the demonetization of these denominations forced a large proportion of the population to endure massive lineups for weeks. Retail trade ground to a halt.
Demonetization is too blunt of a tool to effectively solve the complicated inequities arising from cash-based tax evasion. So should Indians (and the rest of us too) simply live with these imperfections, accepting unfairness as an acceptable cost of maintaining cash systems?