Five months after India’s demonetization of 500- and 1,000-rupee bills, there is still wide disagreement about the effect of the decision. I wrote critically about this policy in an AIER article last month, but the fallout continues.
At present, both sides feel vindicated by the outcome. Critics warned that demonetization would not do much to curtail illegal activity funded by “black money,” but would disrupt the Indian economy, especially for the rural poor who were especially likely to have conducted business in cash. I cited several examples in the previous piece in support of the criticism, and more evidence continues to flow in—for example, this Forbes article on job cuts at Indian startups. However, others claim it has not been so bad. Car-sales growth is up, economic growth outperformed projections in the fourth quarter of 2016, and most importantly, Prime Minister Modi’s party performed well in recent state elections, which the opposition positioned as a referendum on demonetization. If voters were hurt so much by demonetization, why hasn’t it harmed economic growth, and why did they vote to support its architects?
The answer to the first question is that it probably has harmed economic growth but the reporting on the ground is ahead of official statistics. The fourth-quarter numbers come partially from before demonetization and are partly based on estimates that may not have accounted for demonetization, as Bhaskar Chakravorti explains in the Harvard Business Review. More importantly, the informal economy in India is huge. An Indian Express columnist writes it “produces 45 per cent of the output and employs 94 per cent of the work force.” These are the people who are toughest to measure and whom we expect to be affected most by demonetization.
Still, if the statistics are wrong and demonetization harmed average Indians, why didn’t they express their frustration at the ballot box? One persuasive argument is that Prime Minister Modi was simply effective at selling the measure as an anti-corruption initiative, whether or not it worked. Chakravorti writes that “the message that carried the greatest weight was that the government was acting, and acting decisively, on behalf of ordinary people to fight corruption.” This sentiment is echoed in other columns. The most striking excerpt I have seen is from Henny Sender of Nikkei.com:
The village barber said his daily income has dropped from 200 rupees a day to 50 because of the cash shortage caused by demonetization, though it is slowly recovering. A woman whose husband is in Mumbai, (and has taken the family cell phone with him), said she does not understand what demonetization was about. Micro finance lenders report soaring defaults because their borrowers have seen their earnings vanish.
Responses like these do not seem to have damaged Modi, however. The prime minister, who says demonetization was aimed at tax avoiders holding large amounts of cash, has convinced the poorer residents of the state that the policy was implemented to help them. "He may have hit us in one eye but he hit the rich in two eyes," said another villager.
Although new cash has been issued and withdrawal restrictions lifted, the story of demonetization is not over. Analysts are still measuring the total economic impact of demonetization—and small businesses and workers are still feeling it. It also remains an open question whether the stated goal of cracking down on corruption will result in long-term benefits. It will be interesting in the months ahead to keep an eye on continued evaluation of demonetization, both by economists and by Indian voters.