On the first anniversary of demonetisation, economist Prabhat Patnaik speaks about why its stated objectives were not achieved, the role of GST and more.
Jahnavi Sen: Hello and welcome, I’m Jahnavi Sen from The Wire and with me today is economist and professor emeritus at Jawaharlal Nehru University Prabhat Patnaik. Thank you so much for joining us. We had actually spoken around the same time last year, just after demonetisation happened, and you had said certain things then, so maybe we could revisit some of those. One of the main things you had said was that the stated objectives of demonetisation, particularly the weeding out of black money, would not be successful. Now we know that 99% of demonetised currency – which is a lot more than the government expected – is back in the system. But even now, finance minister Arun Jaitley is making statements claiming that demonetisation was a success. And he’s also been saying that people didn’t really understand the objectives of demonetisation, and that’s why there has been criticism. So what would you say to that?
Prabhat Patnaik: You know actually, he has been making a number of statements which I find quite worrying, because I don’t believe a responsible public functionary should be using such utterly specious arguments. One of things he said when it turned out that 99% of the currency had actually come back to the banking system is that ‘No, our idea was not that this currency would not come back, but we just wanted to flush out the system so that this currency actually surfaces’. Now I don’t see how flushing out the system in any way really affects the whole question of black economy, black operators, black money, etc – there’s just no connection. But on the other hand, he used that argument.
Then he used the argument – some time ago in a press conference – that because currency in circulation is now less by Rs 3.8 lakh crore, that is symptomatic of the fact that the economy is now managing with less currency, and that that shows that really illegal activities have gone down. Now, there’s no connection between the currency-GDP ratio on the one hand and the magnitude of illegal activities on the other. Some of the economies with the highest cash-GDP ration, like Japan for instance, are not countries that are particularly well known for corruption, while there are a number of Third World countries where corruption is rampant, which also have very low currency-GDP ratio, so there is no connection.
Secondly, even the figure he’s said, of the currency reduction, is a figure which turns out is no longer correct. In fact, the magnitude of currency with the public is growing very rapidly. It’s growing much more rapidly than the magnitude of deposits, which basically means that remonetisation is not yet complete, and consequently even the figures he gave that time no longer hold, within days of his press conference.
So all these specious arguments are being used, but as a matter of fact, demonetisation has singularly failed to meet any of the objectives that it had set out to meet.
JS: One of the other things that is being said now is that demonetisation will make future tax evasion more difficult, because of all this money that is now in the banks. What do you think about that?
PP: No, but you know, if you have, for instance, exchange of old currency notes for new currency notes, then how is that going to affect tax evasion anyway? And as a matter of fact now, there’s 10% less of currency as compared to what was the case a year ago. But I think the rate at which the demand for currency is growing, you’ll actually find that within a very short time, if the government decides not to deliberately reduce the currency supply in the economy, then you’d find actually that currency supply would have gone back to the old level. So I don’t see how changing old notes for new makes any difference to the question of tax evasion or black money or anything.
JS: Some people have also said that the government may have meant well, even if they didn’t perhaps, like you say, meet their stated objectives, and that’s because the banks allowed some corrupt practices and so demonetisation didn’t work the way it was supposed to. Do you see any merit to that kind of argument?
PP: No, I think it was an utterly and completely mindless act. What does it mean to say the government meant well? I mean, we don’t know what the government meant. But basically, they put forward a set of arguments and undertook a set of measures which were completely pointless. It was a completely mindless exercise which put large numbers of people through great difficulty – some died. It has given a really blow to the economy. So what does it mean to say they meant well? I mean, the way to hell is paved with good intentions, and we don’t even know what the intentions were. That is really no argument.
JS: Like you said, and several others have also argued, it has been a blow to the economy. Would you also say it’s been a blow to the banking sector?
PP: Well, the banking sector of course has been suffering from a number of blows, I think the non-performing assets are a major blow, which again I believe is because the banks were made to give loans to all kinds of projects for infrastructure and so on, perhaps at the behest of the government. But let’s leave that aside. The basic thing is that if suddenly you have a huge influx of deposits into the banking system on which interest has to be paid, and credit off-take is not very much, then the banks would make losses. So effectively then, what happens is that the banks then go to the Reserve Bank of India through what is called it’s reverse repo window, and then exchange this extra currency for extra securities, which basically means that banks can manage their incomes, but at the expense of the Reserve Bank. And since the Reserve Bank’s income is the government’s income, basically then the government subsidises banks from its fiscal resources in order to hold these deposits which have been impounded from the public for a completely mindless exercise.
JS: One of the other things you had predicted after demonetisation last year was that the impact on the informal economy would not be just transient but would extend into the medium term as well. Would you still stand by that?
PP: Yes, absolutely. In fact, I think there is a bit of a misconception about it. Many people think that the impact on the informal economy can be judged only on the basis of what is happening to the figures of GDP growth. I think that’s wrong for two very obvious reasons. One is a kind of statistical reason. Let us say if you have a reduction in the informal sector’s growth rate by 1% – now the informal sector, say agriculture accounts for only about 15% of the weight in the GDP. So a 1% fall in agricultural growth rate would actually mean a 0.15% fall in the overall GDP growth rate. But the 1% fall in the GDP growth rate means half the population of the country that is engaged in agriculture is experiencing a 1% fall in its income. So looking at the overall GDP growth rate in any case is misleading.
But the second thing is that quite often, what the informal sector does and has done in this case is that it has managed to survive by taking loans. Let’s say the peasant: he has to sow the next crop. As a result, in the absence of cash, what he does is take a loan from the seed seller or pesticide seller or whatever. So the debt has gone up greatly. In fact, there have been reports that in the Green Revolution states, where the peasants really do this kind of multiple cropping and so on, the peasantry has been driven into deep distress because of demonetisation. And the debt has a lingering effect, because that actually is a stock phenomenon, not just a flow. It has a lingering effect. So I still stick by the statement that I had made that it has actually dealt a blow to the informal economy which is much greater than is measurable by looking at just GDP growth figures.
JS: Another thing that people have said is that if you look at GDP and you say that it’s a little under 6%, okay maybe it’s a little lower than it was, but it’s still one of the fastest growing economies, so maybe it’s not so bad. But a lot of people, including former Prime Minister Manmohan Singh, have said demonetisation will have led to an increase in inequality in India. And that’s something that you just alluded to as well. So what kind inequality is it that we’re talking about here?
PP: You know in any case, there is a huge inequality between those dependent on the informal sector – I’m talking about the workforce – and the workforce outside of the informal sector. Just take a very simple fact: if half the population is engaged in agriculture, which accounts for only 15% of the overall GDP, that basically implies that the per capita income in the agricultural sector is just a fraction of what it is outside. So that is already there. Therefore generally, those engaged in the informal sector are among the poorest in the country and certainly there is a huge gap between them and those who are engaged outside of it. Therefore anything that deals a blow to the informal sector is simultaneously a blow being dealt to some of the poorest people in the world. And we know this from a number of observations, case studies, reporters who have gone: migrant workers who have gone back to their villages, for instance, who are among the poorest. This is a huge blow for them. Therefore the poorest in the country have really suffered the most from this demonetisation.
JS: Do you see anything positive that has come out of this move whatsoever?
PP: No, I don’t see anything positive that has come out of it. I just think that it was a measure that was adopted because the government wanted to show that it could adopt all these macho measures – shock and awe, etc. It was a mindless measure, and I think it has dealt a blow to the economy and now all kinds of efforts are being made to use specious arguments to show ‘no no’. And what is more, all kinds of marginally positive things are being read into this measure. But fundamentally, I have yet to come across any argument that actually tells me that something good has come out of it; any persuasive argument.
JS: So you mentioned a lot of negative impacts that we’ve seen over the last year, and the Narendra Modi government has come under a lot of criticism for its handling of the economy recently. What are the immediate steps – both immediate and medium term – that you think the government could take to combat some of this, and do you think they’re planning to do anything about it?
PP: Well because immediately after demonetisation, the fact that they introduced the GST in such a hurry shows that the government is much more interested in actually presenting this macho image of someone who is capable of doing fantastic things rather than really thought out measures. You know, things like the economy must not be mucked around with just like that, in order to create impressions, in order to display ones attitudes. So the point is that GST, for instance, is something that is going to affect the informal sector – is already affecting the informal sector – badly. I think again there is a lot of misunderstanding about it, I think this misunderstanding is apparent to my mind even in what Rahul Gandhi is saying. What you have is that compared to before, there is now a greater taxation on the informal sector. Now whether you have 18% as a common rate or whether you have 28%, or whether you have four rates, five rates, makes no difference to it. In fact if you have a uniform 18% tax rate, then the informal sector also would be taxed at 18%, which is perhaps what Rahul Gandhi is saying.
So this whole impact of GST in a fundamental sense on the informal sector is something which is missed out. As a result, I think in the economy now, the government is dealing blow after blow to the informal sector. I think to some extent they have this wrong idea that formalisation of the economy per se is a very good thing. Now if the economy got formalised on its own, through its own development, that’s one thing. But if you actually forcibly get the economy to be formalised, that basically occurs by dealing [a blow] to the informal sector. Now that is what is wrong, because those who are affected by it, there’s no cushion for them, they are not going to get jobs anywhere else. As a result, they just go under.
JS: And do you think there is something that the government could do now to reverse some of these negative impacts?
PP: Yes of course, the point is that there are many things you can do. For instance, to start with there is a big recession. The first thing that they can do is to make sure that the cash shortage is overcome. Even to this day, as I said remonetisation has not been completed. So complete remonetisation. Provide help to the informal sector; as far as agriculture is concerned, the steps that can be taken are well known. You have a crisis occurring in cash crops? Provide remunerative prices to the growers of cash crops. Provide low-interest loans to the growers of the cash crops. And so on.
Earlier, what used to happen – I’m saying even before the neoliberal policies got going – what used to happen is that the state aided what I would call the petty production sector in very many ways to survive. Through giving assured prices, through giving subsidies, through protecting them from world market price fluctuations and so on. All those cushions have been removed, as a result this is a sector that is now being buffeted around by the so called market forces, which basically means being encroached upon by the large capital, the formal sector, and so on. And I think providing them succour by protecting them against such encroachments is the way to revive them and through that, the economy itself.
JS: Right. Thank you so much for your time.
PP: Thank you.