Demonetization: Wrong ‘Panacea’ For The Wrong Disease?


Demonetization may be much pain, little gain – just 7% of black money may be affected by demonetization. This even if we assume large sums are declared as income and taxed, and 18% (!) of high denomination currency is burnt or destroyed. Moreover, without targeting Real Estate and Gold holdings, there can be no real targeting of black money.

Modi’s intent has been clear right from his swearing in. The setup of the SIT, subsequent saber rattling, and the recent domestic and international IDSs have signaled the kind of war on the parallel economy that no political dispensation was willing to wage till now.

The PM would like to believe that the biggest of black marketeers are lining up to exchange a meager Rs4,000 while the poor are sleeping peacefully. Ideologies aside, it is useful to look at the utility of demonetization objectively. Many analysts consider the move to be detrimental to large sections of the economy. Some amount of demand, some sections of trade, some portions of the economy are now considered seriously impaired. This sounds alarmist but has some basis given that a large part of the population (maybe as much as 80%) works in the informal sector. Some leading economic analysts are placing the damage at around 50-100bps of GDP growth this year. Besides, there are plenty of logical arguments being made on how black money cannot be considered a stock (demonetization targets only a stock) but a flow, for which systemic and gradual solutions are needed, not shock treatment.

About the only two things everyone can agree on is that it was a bold move, and that everyone did a great job of springing the surprise. So how much is all this disruption and demand loss going to net us? Not much from the looks of it. Here, I try to work down from the GDP⇒Black Money⇒Black Cash⇒Demonetization Benefit:


* Latest estimates are from Ambit, which put it at 20%. Friedrich Schneider in “Shadow Economies and Corruption All Over the World: What Do We Really Know?” puts it at 23-26%. I’ve assumed 30% on the higher side.

From this black pie piece of ~Rs40.2 lac crores, there have been recoveries through raids and declarations. Adjusting for that:


So based on estimates, the net stock of black money after all recoveries in last couple of years through raids, surveys, and declarations is about Rs39.1 lac crores. This ‘black money’ can be estimated to be held as:


  1. India’s Cash/GDP ratio is 13%. Since black money is ~30% of GDP, it is assumed that black cash is also ~30% of total high denomination (1000s/500s) currency.
  2. Real Estate is ~15% of GDP. It is assumed that ~50-60% of the value is black given that 35-50% of property transactions and 75% of land transactions take place in cash (per experts, pan-India average).
  3. Gems & Jewelry is around 6-7% of GDP. It is assumed that most of this is based on cash generated through unaccounted income.
  4. Others is the balancing figure and would represent overseas deposits (estimated by BJP in UPA days at $500bn!), stock in trade, foreign currency notes, etc.

The total domestic black cash thus can be estimated at ~Rs4.5 lac crores.


Making some assumptions about what could happen with this cash pile with demonetization:

  • Say ~10% or Rs44,944 crs actually gets tendered to tax, earning the Government ~Rs15,730 crs as income tax @35%
  • A SBI report suggests that ~Rs2,50,000 crs worth of high denomination currency may actually get extinguished. I have used this estimate, though it appears unrealistically high.
  • ~34% gets deposited as legitimate cash. The Government continuously reiterates that deposits below Rs2,50,000 will not be questioned.

Thus, we have:44

So what will it take to deposit this large sum of Rs1,54,492 crs? Not much it seems. Even assuming the lower threshold of Rs50,000 (which is the maximum limit for Jan Dhan accounts), just 3.1 cr Jan Dhan accounts are needed to make the mark. Sounds like a lot? It isn’t.


It seems just 12% of the Jan Dhan accounts out there are enough to cover the remaining black cash. Just 12%! Reports of Jan Dhan account holders’ coercion by black marketers have already started floating in.

Against this (potential, uncertain) benefit, you have the disruption to growth/trade, Rs12,000 crs of currency printing costs, unquantified logistics and overtime costs that have been lumped on to banks for no fault of theirs, and dozens of avoidable, directly attributable deaths.

A few things that come out starkly from this:

  1. Even making these generous assumptions about currency extinguishment and declarations of income, just 7% of black money in annual GDP will be affected by demonetization (declared as income + assumed extinguished).
  2. Gaming is a reality. The above analysis shows that just 12% of the total Jan Dhan accounts are sufficient to cover the balance black cash, even after considering the reduced maximum permitted balance of Rs50,000 (as against Rs2,50,000 of permitted deposits). A sizable amount will end up getting deposited in regular accounts too.
  3. Without targeting Real Estate and Gold holdings, there can be no real targeting of black money. This makes sense: Cash isn’t safe, land/property is. Gold doesn’t deflate, perish or get demonetized, currency does. The hard, unaccounted cash is usually held for a purpose, which could be commerce or nefarious. Besides, if gold and property holdings had been targeted ruthlessly, the poor would’ve slept a lot more peacefully!
  4. Most of all, we do need to bear in mind that this minuscule 7% too is exaggerated in a sense. As a percentage of total black money stock, the recoveries would not even register. For eg. if we were to assume that total black money stock at market value is say 2x GDP (conservative estimate), the recoveries are 1.1%!

This is purely a numerical estimation of the immediate benefit (many assumptions, still more estimations). However, the estimates above are consistent with independent analysis quoted by P.Sainath here, and the insightful interpretations of Arun Kumar, an eminent economist who has closely studied the black money problem for decades. To specifically quote him:

“Of Rs 13 lakh crore, at least half would be used in businesses: petrol stations, railway stations, airports, etc. What may be held in households may be only 5-6 lakh crore [rupees]. Now, assuming that the top 3 percent of the population owns much of the black wealth, that would amount to only Rs 1.5 lakh held per person. So the immobilised cache of black money is just Rs 2-3 lakh crore.”

There will doubtless be some long term gains. People will move towards electronic payments and feel obligated to come within the system, the signs of which are already appearing. So is demonetization symbolic in that sense? Certainly. Is it effective? Certainly not in the sense it has been sold in.

Demonetization seems like a war on black money. A war with collateral damage moving up high in the objectives list.

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