The Big Reverse Read online

  The Wall Street Journal captured the rumours circulating in Lutyens’ Delhi:

  Demonetization has resurrected fears that the ruling Bharatiya Janata Party takes policy advice from quacks. It damaged the credibility of India’s central bank... It also shows how susceptible Mr Modi and his aides are to the unorthodox ideas of assorted cranks and oddballs from the Hindu nationalist movement to which the BJP belongs. The loudest backers of demonetization include a telegenic yoga guru, a chartered accountant best known for propounding the homespun economic philosophy of ‘swadeshi,’ or self-reliance, and a nongovernmental organization that wants almost all taxes to be replaced by a single levy on bank transactions.24

  It does not take much imagination or powers of deduction to arrive at who the Wall Street Journal is referring to as the telegenic guru, the chartered accountant, and the non-governmental organization. Anyone who had watched the brouhaha during the initial days of demonetization about the brilliant minds that sparked the idea and inspired the Prime Minister would easily recognize these entities.

  Over the course of the next few months, various media reports25 suggested that Hasmukh Adhia, the Revenue Secretary in the MoF, and a few others were the core members of the planning team. They were reportedly supported by a young team of researchers, who worked from a few rooms in the Prime Minister’s residence.

  Adhia, a chartered accountant and graduate from IIM Ahmedabad, also had a PhD in yoga from the Swamy Vivekananda Yoga University, Bangalore. A Gujarat cadre IAS officer, he had earlier served as principal secretary and additional chief secretary in charge of finance while Narendra Modi was Chief Minister of Gujarat. It was rumoured in Lutyens’ Delhi that though he formally reported to the Finance Minister, in reality, he had a direct line to the Prime Minister. Minutes after the demonetization announcement, Adhia tweeted from his own handle: ‘This is the biggest and the boldest step by the government for containing black money. It is like a surgical strike on black money.’

  In November 2017, he was elevated as the Finance Secretary. The person he replaced, Ashok Lavasa, was reportedly also involved in the planning of demonetization.26 A former Madhya Pradesh cadre IAS officer, he was appointed as an Election Commissioner in January 2018, following his retirement.

  A third member of the core team was believed to be Shaktikanta Das, the then Economic Affairs Secretary.27 A Tamil Nadu-cadre IAS officer with roots in Odisha and a postgraduate from St. Stephen’s College, he had spent almost a decade in the North Block, India’s Ministry of Finance. Post-demonetization, Das became the ‘public face’ of the MoF, fielding questions from the media and holding press conferences to announce and explain the convoluted rules and their frequent changes. On his retirement in November 2017, Das was appointed India’s G20 Sherpa.28

  Whether these three senior officials were in fact part of the core planning team or not, is hard to confirm. However, there is no doubt that the Prime Minister himself was the principal architect of the move. Press reports stated that three ministers who had attended the Cabinet meeting on 8 November 2016 shortly before demonetization was announced, shared that the Prime Minister had said, ‘I have done all the research and, if it fails, then I am to blame.’29

  When Did the RBI Board Approve the Demonetization Decision?

  Speaking in the Rajya Sabha on 16 November 2016, the Union Power Minister, Piyush Goyal, while defending demonetization, asserted that the ‘the Reserve Bank of India (RBI) runs the monetary policy of the nation and this decision was taken by the RBI board.’

  In the absence of the minutes of the Board’s meeting, which RBI has to date refused to make public, all that can be reliably said about when the decision was made and who made it, is drawn from the RBI’s written submissions to the Parliament’s PAC and Parliamentary Finance panel.

  The PAC was informed that demonetization was under discussion between the government and the RBI for ‘some months’, following which the proposal was placed before the Central Board of RBI on 8 November 2016 for consideration.

  Separately, in a note later submitted to the Parliamentary Finance panel (headed by Congress Member of Parliament Veerappa Moily), the RBI said that on 7 November 2016, the government of India sent them a letter stating ‘to mitigate the triple problems of counterfeiting, terrorist financing and black money, the Central Board of the Reserve Bank may consider withdrawal of the legal tender status of the notes in high denominations of `500 and `1,000.’ Based on this letter, the Central Board of the RBI convened a meeting on 8 November 2016 at 5.30 p.m., for the withdrawal of the legal tender character of the `500 and `1,000 notes.30

  As reported in the PAC submission, Governor Patel, two Deputy Governors, R. Gandhi and S.S. Mundra, and five independent directors of RBI, Nachiket Mor (National Director for the Bill and Melinda Gates Foundation); Bharat N. Doshi (former Board Member and CFO of Mahindra and Mahindra); Sudhir Mankad (former Chief Secretary of Gujarat); Shaktikanta Das (the Secretary, Economic Affairs, MoF); and Anjuly Chib Duggal (the Secretary, Department of Financial Services, MoF) attended the board meeting. Of the other two Directors, Deputy Governor N.S. Vishwanathan did not attend the meeting as he stayed back in Mumbai for ‘strategic reasons’ (to brief the bankers first-hand, immediately after the decision on demonetization was taken). Another director, Natarajan Chandrasekaran (the then CEO and MD of TCS, and present Chairman of the Tata group of companies) was abroad.

  In an article dated 21 January 2017,31 Reuters stated that a copy of the private testimony to a Parliament panel, seen by them, showed the RBI had also warned the government of ‘possible inconvenience to the public for some time’ among the potential consequences of the massive exercise. Despite its own doubts, the testimony showed that the RBI board approved the plan to ban `500 and `1,000 notes, as it believed the move would rein in counterfeiting and reliance on cash, and pull unaccounted cash out of the financial system.

  Reuters further disclosed that the testimony went on to state, ‘It might not immediately be possible to replace these notes fully in terms of both value and volume,’ but the RBI board ultimately believed that ‘corrective’ action could be taken and decided to recommend the move. The RBI board also believed the impact of such an exercise would be ‘transitory’, given its efforts to quickly replace the old notes. The document also noted that the proposal to ban the cash had come from the government in a letter, a day before the announcement, that advised the RBI to ‘immediately’ put the plan before its board for approval.

  After receiving the sign-off from the RBI board and obtaining his Cabinet’s approval, on 8 November, Prime Minister Modi announced demonetization in his address to the nation at 8 p.m. on the same day.

  The submissions by the RBI to the PAC and the Parliamentary Finance panel, as well as the Reuters report, appear to contradict minister Goyal’s assertion in the Parliament that it was the RBI who made the demonetization decision. Instead, it appears that the RBI and its Board of Directors were merely passive facilitators.

  Where Is the Demonetization Dividend?

  In the first few days following demonetization, there was the euphoric expectation, fuelled by overeager television anchors, that the exercise would flush out `3–4 trillion (i.e., `3–4 lakh crores) of black money. The belief was that black money hoarders, shocked and surprised by the move, not knowing what to do with all their ‘old notes’ and fearing income tax raids, would burn or drown their ill-begotten wealth.32

  The logic was that this money would, therefore, never be returned to the banks. The difference between the notes demonetized and the notes returned to the banks would be the black money extinguished from the system. Many quickly assumed that this would be a profit that the government could appropriate to use as it wished, and this amount popularly began to be referred to as the Demonetization Dividend.

  Convinced of the absurdity of this argument, I wagered a glass of lime juice with one of India’s most reputed economists during a panel discussion on national television. I said that
there would be no Demonetization Dividend, and further, any money not returned to the banking system could not legitimately be appropriated as profit by the government. He disagreed and asserted that at least 25 per cent of currency demonetized would never return to the banks. Later, as data emerged, he was gracious enough to acknowledge that he was wrong!

  The Attorney General, Mukul Rohatgi, representing the government of India in a spate of petitions against demonetization, predicted that this number could be even higher. On 16 November 2016, he told the SC bench of Chief Justices T.S. Thakur and D.Y. Chandrachud: ‘About `3.25 lakh crore has been deposited with banks by people and the government expects the total to go up to `10–11 lakh crore by March 2017 end.’ He added, ‘In all likelihood, `4–5 lakh crore may not come back to the banks.’33

  Before long, the nation was speculating on how this Demonetization Dividend would be spent: infrastructure projects; recapitalizing India’s PSU banks; social security schemes for the poor – many creative ideas were floated.

  This became a topic of much spirited debate. The most popular notion was that the Prime Minister would use this dividend to deliver on his 2014 election promise of crediting each citizen’s account with ‘recovered’ black money. In ATM queues and markets across the country, people started saying: ‘If not `15 lakh, at least we will get `15,000… if not everyone, at least the Jan Dhan account holders will!’

  The next question was how the Demonetization Dividend would be transferred from the RBI to the government and indeed how the RBI itself would account for it.

  C. Rangarajan34 (RBI Governor, 1992–1997) swiftly sounded a cautionary note, stating categorically, ‘This is basically a balance sheet problem and it is not a profit in any sense of the term. The reduction in the liability side will be matched by the reduction in the asset side. There is no capital gain or capital loss as far as the RBI is concerned. Therefore, I would really say that there is no scope for any extra dividend to be declared to the government.’35

  D. Subbarao36 (RBI Governor, 2008–2013) made several important legal and accounting points on the same subject:37

  All currency issued by the RBI carries a promise by the Governor to pay the bearer a sum equivalent to the value of the currency. This is a legal obligation…Will the RBI treat ‘the promise to pay’ as a continuing liability and transfer an amount equivalent to the wealth destroyed to a special reserve? Or will it treat this as an extinguished liability and account for it as ‘profit’?

  Subbarao also raised a very important question that remains unanswered. ‘Can the RBI withdraw from its sovereign obligation to honour its promise to pay the bearer of an Indian currency note?’

  The views of former Governors Rangarajan and Subbarao served to dampen the enthusiastic plans of the ruling party’s spokespersons of appropriating the Demonetization Dividend, though these were only finally laid to rest as it became apparent that practically all the currency demonetized had been returned to the banking system.

  In August 2018, the RBI confirmed that 99.35 per cent of the currency demonetized had been returned to the banking system. Only `10,720 crore had not been returned, a far cry from the `3–4 lakh crore that had been enthusiastically anticipated. This amount could reduce further, as there are a large number of demonetized notes being held by various district central cooperative banks (DCCBs) which had not yet been accepted by the RBI due to pending cases before the Supreme Court.

  The actual dividend finally declared and transferred to the Central Government by the RBI for FY 16–17, was only `30,659 crore as compared to `65,876 crore in the previous year, a decline of 53 per cent. Reflecting the ongoing costs of demonetization, the RBI report for FY 17–18 showed that income in 2017–18 continued to remain lower than in each of the three preceding years, while costs remained twice as high. As a consequence, the `50,000 crore dividend declared for FY 17–18 was even lower than that declared in FY 13–14.38

  Interestingly, the RBI’s 2018 Annual Report also confirmed Subbarao’s view that the money not extinguished remained an ongoing liability of the central bank, and hence transferred it to a special reserve, stating:

  An amount of `107.20 billion, representing the value of SBNs which has not been paid on June 30, 2018 and was forming part of liability head ‘Notes issued’, has been removed from balance of ‘Notes issued’ and transferred to specific head created for the purpose under ‘Other Liabilities and Provisions’. All future payments of exchange value of SBNs to eligible tenderers under the Rules framed by the Government of India will be made out of the specific head.39

  Far from being a blockbuster, the Demonetization Dividend turned out to be a wisp of smoke.

  Dissenting Notes

  One of the earliest dissenting voices to be raised against demonetization from the RBI family was that of K.C. Chakrabarty, a former Deputy Governor of the RBI.40

  Countering the chorus of sycophantic voices that praised demonetization as a visionary and bold step that would transform India, his views were lucid and clear:41

  It has no economic rationale. It does not serve any purpose. Demonetization is a very blunt instrument, and it has to be used very judiciously and in a very very critical situation. Generally, in a normal situation, it doesn’t give any results. The economic benefit is less and the cost is more. It is necessary to have a very effective pre-planning.

  Explaining that demonetization cannot tackle the menace of black money, Chakrabarty said,

  What is black money? No notes are black. All notes are white. It is the process that creates the black money. When a person does not pay tax, it becomes black money. What we are killing is the note. We are not catching people who have not paid taxes. For that you have the Income Tax department, but they are not doing their duty. The poor hoard cash. The rich, who don’t pay taxes, don’t keep the black money under their pillows.

  On the argument that demonetization would stop the menace of counterfeit notes, he said,

  The person who is counterfeiting the existing note will counterfeit the new notes also. How many counterfeit notes are there? It’s 10–20 in one million. If you purchase dal from the local kirana store and, in the dal, there are some stones, you will pick out the stones, clean the dal and then cook. You never throw away the dal.

  Accurately forecasting the problems that citizens and the economy would face, he said,

  The economy will suffer because liquidity has been sucked out. You have stopped market transactions for 70 per cent of the economy. The poor will suffer more. To withdraw his/her own money, the poor person has to stand in the queue. Ninety per cent of the poor’s liquidity is in cash, so they have no cash. All your trade and commerce are likely to be affected. Already, we can see that farmers and small businesses are hit.

  Speaking of the cost to the banking system, Chakrabarty said, ‘The total cost of replacing the notes will be `10,000 or 15,000 crore. That is a direct loss. Then the banks will be doing only this job for the next two months: exchanging the note, managing the cash, managing the crowds. People will be more busy with these things. All this will have an adverse effect on the economy.’

  He also revealed that a demonetization proposal had come from the UPA II government. ‘After examining the proposal, we had said that this should not be done. The proposal never went to the board level… We said “no” because it does not serve any purpose… the cost is high and the benefit is less.’

  Finally, asked whether the government and the RBI would be able to finish the work by 30 December, within the 50-day period requested by the Prime Minister, he said, ‘It depends on the efficiency of the government and the RBI… It depends on the capacity of the (printing) press. When I was in the RBI, and if that is the position, it will take six months to print the currency notes. Whether they have made any advance preparation or they started printing early … I don’t know.’

  The Reverse Bank of India

  As the demonetization saga unfolded, the RBI issued a stream of notifications and am
endments that got more confusing with each passing day. The RBI became the butt of jokes on mainstream media and social media, and mockingly began to be referred to as the ‘Reverse Bank of India’.42

  A total of 63 notifications pertaining to demonetization were issued by the RBI during 8 November–30 December period, and a further five between 1 January and 30 March 2017. A list of these notifications is attached in Appendix 3. These were in addition to the Standing Orders issued by the Department of Economic Affairs (DEA) in the MoF – which were often contradictory and compounded the confusion.

  The first Standing Order by the DEA, S.O. 3407(E), stipulated the rules for depositing and exchanging SBNs and prescribed limits of how much cash individuals could withdraw from their bank accounts.

  The second notification, S.O. 3408(E), listed the transactions for which demonetized notes could continue to be used. On 8 November, this was a list of eight, during the course of the demonetization period, it was expanded eventually to 20 types of transactions. Initially intended for a period of only two days, the exemptions were extended first till 24 November and then till 15 December. As reports started surfacing that people could be using these exemptions to get rid of black money, fresh notifications were issued, restricting permission to use old notes to pay for fuel and electricity, and limiting the use of demonetized notes at petrol pumps and airline ticket counters to 3 December rather than the previously announced 15 December deadline.

  The third, S.O. 3409(E), notified the new `2,000 banknote as legal currency under Section 24(2) of the RBI Act. However, someone had not done his homework. This was the wrong section as the government gives the RBI the authority to issue banknotes under Section 24(1). So, this had to be changed the next day!

  In S.O. 3410(E), banks were instructed to submit reports listing the amount they held in demonetized notes. This notification also had to be amended the next day, because the names of SBI and several cooperative banks and nationalized banks had been omitted.