Why demonetization was a ‘failure’
Households forced to surrender all their currencies in large denominations now keep much more of their net savings in cash, not less. (Photo file)
The final tally by India’s central bank of Prime Minister Narendra Modi’s 2016 demonetization campaign – intended to remove tax evasion money from circulation – showed that 99.3% of large banknotes prohibited values had been returned. This is a serious loss of face for those in charge, who had argued that the holders of the money would rather destroy it than return it to the banks, which was a boon to the government.
The authorities have presented a number of arguments to defend the initiative. One in particular was attractive to financial markets: the idea that demonetization, in the words of Finance Minister Arun Jaitley, “appears to have led to an acceleration in the financialization of savings.” Households that traditionally kept their savings in cash would now prefer to invest the money in other instruments, perhaps even the stock market, thus increasing the amount of capital available for businesses to deploy and banks to lend, thus stimulating the economic growth.
There were certainly indicators to support the idea. On the one hand, Life Insurance Corp of India saw a 142% increase in premium collection during the month of demonetization. Indian stocks have had a record run, although foreign investors have been net sellers so far this year.
Unfortunately, the Reserve Bank of India also made a hole in this assumption. Its annual report, along with the tally of demonetization results, provided a breakdown of savings by household, a category that includes unregistered small businesses. It turns out that the net financial savings for the fiscal year ended March 31 was 7.1% of overall disposable income – less than the average for the five years before demonetization.
Worse yet, perhaps households keep a lot more of their net savings in cash, not less. And their net savings to banks are almost 50% below the five-year average before demonetization. In other words, the idea that the crackdown would leave banks overflowing with capital they could lend to productive parts of the economy has been completely debunked.
What is happening? Some have argued that falling interest rates are the problem. It’s not an easy sale: Over the past year, India was one of the few countries with strongly positive real rates – and savings on bank deposits made up a higher fraction of income available in 2012-14, when Indians faced a real negative. interest rate.
Perhaps, on the contrary, a change in behavior is responsible. For most Indians, the defining experience of demonetization was losing access to their bank accounts: we had to queue at ATMs, and our withdrawals were strictly rationed. In contrast, those who had stacks of old banknotes seemed to be able to change them easily (at a discount determined by the black market).
What would you teach you? Would you trust a banking system that can be shut down on a whim? For many Indians, demonetization provided their first experience with banking or digital payments. I just hope the madness of the process hasn’t pushed them away forever.
Still, you could say, at least the markets are doing well. This reflects the greater willingness of households to put their savings in stocks, doesn’t it? And indeed, the RBI data suggests it.
But take a closer look and things aren’t that bright. One of the reasons why domestic institutional investors – who have injected US $ 10 billion (327.8 billion baht) into Indian markets so far this year, while foreigners have withdrawn US $ 280 billion (9.2 trillion baht) – are optimistic is that they believe in structural change. how Indians save is ongoing. They think we are definitely moving away from cash (and gold and real estate). A shift towards financialization means ever higher stock prices.
However, central bank data suggests we shouldn’t be so sure. Heights scaled by Indian markets could prove fragile.
Whatever the impact on the savings behavior of the demonetization, it is clear that the initiative has been a political failure, even on the administration’s own terms. I would like to think that a lesson has been learned.
Not so fast: the government has just appointed one of the brains behind the 2016 project to the board of directors of the central bank. India’s era of misguided interventions may not be over.– BLOOMBERG NOTICE
Opinion editor for Business Standard
Mihir Swarup Sharma is Opinion Writer for Business Standard.