Demonetisation update 25 – banks under the lens

My friend Praveen Chakravarty had written a good piece in Bloomberg Quint putting the RBI Governor under the microscope. I tried to rework some of the numbers he presents. I got slightly different results.

This is what he wrote:

the percentage of high denomination notes in circulation has actually been constant at roughly 9.7 percent from 2011 to 2015.

the total value of all banknotes in circulation as a percentage of GDP has come down from 21.1 percent to 11.4 percent in the last five years and did not rise [Link]

I took numbers from RBI Annual Reports and GDP data from their Real time Handbook of Statistics on the Indian Economy (cross-verified with MOSPI data) and this is what I got:

india_currency-in-circulation-statistics

Two differences: Specified Bank Notes (SBN) of 500 and 1000 rupee denominations had gone up since NDA came to office – from 9.57% to 10.44%. They had not stayed roughly at 9.7%.

Second, the ratio of ‘Total Bank Notes in Circulation’ to Nominal GDP (2011-12 basis) had indeed remained in the range of 11.4% to 12.1%. Not come down from 21.1% to 11.4% in the last five years.

But, overall, the piece calls for rigour in public policy decisions. One cannot argue with that.

I only wish that the UPA government was rigorous when it announced farm loan waiver in December 2007. But, even then, we only could have commented ex-post. We could not have asked questions of whether really poor farmers took loans, who would benefit and by how much and whether it could have been done differently by setting thresholds for eligibility, whether any quid pro quo could have been asked of the loan beneficiaries (productivity, irrigation – just thinking), etc. That farm loan waiver had moral hazard written all over it.

Indeed, if demonetisation was about short-term pain and potential long-term benefits, that one was the opposite: short-term relief and potential long-term costs. I had mentioned this in my cover-story for ‘Swarajya’ (December 2016 – ‘The Great Gamble’).

Also, in that cover-story, I had mentioned the following about the growth rate in counterfeit currency:

Over the seven years from end of March 2006 until March 2013, the compounded annual growth rate of fake currency notes in India was 21% and that of soiled currency notes was 5.6%. The government was right to be concerned with the growth (flow) rather than the stock of fake currency notes.

I still think that the decision was not so unreasonable. It is definitely debatable and has become more so, especially in the light of the execution challenge. The scale of the exercise that India had undertaken was also clear in the number of currency pieces (as they call it in RBI) that are in circulation in India, compared to other  countries – more than ten times greater than the second placed America:

currency-pieces-in-circulation-in-india_international-comparison_2012-13

Source: Currency management in India – issues and challenges, Keynote address by Dr K C Chakrabarty, Deputy Governor of the Reserve Bank of India, at the Banknote Conference 2014, Washington DC, 8 April 2014 (http://www.bis.org/review/r140424d.pdf)

So, the larger question is whether it is RBI or the public – do we really get to preview or comment? Should the government engage in a consultation process for such important and massive decisions? Not that they would have done so in this particular case. But, the question of whether they consulted widely or not would remain – even if only in private.

Another friend forwarded this important news from MINT – that PMJDY accounts could not have been used for money laundering.

That makes the question of how so much money came back and accepted into the banking system, even curiouser!

So, banks have made these mistakes – deliberate or otherwise:

(1) Giving out lots of new notes to select customers
(2) Accepting any amount of old money from the public without question
(3) Not loading ATMs with enough cash and preferring to distribute
them through branches.

Therefore, a logical question is the extent to which the so-called execution snafus were really exacerbated by the above three aspects of the conduct of banking staff.

All the more reason that a disruption to the public sector model of banking in India is overdue or should have preceded the currency swap exercise, as I had argued in my column in MINT on Tuesday.

Now that the currency swap exercise is water under the bridge, what more needs to be done for the decision to bring long-term rewards to the economy – on the corruption front and on the informality front? That is the critical question.

Could those measures have been done without demonetisation? Or, will they have happened in the normal course of business?

My guess is that, in theory, YES but in practice, only crises focus minds. By creating a ‘crisis’ of short-term growth and employment, the government has given itself an opportunity to make major structural decisions. Why let a ‘crisis’ go waste? Will they?

(postscript: Karthik Shashidhar has an informative article in MINT on the use of electronic payment systems after November 8)

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