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World steps up to study India's cash ban while Modi looks away

New Delhi

INDIAN Prime Minister Narendra Modi's administration hasn't assessed the impact of one of history's most sweeping changes in currency policy.

"No, Madam," was the Indian junior finance minister's reply to a lawmaker's question in Parliament on Dec 14 on whether the government had studied the after-effects of the move in November 2016 to invalidate almost all of the country's currency overnight. One of the chief aims of the exercise was to curb corruption in Asia's third-largest economy.

The decision to look away from demonetisation may be an attempt to distance authorities from what's since been termed "a total failure" and a "draconian" act. However, economists all over the world have dug through the rich trove of data, and here's what they found about the monetary shock that still lingers over India's economy, politics, society and markets.

  • Gabriel Chodorow-Reich, economics professor at Harvard University and his colleague Gita Gopinath, now chief economist of the International Monetary Fund, wrote in a paper along with Goldman Sachs Group Inc's chief India economist Prachi Mishra and the Reserve Bank of India's Abhinav Narayanan that it was comparable to a 2 percentage point tightening in the key policy rate and reduced economic activity by at least 3 percentage points in the months immediately after.

However, the decline in output was relatively smaller and wasn't fully seen in national gross domestic data, given that these numbers don't completely capture India's vast informal economy.

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They called for deeper evaluations of the long-term consequences of demonetisation.

  • Frederick Betz, Timothy R Anderson and Aurobindh Kalathil Puthanpura at Portland State University used the exercise to test the validity of monetary theory. They wrote that the move supported the Chartalist School, which holds that there are crucial differences between currencies in an economy.

The withdrawal of so-called Fiat Money, which is currency issued by a government, reduced the availability of Commodity Money, which is used in trade and commerce. The gap could not be filled by Managed Money, the term used for organised finance, because a large portion of the population lacked bank accounts and the government was slow in replacing currency bills.

It's clear policymakers didn't consider how money interacts in India, they wrote. "Was it bad implementation of good policy or bad implementation of bad policy? It was both."

  • Rikhil R Bhavnani and Mark Copelovitch, associate professors of political science at the University of Wisconsin-Madison, say: The economic impact was felt most acutely in relatively "unbanked" and cash-dependent areas.

Still in elections held soon after, Mr Modi's Bharatiya Janata Party was penalised the least in relatively unbanked districts. This shows that a substantial share of voters supported demonetisation despite its negative economic effects.

If Mr Modi hadn't framed demonetisation as a fight against corruption, there might have been a loss of support for the BJP.

  • Dhammika Dharmapala and Vikramaditya S Khanna, law professors at the universities of Chicago and Michigan, assessed the stock market and concluded that the markets always knew that demonetisation would have only a "modest at best" impact on curbing corruption.

"There is little evidence that sectors thought to be associated with greater tax evasion or corruption experienced significantly different returns." However, banks gained as investors pencilled in the prospect of bigger deposits and state-owned firms also rose. The latter may be due to perceptions of future corruption at government-backed firms that are seen as particularly prone to graft.

Economists from Cambridge, Harvard and Stanford on communication said that implementation of the policy was marked by chaos and confusion as policymakers announced and revised decisions daily.

When there is common knowledge about how information is delivered - press conferences from distant Delhi, in the case of demonetisation - providing more people with information deters their willingness to ask questions and can actually reduce knowledge. BLOOMBERG

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