It is the 12th of November 2019

RBI's Rajan Warned Modi About "Short-Term Costs" Of Demonitization

In what’s likely to be remembered as one of the most spectacular policy failures in recent Indian history, Prime Minister Narendra Modi’s decision to abruptly cancel high-denomination banknotes – a move meant to punish corrupt officials and criminals – instead destroyed the savings of middle- and low-income Indians and caused widespread chaos in the country’s financial system.

And now, less than a year since the “war on cash” was announced, prominent former government officials are speaking out and placing the blame for the policy squarely on Modi’s shoulders, including former Reserve Bank of India governor Raghuram Rajan, who told the Times of India that he had cautioned the government that the short-term costs of demonetization would outweigh the long-term benefits, and suggested "alternatives" to achieve the goal of stamping out black money.

Raghuram Rajan

When Modi announced in November that Rs1,000 ($16) and Rs500 notes would no longer be legal tender, he suggested that corrupt officials, businessmen and criminals — popularly believed to hoard large sums of illicit cash — would be stuck with “worthless pieces of paper”. At the time, government officials had suggested that as much as one-third of India’s outstanding currency would be purged from the economy - as the wealthy abandoned or destroyed it, rather than admit to their hoardings - reducing central bank liabilities and creating a windfall for India’s government. Meanwhile, ordinary Indians would opt to keep more of their money in electronic deposits at their bank, helping to shore up the country’s financial system.

In his new book, 'I Do What I Do: On Reforms Rhetoric and Resolve', an advance copy of which was obtained by the TOI, Rajan says that he first gave his opinion on demonetization orally in February 2016 and, subsequently, RBI submitted a note to the government outlining the steps that would be needed, and the time required, if the government went ahead with it.  

“’The RBI flagged what would happen if preparation was inadequate,’ wrote Rajan, who returned to University of Chicago Booth School of Business as faculty after his term as governor ended.”

Rajan also clarified to the TOI that although RBI was consulted about the policy, at no point during his term, which ended in September, was it asked to weigh in on a decision.

He added that the intent behind the move was good, though it came at a substantial cost to the public. "Certainly at this point, one cannot in anyway say it has been an economic success," he pointed out.

The Indian government has continued to defend the policy, arguing that several other benefits have accrued, from expanding the tax base to an increase in digital transactions.

However, since Modi abruptly implemented his plan in November, India's GDP growth has slowed dramatically. Following a collapse in its Composite PMI, India's Q2 GDP growth slowed to 5.7% during the second quarter, according to data released last week - its weakest since Q2 2014.

In what looks like confirmation of the demonetization’s failure, the RBI’s annual report on Wednesday suggested that most holders of the old currency managed to dispose of it, estimating that banned notes worth Rs15.28tn ($239bn) were returned to the bank. That amounts to 99 per cent of the Rs15.44tn of the old high-value notes that were in circulation when Mr Modi made his announcement, according to the finance ministry.

The government’s critics seized on the RBI’s announcement as evidence of the policy’s failure.

“99 per cent notes legally exchanged! Was demonetisation a scheme designed to convert black money into white?” former finance minister P Chidambaram tweeted.

Rahul Gandhi, de facto leader of the opposition Congress party, tweeted: “A colossal failure which cost innocent lives and ruined the economy. Will the PM own up?”

Many lower income Indians supported the ban because they believed the rich would suffer the worst of its privation. Instead, they became victims of the government’s “good intentions.”

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