Had cautioned government against hasty demonetisation: Raghuram Rajan
13 Apr 2018
Former Reserve Bank of India Governor Raghuram Rajan has reiterated his views that India’s demonetisation exercise was not a good idea and its implementation was ill-planned, adding that he had cautioned the government about it, when the idea was brought up.
"Demonetisation I think was not a well-planned, well thought-out, useful exercise. And I told the government that when the idea was first mooted. It seemed to me that people would find their way around," Rajan said at the Harvard Kennedy School in Cambridge on Wednesday.The Indian government on 8 November 2016 demonetised Rs500 and Rs1,000 notes with the aim of reducing untaxed or black money in the system, removing counterfeit currency and an attempt to curb terrorism. (See: All existing Rs500 and Rs1,000 notes denotified).
"At the time of demonetisation, it was 87.5 per cent of the currency value. Any macroeconomist would say that when you are demonetising 87.5 per cent of the currency, better make sure that you print 87.5 per cent or pretty much close to that. India went into it without having done that," Rajan said.
"So it had a negative economic impact. But also the idea was that somehow people who had money stored in the basements, without having paid taxes on it, would sort of overnight see religion, come to the government and say sorry we were hiding these stuff, let me pay taxes on it. That was to some extent naive. Anybody who knows India knows that very quickly we find ways around the system," he added.
“I didn’t ever say that I wasn’t consulted (on demonetisation). In fact, I have made it quite clear that we were consulted and we didn’t think it was a good idea,” said Rajan who is currently the Katherine Dusak Miller distinguished service professor of finance at The University of Chicago’s Booth School of Business.
Rajan, who had expressed similar views immediately after demonetisation, said essentially the money that was scrapped came back to the system, "but it did not have the direct effect that was sought that a lot of people will pay taxes".
"There may be some longer term impact that people think that if this sort of thing happens, that the government is serious of collecting taxes, there may be greater tax payments, but we still have to see strong evidence that that is true," the ex-governor said.
"So the negative economic impact of people not having currency, not being able to pay, economic activity plummeting, especially in the informal sector - that happened. A lot of people probably lost their jobs; we do not count that well because it is the informal sector.
"The positive impacts are out there in the future, we do not know whether they will be important and to my mind, it was not a policy that was useful at that time."
He estimated the cost of demonetisation to be between 1.5 and 2 per cent of GDP.
"I do not think there is huge amount of dispute about it. I don't think even the government necessarily challenges that and it would be a really diehard government advocate who would say that growth benefits of demonetisation were immediate."
Talking about the non-performing assets and multi-crore Punjab National Bank scandal, Rajan said the worry is some of the banks still follow an antiquated system.
"The worry is systems are not adequate to prevent rogue dealers, rogue employees colluding and making off with stuff," he said.
Regarding the newly introduced Goods and Services Tax, he said, "GST implementation, we will figure it out eventually. It would be nice if we can implement it much better than we do. But it is not an unfixable problem, we can work on it. I won't give up hope on that at this point of time."