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Former CEA speaks up: Demonetisation was a ‘massive, draconian monetary shock’

PW Bureau

In his soon-to-be-released book, Of Counsel: The Challenges of the Modi-Jaitley Economy, Subramanian says that demonetisation accelerated the slide in economic growth New Delhi: The latest person to now train their guns on the Modi government’s decision to ban higher currency notes is none other than former Chief Economic Advisor (CEA) Arvind Subramanian. Speaking up against the move that invalidated 86 percent of the total currency in circulation overnight, he said that demonetisation was a “massive, draconian, monetary shock.” In his soon-to-be-released book, Of Counsel: The Challenges of the Modi-Jaitley Economy, Subramanian has devoted an entire chapter to demonetisation: The Two Puzzles of Demonetisation — Political and Economic, a news agency reported. The book is an account of Subramanian’s rollercoaster journey as the CEA to the government of India from 2014 to 2018 and is expected to hit the shelves on December 5.

"In the six quarters before demonetisation, growth averaged 8 percent and in the seven quarters after, it averaged about 6.8 percent"

“Demonetisation was a massive, draconian, monetary shock: In one fell swoop, 86 per cent of the currency in circulation was withdrawn. The real GDP growth was affected by the demonetisation. Growth had been slowing even before, but after demonetisation, the slide accelerated,” Subramanian wrote. According to the former CEA, the popular vote is not divided over whether demonetisation slowed growth, but about the size of the impact — whether it was 2 percentage points or less, since several other factors had affected growth in this period, especially GST, oil prices and higher real interest rates. “In the six quarters before demonetisation, growth averaged 8 percent and in the seven quarters after, it averaged about 6.8 percent (with a four quarter window, the relevant numbers are 8.1 per cent before and 6.2 per cent after),” he added. While he claims not to have a strongly-backed empirical view he points to the fact that the welfare costs, especially on the informal sector, were substantial.

"Understanding the political economy of demonetisation may require us, therefore, to confront one overlooked possibility — that adversely impacting the many, far from being a bug, could perhaps have been a feature of the policy action."

“When a shock like demonetisation occurs, that primarily affects the informal sector, relying on formal indicators to measure overall activity will overstate GDP. This hypothesis goes only a small way towards explaining the puzzle since any squeeze in informal sector incomes would depress demand in the formal sector, and this effect should have been sizable,” he is believed to have written in the book. “Understanding the political economy of demonetisation may require us, therefore, to confront one overlooked possibility — that adversely impacting the many, far from being a bug, could perhaps have been a feature of the policy action. Not necessarily by design or in real time, but in retrospect, it appears that impacting the many adversely may have been intrinsic to the success of the policy,” Subramanian reportedly summed up. Even though the former CEA touched upon the issue of demonetisation, he remained tight-lipped on whether he was consulted by the government on the crucial decision or not — a charge levelled by the Opposition for long. Subramanian was appointed as CEA on October 16, 2014, for a three-year term and was given an extension last year. However, although his official contract was till May 2019, he resigned in July due to “pressing family commitments.”