Shock therapy can work, even in India, but not without leaving some burn marks. The World Bank’s latest India Development Update attempts to make another assessment of the impact of the Narendra Modi government’s demonetisation experiment. It does not shy away from saying that demonetisation caused considerable distress among informal sector workers in general. But its general conclusion is that ‘notebandi’ had many more pluses than minuses and its negative fallout was limited. Part of the reason for this, however, was simple luck: A normal monsoon helped cushion the rural economy.
The report interestingly looks at the velocity of M1 money supply, a way to measure the number of transactions in cash, bank accounts and normal places people keep their money. The velocity fell from 5.7 to 5.6 between the last quarter of 2016 and the second quarter of 2017. This would be expected but the fall was remarkably small, indicating that a national inclination for jugaad found ways around the lack of physical banknotes. The bank predicts a sharp rebound in velocity in the coming quarters.
The report repeats what other studies have shown, that India’s GDP growth rate dipped but only marginally during the demonetisation period. It estimates GDP growth rate was at 7.3% in the first half of the fiscal year and dropped a mere one-third of one percentage point in the second half. However, like everyone else who has come out with such a figure, the bank admits it has no clear means to calculate the impact on the informal sector. But certain parts of the formal economy proved quite resilient: Air travel by the urban middle class was wholly untouched by ‘notebandi’.
There are clues to the degree of turmoil in the informal sector. Demand for jobs in the formal sector by February, for example, matched the entire demand of 2016. This is a clear sign of how many jobs were lost during demonetisation. However, this also underlines a key advantage of demonetisation, at least if it is merged with a widespread digitisation of financial transactions: It is helping push India out of the shadow of its black economy.
Formalisation of the economy has numerous gains: It means better wages and conditions for workers, greater revenue for government, less corruption and more transparency, and higher productivity and investment levels overall. There are many who speak in favour of the informal sector. But the poor man’s economy has a crucial flaw. Because of its static productivity and technology levels it keeps its inhabitants in poverty. If India’s economy is substantially whitened, demonetisation will be remembered as the act that began the process.
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