Subramanian calls demonetisation was a massive, draconian shock which rendered 86 percent of the currency in the system illegal
Former Chief Economic Advisor Arvind Subramanian called demonetisation a massive, draconian, monetary shock that slowed economic growth to average 6.8 percent in the seven quarters following the move as against the 8 percent average growth recorded in six quarters before it.
He said there is little dispute that demonetisation slowed growth. But the debate has been about the size of the effect, whether it was 2 percentage points, or much less. "After all, many other factors affected growth in this period, especially higher real interest rates, GST implementation and rising oil prices."
And therefore, he said he does not have "a strongly-backed empirical view apart from the fact that the welfare costs, especially on the informal sector, were substantial."
In his new book, 'Of Counsel: The Challenges of the Modi-Jaitley Economy', the former CEA also attempts to understand the political success of the move and the impact of the shocking policy on economic growth.
In a televised address on November 8, 2016, Prime Minister Narendra Modi had announced that the two high-denomination currency notes of Rs 500 and Rs 1,000 would cease to be legal tender. The move that rendered 86 percent of the currency in circulation useless, sent shockwaves across the country.
The move "presupposed an extraordinary amount of resilience in the economy, especially amongst the vulnerable, because it was going to be the first of two major shocks—along with the GST—to affect those in the cash-intensive, informal sectors of the economy," he said.
Subramanian said he thought the visible effects of this step were much smaller compared to the magnitude of the shock.
He demonstrated how cash levels and GDP moved in tandem before demonetisation and yet the movement of the two indicators stayed seemingly unaffected by the sudden drop in the level of cash.
This, he explained could also be due to the manner in which GDP is calculated.
Since there is no timely measure of the informal sector performance, the GDP simply takes into account the formal indicators of the organised sector. This is usually acceptable because both sectors tend to move in a similar way. However, considering an event such as demonetisation would have a greater impact on the unorganised/informal sector, the GDP could have given an incorrect picture.Another theory Subramanian presented was that people continued using Rs 500 notes even after the ban, deferred payments until cash was available, or used informal/electronic modes of credit to get by. This could have mellowed down the effect that demonetisation would have otherwise had.