Neither Modi, nor Jaitley, nor those in PMO or Finance Ministry had any idea about the immediate after-effects of demonetisation

By Venkateshwar Rao jr
Prime Minister Narendra Modi and Finance Minister Arun Jaitley can continue to indulge in the rhetoric of demonetisation, but the Reserve Bank of India’s Annual Report for 2016-17 tells an absorbing story of economic disaster management. Modi’s November 8, 2016 televised announcement of withdrawing Rs 1000 and Rs 500 notes from circulation was nothing but an act of bravado, meant to take the bulls of black money, counterfeit currency and terror funding by the horns as it were, but basically an empty attention-grabbing gesture.
Neither Modi nor his government had any clear idea about the extent of counterfeit currency, black money and terror funding in the money circulating in the system. It is quite unlikely that the government would put the information in public domain for sanctimonious reasons of state even if it had specific information at the time.
But the information about currency in circulation and the money available in the banks is known through the Reserve Bank of India’s weekly statistical supplements. On March 31, 2016, the currency with the public was Rs 15,972.5 billion, and on November 11, 2016 it was Rs 15,262.3 billion. It was at a high of Rs 17,013.8 billion on October 28, 2016. It came down to Rs 9,119.1 billion on November 25.
And the bank’s annual report for 2016-17 says that currency in circulation declined by Rs 8,997 billion on January 6, 2017, “which resulted in a large increase in surplus liquidity with the banking system, equivalent to a cut in the CRR by about 9 per cent.” (CRR or cash reserve ratio is the mandatory cash that the banks have to maintain apart from their daily turnover.)
The bank used “unconventional measures” like market stabilisation scheme (MSS) by issuing securities of short-term duration. Apparently, the bank had asked the government to increase the limit on issuance of securities from Rs 300 billion to Rs 6,000 billion. Cash management bills (CMBs) under MSS were used between December 2, 2016 and January 13, 2017. And the bank managed to deal with excess liquidity in the system. “With fast paced remonetisation surplus liquidity in the system declined by mid-January 2017,” the bank’s annual report notes.
It looks like that neither Modi nor Jaitley nor those in the Prime Minister’s Office (PMO) or those in the Ministry of Finance seem to have had any idea about the immediate after-effects of demonetisation. The RBI identifies five phases in the post-demonetisation period to deal with the flood of liquidity in the banking system unleashed by demonetisation. In the first phase, from November 10, 2016 to November 25, 2016, the RBI used various measures of reverse repo. That is, the central bank borrowed money from the banks which were now flush with cash at variable and fixed rates.
According to the bank, it absorbed Rs 5,242 billion on November 25, the peak. In the second phase, from November 26 to December 9, the bank absorbed up to Rs 4,000 billion through Incremental Cash Reserve Ratio (ICRR) of 100 per cent, which meant that banks’ CRR rose from existing 4 per cent to 8 per cent and more. In the third phase, from December 10, 2016 to January 13, 2017, the bank it used Cash Management Bills (CMBs) under the Market Stabilisation Scheme (MSS), and it took in Rs 7,956 billion on January 4, 2017.
In the fourth phase, from January 14, 2017 to end-March,2017, the bank fell back on the traditional reverse repo to drain the excess liquidity from the banks. This measure peaked on March 6, 2017 with the bank absorbing Rs 5,522 billion, and it declined to Rs 3,141 billion by the end of March. But the bank report says that surplus liquidity persisted through March as a result of which the government maintained cash balances and the banks kept excess CRR.
In the fifth phase, beginning with the new financial year in April 2017, the bank anticipated that surplus liquidity will persist through 2017-18, the bank provided for MSS and reverse repo measures of up to Rs 1 trillion and it had auctioned Treasury Bills for Rs 1 trillion in April and May, 2017.
There is an interesting twist to the story of demonetisation. While post-demonetisation witnessed unprecedented excess in liquidity, the period from April,2016 to November 8, 2016, the RBI injected Rs 2.1 trillion to move from liquidity deficit of Rs 813 billion in Quarter 1 from April, 2016 to June, 2016 to a liquidity surplus of Rs 292 billion in Q2 (July, 2016 to September,2016) and to a surplus of Rs 64 billion in Q3 (October,2016 to November 8,2016).
The tacit assumption behind the demonetisation argument was that there was excess liquidity in the system, which the subversive elements were manipulating, and therefore there is a need to drain that excess. It turns out that the assumption was wrong. There was no excess liquidity in the system. And the RBI’s statistics reveal the exact volumes of liquidity in the system. While Prime Minister Modi revelled in demonetisation, the RBI had to step in and carry out remonetisation operations and that too in double quick time.
And the bank assures, “The continuing increase in currency in circulation on the back of remonetisation is likely to reduce the magnitude of the liquidity overhang during the course of the year.” The disruption, and let us be clear that there was nothing clear about it, that Modi has caused through demonetisation had to be repaired by the RBI through the remonetisation measures. The argument for a less-cash economy is so much of baloney. It is possible to split hairs about cash and liquidity, and how they are not the same, and how draining out cash from the system is not the same as creating a liquidity crunch.
The RBI report makes it clear that there is not much of a theoretical difference between the two, and less cash translates into less liquidity. The banks cannot handle too much liquidity or cash, and people cannot do with less cash. And there is a moral in all this: Fools venture where angels fear to tread!