(Bloomberg) -- The man who predicted the 2008 global financial crisis also presaged the damage Prime Minister Narendra Modi's unprecedented cash ban would cause to India's economy.
Raghuram Rajan was governor of the Reserve Bank of India in February 2016, when he was asked by the government for his views on demonetization, according to Rajan's book "I do what I do", the first time he's spoken about his experience in the country.
"Although there may be long-term benefits, I felt the likely short-term economic costs would outweigh them, and felt there were potentially better alternatives to achieve the main goals," he wrote in the book. "I made these views known in no uncertain terms."
The central bank then prepared a note outlining costs, benefits and other options available, as well as detailing the preparation that would be needed and the time it would require.
"The RBI flagged what would happen if preparation was inadequate," Rajan said. "At no point during my term was the RBI asked to make a decision on demonetization."
Outspoken Behavior
Rajan left the central bank last September after unnerving political leaders with his outspoken nature. Several months later, Modi blindsided the nation by scrapping 86 percent of currency in circulation, saying the move was essential to unearth unaccounted wealth and fight graft. Since then, speculation has raged over who thought up the policy, with the debate getting more divisive last week as a slew of data showed demonetization contributed to a growth slump without meeting its targets.
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This wasn't the first time that Rajan had warned against demonetization. Back in 2014, when the matter hadn't yet been broached by the government, he was asked at a public lecture for his views about invalidating currency bills. He replied that holders of unaccounted wealth find ways to divide their hoard into many smaller pieces, and much of this is typically in the form of gold, making it harder to track.
"It's not that easy to flush out the black money," Rajan had said, using the local term for cash stashed away illegally to avoid tax. He added that he'd rather focus on the incentives for black money, such as tax rates.
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Modi's government initially predicted about a third of the 15 trillion rupees invalidated wouldn't be deposited into banks, indicating that while honest tax payers would line up to return their bank notes, others would prefer to give up their wealth rather than risk investigation. However, an RBI report on Wednesday said 99 percent of the bills had been returned.
Growth Slumped
Data the following day showed Indian growth slumped, supporting surveys that claimed the cash ban devastated small businesses. More than 1.5 million jobs were said to be lost and newspapers reported deaths linked to the decision.
Gross domestic product rose 5.7 percent in April to June, the slowest pace since 2014 and less than the 6.5 percent predicted in a Bloomberg survey. Investors are awaiting the Nikkei Purchasing Managers' Index for services due 10:30 a.m. Indian time after data last week showed the manufacturing gauge recovered in August from a contraction the previous month.
"In the medium term, benefits including increased tax compliance and financialization of savings will likely play out," Teresa John, Mumbai-based economist at brokerage Nirmal Bang, said in an Aug. 31 report, referring to the cash ban. "But the key question is whether such a drastic measure was required to achieve these objectives."
--With assistance from Sunil Jagtiani
To contact the reporter on this story: Unni Krishnan in New Delhi at ukrishnan2@bloomberg.net.
To contact the editors responsible for this story: Ruth Pollard at rpollard2@bloomberg.net, Jeanette Rodrigues, Nicholas Reynolds
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