Political Punishment and Financial Safety Nets: Evidence from India's Demonetization

Abstract

We analyze the electoral consequences of India’s 2016 ‘demonetization’: a unique policy that unexpectedly made 86% of the currency-in-circulation redundant overnight, and led to severe cash shortages in the subsequent months. We leverage a discontinuity in the number of bank branches arising from a nationwide district-level bank expansion policy, instituted by the previous government in 2005. We first document that the impacts of the branch-expansion policy around the cut-off were meaningful: areas just above the cut-off had fewer bank branches, less outstanding credit, and households were less likely to report having bank accounts. Importantly, these effects strongly persisted in 2016, when the demonetization policy was instituted. As districts with fewer banks had greater cash shortages, we identify the impacts of demonetization at the bank-expansion cut-off. Regression discontinuity estimates show that following demonetization, places with fewer banks had lower economic activity, as measured by nighttime lights, and voters reported having less favorable views on demonetization. Using electoral data and a difference-in-discontinuity design, we find that in elections following demonetization, the ruling party did relatively worse in regions with discontinuously fewer banks, receiving a 4.7 percentage point lower fraction of votes. We finally show that voters that were historically strongly aligned with the ruling party, are nearly unresponsive in voting behavior, despite having a less favorable view of the policy itself.