4 years of Demonetisation

Why in NEWS ?

• Prime Minister Narendra Modi on the fourth year of implementing demonetisation, which is aimed at flushing out money hidden from the taxman, known as black money, said "Demonetisation has helped reduce black money, increase tax compliance and formalization and given a boost to transparency."

About

• Echoing PM's thought, Finance minister said demonetisation led to better tax compliance and push towards digital economy.
• Meanwhile, Rahul Gandhi slammed govt over demonetisation, alleging that PM Modi's move was aimed at helping few of his 'crony capitalist friends' and had 'destroyed' Indian economy.

Meaning of Demonetization

• Demonetization is the act of stripping a currency unit of its status as legal tender.
• It refers to the decision of the government to revoke the legal tender status of a currency note.
• It occurs whenever there is a change of national currency.
• The old unit of currency must be retired and replaced with a new currency unit.
• The opposite of demonetization is re-monetization where a form of payment is restored as legal tender.
• Once the currency note is demonetised, it cannot be used anymore.
• Central banks all over the world follow a practice where older currency notes are revoked and new currency notes with better features are issued.

Background

• The government under the PM Narendra Modi on November 8, 2016, had announced that the largest denomination of Rs 500 and Rs 1000 were demonetised with immediate effect ceasing to be a legal tender.
• The government introduced new notes of Rs 2,000 and Rs 500 .
• There was also no change effected in any other form of currency exchange like cheque, Demand draft (DD), payments made through credit cards and debit cards.
• The move was taken to curb the menace of black money, fake notes and corruption by reducing the amount of cash available in the system.
• This move led to widespread impacts across all the sectors of the economy.

Demonetising Acts in India

• India opted for demonetization two times before the 2016 monetisation.
• The first instance of demonetisation by the government was implemented in 1946 when the RBI demonetised Rs 1,000 and Rs 10,000 notes.
• Later, higher denomination bank notes (Rs 1000, Rs 5000 and Rs 10000) were re- introduced in 1954.
• However, the Morarji Desai government demonetised these notes in 1978.
• According to data provided by RBI Rs 10,000 note was printed in 1938 and 1954 and was subsequently demonetised in 1946 and 1978 respectively.

What were the main motives behind 2016 Demonetisation?

• Government and RBI had many intentions behind this.
• The major objectives of the demonetisation drive are as follows:
  I. Curb Corruption: Cash and corruption are correlated. By reducing the cash circulation one can control the corruption as well.
  II. Eliminate Counterfeiting/Fake currency: The Annual Report of RBI shows that during the year 2016-17, Rs 41.5 crores worth of fake currency notes in the form of old Rs 500 and Rs 1,000 notes were detected in the banking system. The estimate of the total fake currency in the system was Rs 400 crores.

Effect of Demonetisation in India

A. Pros of Demonetization

• DeMo has rung in a climate of tax compliance, even if through coercive means.
• According to the Finance Minister, an additional 9 million people have come under the tax net.
• The growth in the direct tax base.
• The government is also aiming to raise its revenue collection.
• The menace of black money can be controlled to some extent.
• The black money adds to the inconspicuous demand and hence the inflation to some extent will be under control.
• The elections are usually associated with black money generation and circulation, with this scheme the funding of elections through nefarious ways will be hit.
• Terror financing, using black money for illegal activities, etc took a hit.
• Over 200,000 shell companies have been deregistered.
• Real estate shenanigans have been reined in.
• Real estate is one of the major sources of black money generation. With this move, it is expected that the property market rates may bottom out or moderate.
• The counterfeit currencies which have an impact on the real economy estimated to be rooted out.
• The mobilization of deposits in the banks will increase, which may lead to increased credit flow and lowering of lending rates.
• The increased use of digital payment as it’s a major step by the government towards forming a cashless economy
• It is expected that with this move the Fiscal Deficit of the government may come down.
• The switch in the financial holdings of households from cash to bank deposits

B. Cons of Demonetization

• The main negative economic consequence of demonetisation has been the disruption of unorganized supply chains that are dependent on cash transactions.
• Growth has been slowed down since Demonetisation as leads to decline in economic growth to a three year low of 5.7 per cent.
• GDP growth in Q1 of 2017-18 was at 5.7%, against 7.9% in 2016.
• RBI report had revealed that nearly 99% of the scrapped currency notes had come back to the banks, and it would become 100% if cash in the pipeline is accounted for.
• For one all the black money is not stored in the form of cash only and secondly, the measure takes care of the result but not the cause-black money is generated mainly because of corruption and tax evasion. This measure controls the usage of black money but cannot control the causes
• Panic amongst the common man, already the panic has led to people hoarding currencies which have further reduced the liquidity in the market
• The disruptive impact of the withdrawal of cash on supply chains and inventories.
• The rate of loss of jobs registered in the trade sector and industries was “almost” 55% in the two months after the note ban.
• The job loss is significant in the middle-age group (40 to 50), among people with limited options. Job creation was zero in November-December 2016.
• Though cashless transactions prevailed initially, cash transactions have returned. The major reasons for this are connectivity issues with POS, the transaction charge and security concerns.
• Government projects that it achieved a lower cash-to-GDP ratio of 9% after demonetisation, from over 12% earlier. It was said that a 12% cash-to-GDP ratio for India is too high, when compared with other countries, seemed to be incorrect as the comparison is not valid as India has a large informal sector and its cash needs are also higher.
• A lower cash-to-GDP ratio could mean that the informal sector has shrunk due to demonetisation thereby needing lower cash. This again indicates rise in unemployment.
• The small trade/shopkeepers faced difficulties in conducting business.
• Terror Funding - Since demonetisation, the number of infiltration attempts in the Valley has reached a high, Pulwama attack in 2019 is one of them. In the theatres of Left Wing Extremism, more security personnel have been killed in Naxal attacks but in fewer incidents, which have dropped 21%.

C. Impact of demonetization on rural economy

• Rural sector was affected the most with 2.3% growth in Q1 2017-18, against despite record food grain output in 2016-17.
• The hardest-hit were those in rural areas, where access to banking and the internet are quite low.
• A 2016 Reserve Bank of India (RBI) report on branch authorization policy classified 93% of rural centres in the country as unbanked, with the population dependent on roving banking correspondents and on distant urban or semi-urban branches.
• Access to the internet is equally patchy, with only 3% of households in underdeveloped rural access to internet in a 2016 consumer economy survey.
• The liquidity squeeze led to a pile-up at wholesale markets, leading to a sharp decline in the Wholesale Price Index (WPI) of perishables such as fruits and vegetables in the immediate aftermath of demonetisation.
• By turning farm markets into buyers’ markets, demonetisation may have also contributed to the decline in prices of pulses
• Rural consumer sentiment too took a hit, with domestic sales of two-wheelers plunging sharply.
• New project announcements declined sharply in the wake of demonetisation, a Centre for Monitoring Indian Economy (CMIE) analysis showed, hurting the capex cycle

Conclusion

• Demonetisation was brought into effect with the major intend of curbing black money, containing terror funding, making a cashless economy etc. but without proper implementation and awareness among the masses which resulted in panic across economy and resulted into more cons than pros.
• Tax reforms and effective monitoring of suspicious transactions could be a viable alternative for resolving the issues that the policy-makers sought to fix through demonetisation.
• Another benefit is that digital transactions have become more common. But financial savings in the form of currency notes have also increased, which means that people still value cash. To conclude in the words of the ex-RBI governor, Raghuram Rajan, “the demonetisation is not a well-planned or well-thought-out, useful exercise”.