November 2016 Demonetisation: Lasting Impact on Indian Economy

 

Demonetisation means withdrawing the legal tender rights of any denomination of currency. Units of money have deprived the status of legal tender. Demonetisation is an act of taking away the legal tender rights of any currency. The units of currency will not be considered as valid currency.

Demonetisation is the process of ceasing a unit of money of its status as legal tender. Demonetisation is a necessary condition for changing the old currency with the new units of money. It may involve the introduction of new notes or coins of the same denomination or completely new denomination.

The currency has been demonetised thrice in India. The first demonetisation was on 12th January 1946 (Saturday), second on 16th January 1978 (Monday) and the third was on 8th November 2016 (Tuesday).

The government believe that this currency ban is required for the four main reasons. To control inflation, to fight against corruption, to remove counterfeit currency and to discourage the cash transaction.

Developing country like India has to find the solution to come out of the problems like this for the betterment of the country. The government needed to keep the decision secret so that the tax evaders would not be aware of this clean-up mission before the announcement of demonetization takes place.

Why Demonetisation:

The demonetisation effort being led by PM Modi in India is appreciable to an extent but follows positive as well as negative aspects. The aim is to wash the stock of “black money” out of the economy and get it into the banked and taxable part of the economy.

“Cleaning of the black money is a very positive step. However, certain things will happen as a result of this. Transactions will now begin to move to white economy through the banking system which means there will be surge in bank deposits. Even savings in terms of deposits will go up.”

Many renowned personalities like politicians, businessman, and so on have huge reserves of black money either in India or abroad. All the notes of are in high – value denominations.

Now with the news of demonetisation they will be forced to deposit their black money into the banks, after submitting their PAN or Aadhaar or Passport number, to get new currencies.

This will help the government to catch the culprits and keep an eye on all the fraud people who are helping them in converting their black money into white money.

Though this move causes some difficulties for the common people because banks and post offices do not have sufficient amount of cash. People are facing lot of problems with the old currencies.

They have to make long queues either to deposit their money or to exchange them. Moreover, the ATMs are not updated yet.

The shopkeepers and the others are refusing to take 2000 rupee note because they don’t have sufficient amount of small denomination currencies.

The government is taking necessary steps to upgrade the ATMs and printing new currencies at a very high speed so that it reaches the people without making any more chaos in the market.

The sudden stop in the availability of currency has led to a liquidity shock to the people in the nation. Lack in currency of Rs.500 and Rs.1000 has disturbed economic activities such as consumption, investment, production, employment etc.

Reasons of Demonetisation:

1.   Black money:

Demonetisation was a bold and revolutionary action taken by the government of India to curb black money and one that will have the deep impact on the parallel economy in the country.

Pockets and persons with black money can be identified with this move. A few businesses like property dealers, jewellers, foreign currency dealers, private money lenders generally hold huge amounts of unaccounted money in form of currency notes.

Such unaccounted money had created a parallel economy in the country. Such illegal money has reached the bank accounts through direct or indirect channels.

2.   To hit the fake currency rackets:

Fake Currency Notes have been wasted by the demonetisation. Withdrawing highest currency notes out of the economy will have a serious impact on the fake currency syndicates, thus putting an end to the terror funding in Jammu and Kashmir, Naxalite hit states and North-eastern states.

The fake currency with racketeers have been left in vain, and new currency notes with high security; making a counterfeit impossible. Demonetisation was a surgical attack on a fake currency circulating in the economy. Demonetisation has converted those fake currency notes into a mere piece of papers.

3.   Online transactions:

Demonetisation's motto was to encourage the cashless/digital economy. More and more cash-less or less-cash transactions will lead to more disclosure of income which will increase the direct tax collections.

With a reduction in cash transactions, alternative forms of payment will more in demand. Electronic mode of payment like online transaction, payment through applications, E-wallets E-banking, usage of debit and credit cards etc. will surely see the substantial increase in demand.

4.   To hit Maoists:

This step actually made money with Maoists worthless. As reported Maoists had hoarded over Rs.7000 cores with them at Baster in Chhattisgarh. All such currency is now nothing but pieces of papers.

5.   Rise in GDP:

Though demonetisation has negatively impacted sectors such as real estate and property, construction, and household consumption in general, it is believed that long-term benefits for GDP growth will outweigh the short-term transitional impact. We are now heading towards a 9% GDP growth by FY2018-19.

Issues and Challenges of Demonetisation on Indian Economy:

Demonetisation technically is a liquidity shock; a sudden stop in terms of currency availability. It creates a situation where lack of currencies jams consumption, investment, production, employment etc.

Demonetisation is not a big disaster like global banking sector crisis of 2007; but at the same time, it will act as a liquidity shock that disturbs economic activities. Following are the main impacts:

1.   Welfare loss for the currency using population:

Most active segments of the population who constitute the “base of the pyramid‟ uses currency to meet their transactions. The daily wage earners, other labourers, small traders etc. who reside out of the formal economy uses cash frequently.

These sections will lose income in the absence of liquid cash. Cash stringency will compel firms to reduce labour cost and thus reduces income to the poor working class. There will be a trickle up effect of the liquidity chaos to the higher income people with time.

2.   Consumption will be hit:

When liquidity shortage strikes, it is consumption that is going to be adversely affected first.

Consumption ↓→ Production ↓→ Employment ↓→ Growth ↓→ Tax revenue ↓

3.   Loss of Growth momentum:

India risks its position of being the fastest growing largest economy: reduced consumption, income, investment etc. may reduce India’s GDP growth as the liquidity impact itself may last three -four months.

4.   Impact on bank deposits and interest rate:

Deposit in the short term may rise, but in the long term, its effect will come down. The savings with the banks are actually liquid cash people stored. It is difficult to assume that such ready cash once stored in their hands will be put into savings for a long term.

They saved this money into banks just to convert the old notes into new notes. These are not voluntary savings aimed to get interest. It will be converted into active liquidity by the savers when full-fledged new currency supply take place.

5.   Impact on black money:

Only a small portion of black money is actually stored in the form of cash. Usually, black income is kept in the form of physical assets like gold, land, buildings etc.

Hence the amount of black money countered by demonetisation depend upon the amount of black money held in the form of cash and it will be smaller than expected. But more than anything else, demonetisation has a big propaganda effect.

People are now much convinced about the need to fight black income. such a nationwide awareness and urge will encourage government to come out with even strong measures.

Positive Impacts of Demonetisation on Indian Economy:

In what could be termed as the mother of all reforms, Prime Minister Modi’s demonetisation move will have far reaching implications. This is not to dispute that the transformative step has brought some hardship for the citizens, but those are temporary and will blow over soon.

For the larger benefit of the nation, we the citizens can bear such hiccups with a smile. After all, this is how we as citizens can contribute in policy making and nation building. While bank employees are working overtime to make Modi‟s ambitious demonetisation drive a success. Let’s discuss its many-fold impacts:

1.   Black money:

At one stroke the Prime Minister has choked the supply of black money stacked inside the country. Of the Rs 17 lakh crore of total currency in circulation in the country, black money is estimated at mind-boggling Rs 3 lakh crore.

Black money is nothing but a plunder of the nation. Black money operators run a parallel economy which shakes the very foundation of the Indian economy. With Modi’s demonetisation move, all domestic black money will either be deposited into the banks with heavy penalty or be simply destroyed.

2.   Economy:

Demonetisation will have a huge resultant effect on the Indian economy. The clean-up of illegal cash will help turn around the economy. First, it will bring more borrowings to the exchequer, improve inflation outlook and increase India’s gross domestic product (GDP).

Second, it will revive investment opportunities and give a fillip to infrastructure and the manufacturing sector. Third, it will help reduce interest rates and lower income tax rate.

3.   Note bank politics:

In the run up to the crucial assembly elections in Uttar Pradesh, Punjab, Goa and Uttarakhand, Prime Minister Modi’s demonetisation announcement has come as a shock and awe for the political parties and politicians for whom black money is a lifeline.

The pulling out of the old Rs 500 and Rs 1,000 currency notes will help make the election process clean and transparent. But it has brought tough times for the political parties and politicians who believe in the idea of purchasing votes in exchange for notes.

That is precisely the reason a rainbow coalition of a galaxy of regional parties and the Congress is building up against Modi, because their political interests are badly hurt.

4.   Real estate cleansing:

It is said that real estate is an industry built on black money. The extent of black money floating around in the sector is huge. According to an estimate at least 40 per cent of real estate transactions in Delhi-NCR are in black.

Modi’s demonetisation move will curtail the flow of black money into the real estate sector. This will help in making the much needed correction in the sector. The impact: An unexpected dip in land and property prices.

Conclusion:

If the money disappears, as some hoarders would not like to be seen with their cash pile, the economy will not benefit. On the other hand, if the money finds its way in the economy it could have a meaningful impact.

However, experiences from different countries shows that the move was one of the series that failed to fix a debt burdened and inflation-ridden economy.

 

Written by – Sakshi Chauhan