INTRODUCTION stripping a currency unit of its status

 

INTRODUCTION

 

The
8th of November of 2016 witnessed a momentous event in the resurgent
Indian economy. Prime Minister Shree Narendra Modi announced in a press
conference at 8 o’clock in the evening that all Rs 500 and 1000 currency notes
would be considered demonetised post midnight of the same day. New Rs 500 and
2000 notes would be introduced in their place. Leading financial news platform
Investopedia defines Demonetisation as the act of stripping a currency unit of its status as legal
tender.
Demonetisation is generally done when there is a alteration in the National
currency. The current form or forms of money is pulled from circulation
and retired, often to be replaced with new notes or coins. This was a huge decision considering nearly 86% of all
the money in circulation in the form of currency notes consisted of Rs 500 and
1000 notes.

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Economists,
politicians and people in general were shocked by the news. India had witnessed
Demonetisation in the past too ( as in 1946 in a hope to penalise Indian
businesses that were concealing the fortunes amassed supplying the Allies in
the WWII. The other time the nation witnessed such an event was in 1978 when
the Janata Party government demonetised notes of  Rs 1000, 5000 and 10000 ) but the Modi
government decision was completely unprecedented given the known fact that it
would jeopardise the phenomenal rate with which Indian economy was growing.

 

The government justified the decision by saying that
the move was aimed to curb the widespread funding of terrorism by pushing all
the counterfeit notes that were in circulation, out of the economy. One more
reason was to try and eradicate black money. The government reported that the
number of Rs 500 notes in circulation had increased by 76% between 2011 and
2016 and Rs 1000 notes had jumped up by 109% all owing to forgery. The Economic
Affairs secretary and the Governer of the Reserve Bank later in the press
conference explained in detail the various aspects of the decision, adding that
the decision to demonetise was made about 6 months prior to the announcement.
The government also imposed a fine of Rs 10000 or five times the amount of
money , whichever was more if anyone was found transacting with the demonetised
notes after November 8.

 

Different countries have tried Demonetisation in
history with USA being the first one to demonetise currency, deeming silver
coins of two-cent piece, three-cent piece, and half dime invalid by The Coinage Act of 1873 but as it led to a
five year long depression in the country, The Allison Act remonetised silver
coins in 1978.

 

The European Union also demonetised the German Marc,
the French Franc and the Italian Lira while switching to a continent wide
uniform currency, the Euro in 2002.

 

The Zimbabwean government in 2015 demonetised its
dollar in an attempt to stabilize the economy as the country was hit by severe
hyperinflation. The inflation rate was recorded to be 231000000% in the year. Zimbabwe
endure the three month long process in order to bring this into control.

 

In India, the move received mixed reactions. Various
leading economists and experts hailed the move as an effective tool against
terrorism and black money. People including Arundhati Bhattacharya (Chairperson
of State Bank of India ), Chanda Kochhar ( MD & CEO of ICICI bank ), Anand
Mahindra, Sajjan Jindal and Kunal Bahl also supported the move. Finance minister
Arun Jaitley said that demonetisation would completely clean the economic
system and paired with the Goods & Services Tax would change the lifestyle
and spending habits of the masses of the nation. Public figures including
Nitish Kumar, Anna Hazare, former President of India Pranab Mukherjee and S Y
Quaraeshi praised the move. Prime critics included the Indian National
Congress, Nobel laureate economist Amartya Sen and Cheif Economist of World
Bank, Kaushik Basu.

 

Demonetisation stirred up a nation wide debate whether
the decision was good or bad with several people in favour and against the
argument.

The problems but, which have been discussed in detail
later, lay in execution of the decision. The nation was hit by severe cash
crisis in the days that followed with the state machinery failing to cope with
the pressure. Read on to find out more.

 

 

 

Intent for Demonetization

As
per the details published in the Gazette of India, there were three basic
intents of government behind demonetization exercise viz.

1.
Eliminate fake currency that was causing adverse effect to the economy;

2.
Unaccounted wealth was largely accumulated in high denomination bank notes of
five hundred and one thousand;

 3. Risk to the security and economy of the
country as fake currency was used to finance subversive activities such as drug
trafficking and terrorism.

 

Agenda of the Government behind
Demonetization

 

The
actual agenda of the government is not in public view and hence not easy to
comment upon but various newspapers, political statements and social media
highlighted few points that were the prime reason behind demonetization.

During
election time, one of the biggest promises of Bhartiya Janata Party (BJP) and
their star campaigner Shri Narendra Modi was to eliminate corruption from India
and bring the black money back from their safe homes abroad. It had to
demonstrate to the general public that it was a sincere commitment and not a
political gimmick. And that has to be done before the next assembly elections
take place in India which were seen as an opinion poll on various initiatives
taken by NDA government under Prime Minister Narendra Modi.

 

Another
theory widely published by different papers and spread on social media was that
elections in five states were fast approaching and the government wanted to put
a check on money in the hands of other political parties that might be used to
influence voters so as to gain power in the states going under election.

A
more rational aspect and point of view of demonetization lies in the higher tax
structure that is considered as root cause of the spread of black money. To
reduce the tax rates, government needed sufficient revenue and an estimation of
about three lakh crore black money coming as dividend to government was really
lucrative for the government to act upon.

 

 

Why did People Support
Demonetization?

 

People
of India faced all sorts of hardships and news, videos and images of people
spending entire day and even nights in front of banks in long serpent like
queues kept coming on daily basis. Over 127 people reportedly died standing in
long queues or from shocks or committed suicides not able to get money for
their needs. People were forced to change even their children’s marriages plans
or lowered down the scale. People were forced to even beg money from others
even for basic necessities as a result of sudden withdrawal of old money from the
system and by putting curb on withdrawals. ATMs ran dry. Business community,
especially whole sale markets and businessmen were the most to suffer as their
most of the transactions were in cash earlier. It was however surprising to
witness that majority of people, though faced such large scale difficulties by
government’s sudden move, supported the Prime Minister’s intent of eliminating
all malpractices from the financial system and bringing transparency in all
financial dealings. This reflects an intent and willingness among people to
come out of the strong clutches of black money and its other formats.

 

The
Prime Minister’s highly effective speeches and connecting demonetization with
patriotism made the general public believe him blindly and support demonetization
in spite of difficulties hoping sincerely black money and its hoarders will be
booked in these fifty days and India will emerge a corruption free nation.

 

 

Opposition of Demonetization

 

However,
not everyone was convinced that it was a step taken in right direction. As the
things worked out after lapse of 50 days period that the Prime Minister had
asked from the nation to change the economy fully, it has turned out that this
change didn’t turn out to be same as planned. For majority of opposition
leaders and general public, it turned out to be a monumental mistake and a step
taken in haste without proper planning and without proper back up to ease
common man’s problem. Prime Minister’s claim of long term benefits is being
mocked by none other than the man credited for economic liberalization in the
country, ex-prime minister Dr. Manmohan Singh, who is world renowned economist
himself.

 

The
father of macroeconomics, John Maynard Keynes said in his work “A tract on
monetary reform” (1923) on page 80 of Chapter 3, that “But this long run is a
misleading guide to current affairs. In the long run we are all dead.
Economists set themselves too easy, too useless a task, if in tempestuous
seasons they can only tell us, that when the storm is long past, the ocean is
flat again.” 2 These lines were quoted by our Ex. Prime Minister Dr. Manmohan
Singh, a highly acclaimed economist and father of Indian economic
liberalization in 1990s in Rajya Sabha while participating in a debate on
demonetization. He said that it is a monumental mismanagement which has caused
great distress to the common man of the country. He further said that Indian
GDP could shrink by 2 per cent due to poor implementation of demonetization.

And
politics apart, his claims seem to be true.

 

While
Reserve Bank of India, in its recent monetary policy review, reduced the
percentage of economic growth substantially and that too when it didn’t take
into account industry figures for November and December post demonetization,
but the World Bank and other leading international rating agencies like Moody
also downgraded India’s economic growth rate. India is no more the fastest
rising economy of the world and has lagged behind China after demonetization,
according to the recent reports.

 

Nobel
Laureate and another leading economist Dr. Amartya Sen has also criticized
demonetization as “despotic action that has struck at the root of economy based
on trust” meaning this is a step as if taken by a tyrannical, autocratic,
dictatorial government. According to him, this step undermines all established
norms and institutions. He mentioned that by declaring promissory notes as
illegal, government has broken the trust of people.

 

 

 IMPACT OF DEMONETIZATION ON INDIAN
ECONOMY

 

Demonetization
has impacted the Indian economy both positively and negatively. But in short
term it has more negative impact than positive, it has affected people life
very badly even and that
was indicated by the Prime Minister himself when he said in his TV telecast
that you will have to suffer pains in the shorter run.

 

NEGATIVE EFFECTS:

The sector that was affected the most because
of demonetization was the industry segment. As reported by the industries like
HINDUSTAN UNILEVER LTD, they had faced a 4 percent decline in its sales volume.
According to the reports the rural markets have suffered more than the urban.
Even the real estate sector has been affected a lot, there were very few buyers
for the real estate properties and not just the real estate market, automobiles
and gold & jewelry sector has also faced problems and to make things worse
steps like minute scrutiny of all transactions of these sectors were introduced
by the Ministry Of Finance And Income Tax Department.

 

Demonetization led to decrease in the demand
due to which there was decrease in the manufacturing of goods. As the withdrawal
of money was strictly controlled by the government and also with each passing
government kept on changing the rules which resulted into low purchasing power
even if people had money in their bank accounts. Industries which primarily run
on cash transactions suffered a lot in this process. Many bank officials also
helped the big fishes to convert their money to white using various dormant
accounts or other means.

 

In fact government failed to catch hold black money as per its
estimation. And to deal with demonetization people came up with different
different ideas to convert their 500 and 1000 currency notes, they asked their
workers or employees to deposit their money in their accounts for time being or
they used to pay to labourers to stand in big ques in the bank and convert
those old currency to new, they used the
Jan Dhan Accounts opened in millions under another scheme launched by NDA
government earlier, or buying gold at a premium to convert later when the curbs
relaxed and so on.

 

Moreover, governments decided to print and circulate two thousand
rupees note in place of one thousand and five hundred rupees notes which made
critics to point out that it will be even easier for the money launders or
hoarders to hoard money with large denomination notes. Another disadvantage is the
printing of the new currency and of the destruction of the old currencies was
that the costs will have to be borne by the government and not to properly
absorb the high cost of using malicious anger.

 

According to World Bank’s latest report as reported on “online news
channel Firstpost, Indian GDP may face a fall of 0.5 per cent to 2 per cent due
to demonetization”, the higher side matching the estimate mentioned by Ex-Prime
Minister Dr. Manmohan Singh.

 

 

POSITIVE EFFECTS:

It is not that demonetization had only negative impact on the economy.
It has many positive impacts also but are not much visible in shorter run. In
fact it was believed by most of the economists that the long term benefits of
demonetization will overcome the negative impact on the economy. With more and
more unaccounted money making its way to formal banking system, government will
get much higher tax collections and will be able to check the fiscal deficit in
the financial year 2017. With rapid growth in digital transactions, government
will certainly benefit in getting more revenues from business transactions
which were so far out of the system to a larger extent due to non reporting of
cash transactions. This will also mark a rise in GDP ratio in the country.

 

This decision of government is also beneficial for the Indian banking
system as now people are depositing more and more money into their bank
accounts therefore cost of capital has become much lower for them as the
interest rates on deposits have been reduced. It is beneficial for borrowers as
well because the can get loans on lower interest rates.

 

There was news that the State Bank Of India has reduced the rates on
deposits after demonetization significantly for one year to 455 days to 6.90%,
down 15 basis points, which came as a bad news for those who put their money
into bank deposits. “SBI Chairman Arundhati Bhattacharya said that “All rates
will fall”. On one side there is a huge inflow of deposits in the bank, on the
other hand, demand for credit has slowed down, so bank lending rates will fall
soon”11. And her statement came true as all leading banks reduced their lending
rates one after the other in order to remain competitive. 

 

Another economic advantage of demonetization lies in the fact that
vaporization of unaccounted money would reduce the government liabilities and
hence add to its finances. Government would then need to buy lesser money from
the market to finance its expenses.

 

Demonetization will also likely help in curbing use of cash or black
money in real estate transactions, a major platform to absorb black money. This
will make real estate transactions transparent and make housing affordable.

 

Thus, positive impact of demonetization include better tax compliances,
better tax to GDP ratio; much higher and improved tax collection meaning less
borrowing by the government and better fiscal management. People of India may
benefit in terms of lesser inflation with lesser cash transactions and with
possible benefit of lower income tax rates. Industry will also benefit in long
run once people get more dispensable income in their hands due to low tax
rates.