Effect of Demonetization in Indian life

by | Finance |

Effect of Demonetization in Indian life

Demonetisation, a landmark in the history of the Indian economy, was an experience which might create fear in the minds of the people who indulge in illegal activities like tax evasion or money laundering of any kind.

When a currency note of a particular denomination ceases to be a legal tender, it is termed as demonetization. Legal tender refers to money which can be legally used to make payments of debts or other obligations. A creditor is obliged by law to receive such money in payment of due debt to him.

The term demonetization is not new to the Indian economy. The highest denomination note ever printed by the Reserve Bank of India was the 10,000 rupee note in 1938 and again in 1954. It was demonetized first in 1946 and then in 1978. Since not many people had access to such notes at the time, this did not have a big impact on the country.

 

The latest round of demonetization has undoubtedly affected the common public and bankers. Two years ago, on 2016 the Government of India announced a radical policy move which has become known as demonetization.

On November 8, 2016, all 500 Rupee and 1,000 Rupee notes were made invalid (amounting to 15.44 trillion Rupees), or 86% of notes and coins in circulation and 12% of India’s total money supply.

The cash that was rendered invalid was replaced with new 500 and 2,000 Rupee notes, but these were not circulated in full immediately.

The Reserve Bank of India has stated that 99% of the currency that had previously been taken out of circulation has now been replaced by the new currency series. This suggests that the informal economy is vigorously trying to reassert itself.

What was the purpose of Demonetization?

  • To eliminate fraudulent currency, which is often used by terrorist groups;

  • Bring income and wealth into the banking system, where it can be more easily monitored and, if necessary, taxed; and,

  • To help move the population into the digital economy.

  • Many Political Parties use large amounts of undeclared cash to campaign for elections and meet other requirements. Due to Demonetisation such acts might get restricted to an extent and parties will have to formulate new strategies.

  • It was aimed at a clean-up of the economy where Fake Indian Currency Notes (FICN) would be checked. It is aimed at rendering all fake notes of rupees 500 and 1000 useless and thus drastically affecting illegal funding of terror groups in Jammu and Kashmir, states in the North-East, and Naxalism-influenced states.

Demonetization in India

The impacts of Demonetisation on Indian Economy -

Demonetization is a generations’ memorable experience and is going to be one of the economic events of our country. It has had many short-term effects which are visible.

  • Demonetization affects the economy through the liquidity side.

  • Due to only a small portion of the black money is stored in the form of cash and majority is in the form of physical assets like gold, land, and building, demonetization of the rupee 500 and 1000 notes might take out a lot of black money from the economy.

  • Tax receipts were up 16.9% year-on-year in February 2017.

  • 24% increase in the number of tax receipts filed. In addition, the number of suspicious transactions reported in the banking system rose to 473,000 in Fiscal Year (FY) 2017, up from 106,000 in FY 2016, a possible source of future tax revenue.

  • Digital and credit card payments were up by 46% and 65%, respectively, in the year to March 2017.

  • Businesses like the textile industry, salons, restaurants, and seasonal businesses are low capital enterprises and work on the basis of liquidity preference. Demonetisation gravely impacted their revenue collection and threatened their existence to an extent.

Effect of Demonetization in India

  • Nearly 86% of currency value in circulation was withdrawn without replacing the bulk of it.

  • As a result of the withdrawal of Rs 500 and Rs 1000 notes, there occurred a huge gap in the currency composition as after Rs 100; Rs 2000 is the only denomination.

  • The Indian economy is a cash-driven economy and demonetization has largely affected its growth. The GDP growth rate of 8.01% in 2015-2016 fell to 7.11% in 2016-2017 after demonetization. This was largely due to less availability of cash in cash-intensive industries like manufacturing and construction.

  • It has adversely impacted the primary function of banks to issue loans and has put pressure on them as current account holders demand 0 large sums of cash.

  • A major portion of the Indian workforce is a part of the informal economy. They use cash to meet all their expenses and demonetization has resulted in a lot of them losing their jobs due to unavailability of cash. According to CMIE Consumer Pyramids Household Surveys (CPHS), approximately 1.5 million jobs were lost during the final quarter of the financial year 2016-17.

  • The estimated employment during this period was 405 million as compared to 406.5 million during the previous four months.

  • Till months after demonetization, the general economic situation was disturbed. Small shopkeepers who only accepted cash went into losses and some even shut down.

  • The absence of liquid cash has led to people making transactions using cheques or account transfers. They have also switched to virtual wallets like Paytm which allows electronic transfer of money. All this might result in a digital economy where transactions are being recorded and the economy has more white money. This might increase the government’s tax revenue.

Effect of Demonetization in India


 

Demonetisation has been praised as well as criticized on various grounds. There has been a lot of opposition regarding the implementation of this policy. In the short run, there have been problems related to the liquidity crunch, unemployment, loss of growth momentum, and a temporary halt to major economic activities. All this is evident from the data provided by the RBI.

 

The long-term effects of Demonetisation are yet to be ascertained. It is expected that it can improve the Indian economy in the long run by increasing tax compliance, financial inclusion, consequently improving the state of the economy. It can boost the GDP by increasing the availability of funds for lending and also by reducing transaction costs if the economy moves to digital modes of payments.