Abstract
Demonetization of currency is a
radical monetary step in which a currency unit’s status as a legal tender is
declared invalid. This is usually done whenever there is a change of national
currency, replacing the old unit with a new one. The present study is an
attempt to know about the Demonization in India and its objectives and effects.
The purpose of the present study also
elucidates the impact of such a move on black money.
Keywords:
Demonetization, Objectives, Effects, Impact, Black Money.
INTRODUCTION
When a currency note of a particular
denomination ceases to be a legal tender, it is termed as Demonetization. It
occurs whenever there is a change of national currency. The current form or forms of money is pulled from
circulation and retired, often to be replaced with new notes or coins and
sometimes a country completely replaces the old currency with new currency. Such
a step for example was taken when the European Monetary Union Nations in 2002 decided
to adopt euro as their currency. However the old currencies were allowed to
convert into Euros for a period of time in order to ensure a smooth transition
through demonetization. In 2015 the Zimbabwean
government demonetized its dollar as a way to combat the country’s
hyperinflation, which was recorded at 231,000,000%. The three month process
involved expunging the Zimbabwean dollar from the country’s financial system
and solidifying the U.S dollar, the Botswana pula and the South African rand as
the country’s legal tender in a bid to stabilize the economy. Fiji, Singapore
and Philippines were other countries to have opted for currency demonetization.
Review of Literature
Rahul Prakash Deodhar (2016) “Black Money and Demonetisation” The Government of India announced that the Rs 500
and Rs. 1000 denominated currency notes will cease to be legal tender. The move
was targeted towards tackling black money, corruption and terrorism. After
initial euphoria, questions began to emerge. What are the costs of this
demonetization? Will it be effective if people can still create new black money
thereafter? The
author concluded that it is just one move of one piece in the chess board of
black money. To check-mate the black money king, you have to win the board.
There are various steps required as detailed above. Government can play all
these moves and still fail if they play improperly. All we can say is that
Government is playing well. But will it succeed? The efforts will bring massive
amounts of cash into the banking system – a benefit in itself. Once the money
is in the legitimate channels, it should be better utilized and revenue will be
generated from its use. If that is success enough then yes.
Dr
Pratap Singh & Virender Singh (2016) “Impact
of Demonetization on Indian Economy” India has amongst the
highest level of currencies in circulation at 12.1% of GDP. Cash on hand is an
estimated at around 3.2% of household assets, higher than investment in
equities, or roughly around $ 220 billion. Of this cash, 87% is in the form of
Rs 500 and Rs 1,000 notes or roughly Rs 14 lakh crore ($190 billion).A
significant portion of the household cash on hand is generated by economic
transactions that are not reported to tax authorities or generated through
corruption. Scrapping the higher denomination money would either result in
these being brought into the system or the money just disappearing. The study
highlights the probable consequences of this decision on various economic
variables and entities. The author concluded that 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.
Objectives of the Study
Ø To study the Demonetization Policy in Indian
economy.
Ø To
study the various objectives and effects of the Demonetisation in India.
Research Methodology
Keeping in view of the objectives, in the present study secondary data
has been used. Data has been collected
from various research papers, magazines and articles. In addition to this
study, data have also been collected from various journals, economic and
political weekly and the research is also based on the referred sources-
published, unpublished and electronic.
Demonetisation in India
Demonetization
for us means that Reserve Bank of India has withdrawn the old Rs 500 and Rs
1000 notes as an official mode of payment. Demonetization is the act of
stripping a currency unit of its status as legal tender. In India’s case, the
move has been taken to curb the menace of the black money and fake notes by
reducing the amount of cash available in the system. It is also interesting to
note that this was not the first time the government of India has gone for the
demonization of high value currency. I was first time implemented in 1946 when
the Reserve Bank of India demonetized the then circulated Rs 1,000 and Rs
10,000 notes, The government than introduced higher demonetization bank notes
Rs 1000, Rs 5000 and Rs 10000 in a fresh avatar eight years later in 1954
before the Morarji Desai government demonetized these notes in 1978.The
governments move to demonetize, even then, was to tackle the issue of black
money economy ,which was quite substantial t that point of time. The move was
enacted under the High Demonetization Bank Note(Demonetization)Act,1978.Under
the law all ‘high denomination bank notes’ ceased to be legal tender after
January 16,1978.People who possessed these notes were given till January 24 the
same year a week’s time to exchange any high denomination bank notes.
On 28 October 2016,
the total currency in circulation in India was Rs. 17.77 lakh crore (US$260
billion). In terms of value, the annual report of Reserve Bank of India of 31
March 2016 stated that total bank notes in circulation valued to Rs.16.42 lakh
crore (US$240 billion) of which nearly 86% (i.e. Rs. 14.18 lakh crore (US$210
billion)) was 500 and 1000 rupee notes. In terms of volume, the report stated
that 24% (i.e. 2,203 crore) of the total 9,026.6 crore banknotes were in
circulation In an important move, the Prime Minister of India Mr. Narendra Modi
hit hard on corrupt bureaucrats, politicians, and business class, terrorist
groups, smugglers, drug traffickers, black marketers and many others engaged in
unlawful activities declared that the five hundred and one thousand rupee notes
will no longer be legal tender from midnight, 8th November 2016. The people were given a chance either to
exchange the old currency with new one through banks, post offices or deposit
the same in their accounts upon December 30, 2016. According to the government
of India, the RBI will issue Two thousand rupee notes and new notes of Five
hundred rupees which will be placed in circulation from 10th November 2016.
Notes of one hundred, fifty, twenty, ten, five, two and one rupee will remain
legal tender and will remain unaffected by this decision. The main difference
between previous drives of demonetization and the current one is that currency
of higher denomination was barely in circulation in 1948 or 1978, unlike the Rs
500 and 1000 notes in 2016.
Objectives of Demonetization in India
Ø To
track fake currency.
Ø To
cutoff the supply line money, arms and immunizations to terror funding.
Ø To
transform Indian economy into cashless economy.
Ø To
bring tax evasion to halt.
Ø To
unearth and curb the black money.
Ø To
curb illegal and unethical business activities such as, the black marketing,
food adulteration, marketing of spurious goods, human trafficking, smuggling of
gold and drugs.
Effects of Demonetization in India
In an
important move, the Government of India declared that the five hundred and one
thousand rupee notes will no longer be legal tender from midnight, 8th November
2016. The RBI has issued Two thousand rupee notes and new notes of Five hundred
rupees which have been placed in circulation from 10th November 2016. This
measure has been taken by the PM in an attempt to address the resolve against
corruption, black money and counterfeit notes. This move is expected to cleanse
the formal economic system and discard black money from the same. The
present study highlighted the probable consequences of this decision on various
economic variables and entities.
1.
Effect on parallel economy
The removal of these 500 and 1000 notes and
replacement of the same with new 500 and 2000 Rupee Notes is expected to:
· Remove
black money from the economy as they will be blocked since the owners will not
be in a position to deposit the same in the banks,
· Temporarily
stall the circulation of large volume of counterfeit currency and
· Curb
the funding for anti-social elements like smuggling, terrorism, espionage, etc.
2.
Effect on Money Supply: With
the older 500 and 1000 Rupees notes being scrapped, until the new 500 and 2000
Rupees notes get widely circulated in the market, money supply is expected to
reduce in the short run. To the extent that black money (which is not
counterfeit) does not re-enter the system, reserve money and hence money supply
will decrease permanently. However gradually as the new notes get circulated in
the market and the mismatch gets corrected, money supply will pick up.
3.
Effect on Demand: The
overall demand is expected to be affected to an extent. The demand in following
areas is to be impacted particularly; the nature, frequency and amounts of the
commercial transactions involved with these sections of the economy necessitate
cash transactions on more frequent basis. Thus, these segments are expected to
have the most significant impact post this demonetization process and the
introduction of new notes in circulation.
·
Consumer goods
·
Real Estate and Property
·
Gold and luxury goods
·
Automobiles (only to a certain
limit)
All these mentioned sectors
are expected to face certain moderation in demand from the consumer side, owing
to the significant amount of cash transactions involved in these sectors.
4. Effect on Prices: Price level
is expected to be lowered due to moderation from demand side. This demand
driven fall in prices could be understood as follows:
·
Consumer goods: Prices are
expected to fall only marginally due to moderation in demand as use of cards
and cheques would compensate for some purchases.
·
Real Estate and Property:
Prices in this sector are largely expected to fall, especially for sales of properties
where major part of the transaction is cash based, rather than based on banks
transfer or cheque transactions. In the medium term, however the prices in this
sector could regain some levels as developers rebalance their prices (probably
charging more on cheque payment).
5. Effect on various economic entities: With cash transaction lowering in the short run, until the new
notes are spread widely into circulation, certain sections of the society could
face short term disruptions in facilitation of their transactions. These
sections are:
·
Agriculture and related sector
·
Small traders
·
SME
·
Services Sector
·
Households
·
Political Parties
·
Professionals like doctor,
carpenter, utility service providers, etc.
·
Retail outlets
6.
Effect on GDP: The
GDP formation could be impacted by this measure, with reduction in the
consumption demand. However with the recent rise in festival demand is expected
to offset this fall in overall impact. Moreover, this expected impact on GDP
may not be significant as some of this demand will only be deferred and
re-enter the stream once the cash situation becomes normal.
7.
Effect on Banks: As
directed by the Government, the 500 and 1000 Rupee notes which now cease to be
legal tender are to be deposited or exchanged in banks (subject to certain
limits). This will automatically lead to more amounts being deposited in
Savings and Current Account of commercial banks. This in turn will enhance the
liquidity position of the banks, which can be utilized further for lending purposes.
However, to the extent that households have held on to these funds for
emergency purposes, there would be withdrawals at the second stage.
8.
Effect on Online Transactions and
alternative modes of payment: With cash transactions
facing a reduction, alternative forms of payment will see a surge in demand.
Digital transaction systems, E wallets and apps, online transactions using E
banking, usage of Plastic money (Debit and Credit Cards), etc. will definitely
see substantial increase in demand. This should eventually lead to
strengthening of such systems and the infrastructure required.
Conclusion
The Demonetisation undertaken by the government is a
large shock to the economy. The impact of the shock in the medium term is a
function of how much of the currency will be replaced at the end of the
replacement process and the extent to which currency in circulation is
extinguished. While it has been argued that the cash that would be extinguished
would be “black money” and hence, should be rightfully extinguished to set
right the perverse incentive structure in the economy, this argument is based
on impressions rather than on facts. While the facts are not available to
anybody, it would be foolhardy to argue that this is the only possibility.
In
other words, while the cash was mediating in legitimate economic activity, if
this currency is extinguished there would be a contraction of economic activity
in the economy and that is a cost that needs to be factored in while assessing
the impact of the demonetisation on the economy and its agents. It is likely
that there would be a spurt in the banking deposits. While interpreting the
phenomenon, however, one has to keep in mind that a large part of their
deposits were earlier used for transactional purposes. For example, if a small
trader deposits 2 lakh Rupees in the Jan Dhan account since the currency in
which he held these balances in for transactional purposes has been scrapped,
it would be incorrect to interpret this as success of the programme in bringing
in people who were hiding black money. Nor can they be interpreted as
additional balances that the banking sector can lend out on the same basis as
earlier deposits, since the deposits now would remain in accounts for much
shorter periods that deposits based on savings would be.
REFERENCES
v Vishal Gupta “Demonetisation in India
with its social and economic impact” November 18, 2016. See at https://www.examweb.in/short-essay-article-demonetization-impact-5443.
v Dr Pratap Singh and Virender Singh
“Impact of Demonetisation on Indian Economy” International journal of science
technology and management, vol.5issue 12 December 2016.
v Rahul Deodhar “Black Money and
Demonetisation” 14 November
2016,https://papers.ssrn.com/sol3/papers.cfm?abstract_id=286912.
v
Economic consequences of demonetization of 500 and 1000 Rupee Notes 2016 see
at November 09, 2016 I Economics: Policy View.
v
Demonetisation: Impact on the
Economy, National Institute of Public Finance and Policy, New Delhi, Working
Paper no.182, 2016.