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Five years of Demonetization in India – Impact of note ban on Economy explained

Five years of Demonetization in India – Impact of note ban on Economy explained

Relevance:

  • GS 3 || Economy || Banking & Financial Sector || Money

Why in the news?

 5 years after DeMo, Cash at record 14.5% of GDP

Present Context:

  • It has been five years since the government announced demonetisation on November 8, 2016, But it doesn’t seem to have yielded the results expected from it.
  • Reserve Bank of India (RBI) data reveals that the currency amount with the public stood at a record high of Rs 28.30 lakh crore for the fortnight ending October 8, 2021.

  • This is up 57.48% or Rs 10.33 lakh crore from a level of Rs 17.97 lakh crore on November 4, 2016.
  • Cash with the public has shot up 211% from Rs 9.11 lakh crore, recorded on November 25, 2016.
  • NIC had grown at an average growth rate of 14.51 per cent year-on-year from October 2014 till October 2016, the month preceding the demonetisation.

Background:

  • On November 8, 2016, the government, led by Prime Minister Narendra Modi, declared that the biggest denominations of Rs 500 and Rs 1000 will be demonetised, meaning they would no longer be legal money.
  • The government issued new Rs 2,000 and Rs 500 notes.
  • There was also no change in any other kind of currency conversion, such as checks, demand draughts (DDs), and credit and debit card payments.
  • The decision was made to reduce the amount of cash available in the system, hence minimising the threat of black money, counterfeit notes, and corruption.
  • This decision had far-reaching consequences in every sector of the economy.

Demonetization’s Significance:

  • Demonetization is the process of removing a monetary unit’s legal tender status.
  • It refers to the government’s decision to revoke a currency note’s legal tender status.
  • It occurs whenever the national currency is changed.
  • The old currency unit must be phased out and replaced with a new one.
  • Re-monetization is the polar opposite of demonetization, in which a form of payment is reinstated as legal money.
  • Once a currency note has been demonetised, it can no longer be used.
  • Older currency notes are cancelled and new currency notes with enhanced features are issued by central banks all over the world.

What were the primary reasons for demonetization in 2016?

  • This was done for a variety of reasons by the government and the Reserve Bank of India.
  • The following are the primary goals of the demonetisation campaign:
  • Preventing Corruption: Corruption and money are inextricably linked. Controlling corruption can also be achieved by restricting currency circulation.
  • Combat Counterfeiting/Bogus Currency: According to the RBI’s Annual Report, fake currency notes in the shape of old Rs 500 and Rs 1,000 notes were found in the banking system for the fiscal year 2016-17, totaling Rs 41.5 crores. The total amount of counterfeit money in circulation was estimated to be worth Rs 400 crores.

After 5 years of demonetisation, here are 5 markers to demonstrate what has changed:

  • Cash flow in the system: In October of this year, cash circulation in the economy reached an all-time high of Rs 28.3 trillion. The economy’s currency is increasing in tandem with nominal GDP growth.
  • Digital transactions: UPI, PhonePay, and Paytm, among other retailers, have seen an all-time peak in digital transactions.Since November 2016, the number of UPI transactions has climbed from 0.29 million to 4.2 billion. Last month, UPI had the highest transaction value of $103 billion.

What are the differences between the declared goals of demonetization and the realities on the ground?

  • Benefits that are unknown:
    • Demonetisation promised a rapid expansion of the revenue base, but the results have been disappointing. According to estimates provided in the 2017 Economic Survey by the finance ministry, the tax base expansion due to demonetisation was Rs10,600 crore, which is less than the RBI’s interest charges and only 0.1 percent of India’s GDP (GDP).
  • Regarding fake currency:
    • Demonetisation also had the declared goal of detecting and eradicating counterfeit currency. Even though counterfeits of newly issued notes have already appeared in the system, the surge in detected counterfeit notes following demonetisation has not been abnormally high, according to RBI data.
  • On the subject of illegal cash:
    • Demonetization’s purpose: The government reasoned that by eliminating the high currency notes, persons with unaccounted cash or black money would be less likely to deposit in the banking system, putting a dent in the hoard.
  • Reality:
  1. In the near run, demonetisation boosted non-cash payments, but the benefit is fading, with the cash-to-GDP ratio back in the double digits.
  2. As new notes have entered the system, the share of high-value notes (Rs500 and above)—often regarded as conduits for black money—has also risen. The share of high-value notes was 74 percent at the end of fiscal year 2017 (FY17), which was significantly lower than in FY16. However, by the end of FY18, this amount might be substantially higher.

  • Digital Transactions:
  • Demonization’s goals are as follows:
  1. One of the goals was to transition the economy away from cash and toward more digital or electronic transactions.
  2. After demonetization, electronic transactions via prepaid wallets, debit and credit cards skyrocketed, according to NEET (National Electronic Fund Transfer).
  3. At the end of the government’s cash withdrawal deadline in December, the number of transactions increased from 671.49 million in November to 957.50 million.
  4. The number of transactions in July was 862.38 million, a decrease from December.
  • The truth is: Demonetization has not resulted in a significant increase in digitalization in any major economy.
  • Cash owners’ anonymity:
  • Objectives include:
  1. One of the government’s arguments has been that the system’s anonymity regarding cash ownership has ceased, with more people depositing money in the banking system.
  2. According to the administration, it now has information on everyone who deposited currency during the demonetization period.
  3. One of the goals of demonetization was to give cash holdings in the economy a name.
  • The truth is:
  1. The Income Tax Department has tracked 13.33 lakh accounts with cash deposits of over Rs 2.89 lakh crore and got over 9 lakh responses through its “Operation Clean Money” scheme, which was launched in January.
  2. If the IRS can show that a significant portion of the money was not valid, the conclusion may satisfy this goal.
  • Base of taxation
  • Objectives:
  1. Increased tax base was one of the stated goals of demonetization.
  2. Because those dealing in cash were forced to deposit it in banks, personal income tax returns climbed by nearly 25%.
  • The truth is:
  1. The true test would be not simply raising the number of people who file income tax returns, but also how this translates into increased revenue.
  2. More people may be added to the return-filling list, but the gain will be restricted if a considerable percentage of these people earn less than the taxable maximum. For example, mutual funds
  3. Savings in the form of equities, mutual funds, life insurance premiums, and other products, according to government estimates, have increased since demonetization.

Demonetization’s effects on the rural economy:

  • Despite record food grain output in 2016-17, the rural sector was the most hit, with growth of 2.3 percent in Q1 2017-18.
  • Those living in remote areas, where banking and internet connections are scarce, were the hardest hit.
  • According to a 2016 RBI assessment on branch authorisation policy, 93 percent of rural areas in India are unbanked, with residents relying on roaming banking correspondents and distant urban or semi-urban branches.
  • In a 2016 consumer economics survey, only 3% of rural families have access to the internet.
  • In the early aftermath of demonetisation, the cash pressure caused a stockpile at wholesale markets, resulting in a dramatic drop in the Wholesale Price Index (WPI) of perishables such as fruits and vegetables.
  • Demonetisation may have contributed to the drop in pulse prices by turning farm markets into buyers’ markets.
  • Rural consumer confidence suffered as well, with domestic two-wheeler sales plummeting.
  • A study by the Centre for Monitoring Indian Economy (CMIE) found that new project announcements fell dramatically after demonetisation, affecting the capex cycle.

Conclusion:

Demonetisation was implemented with the primary goal of reducing black money, preventing terrorist financing, and creating a cashless economy, however it was implemented incorrectly, causing fear throughout the economy and resulting in more cons than benefits. Tax changes and adequate monitoring of questionable transactions could be a viable option for addressing the challenges that policymakers hoped to address with demonetisation.

Mains oriented question:

Demonetization was itself a debatable step taken by the government. After five years of steps taken, what are the changes observed in the economy? Does Demonetization have achieved its goal, write in detail. (200 words)