Everything you need to know about Demonetization in India
These days there are vibrant discussions everywhere across India post the Government’s sudden demonetization move in which all Rs. 500 & Rs. 1000 were diluted in one go with effect from end of day 8 November 2016. The replacement has come through new Rs. 500 & Rs. 2000 bank notes. People agree or disagree on the goodness of this move across India. Some confused people feel that this move has its good as well as bad but they don’t understand that this feeling of goodness and badness with the same decision can’t logically exist together at the same time especially when the subject in discussion is a national subject. These people feel confused due to their inability to decipher the financial and economical jargons thrown on to them suddenly by the media. This article will not only try to simplify this Demonetization move but will also establish that it is not some badness coming with the Goodness of this decision, instead there are Challenges associated with this Goodness move of Demonetization. This tough decision on Demonetization certainly showcases the audacity of the BJP Government in power in India to take such a big decision impacting everyone based at every region across India. It is not that this decision was taken suddenly with lack of planning as wrongly showcased in the media but it was very much in line with the previous decisions taken to dilute the power of black money involved in corruption & crime and also to make India a matured Bank Based Economy. The sequence of events in this direction including their salient features are briefly shared below:
STEP-1 : Pradhan Mantri Jan Dhan Yojana - This scheme was announced by Prime Minister on his first Independence Day speech on 15 August 2014. Hard work of the Government with clear focus on Financial inclusion in India through a clean and matured Banking System started with Pradhan Mantri Jan Dhan Yojana with mass opening opening of Bank Accounts across the country. Jan Dhan Yojna got covered in Guinness Book of World Records too with the Certificate stating “The most bank accounts opened in 1 week as a part of financial inclusion campaign is 18,096,130 and was achieved by Banks in India from 23 to 29 August 2014". By 1 June 2016, over 22 crore (220 million) bank accounts were opened and Rs. 384.11 billion (US$5.7 billion) were deposited under the scheme.
STEP-2 : Income Tax Declaration Scheme - Then came the notification for people to declare their undisclosed income or considering investment in any asset representing undisclosed income relating to any financial year upto 2015-16. This could be declared by the declarant with amount payable undisclosed income calculated as 30%Tax + Surcharge 7.5%+ 7.5% Penalty (i.e total 45% of undisclosed income). This scheme came into effect from 1 June 2016 and declarations could be filed till 30 September 2016. All consequences of non declaration of undisclosed income in the defined time period included Tax payable, Interest, penalty and prosecution under Income Tax Act.
STEP-3: Demonetization: This recent step is the most revolutionary step of all. As per the Annual Report of the RBI(Reserve Bank of India), as of 31 March 2016, Rs. 500 currency notes in circulation were 15,707 million in number with worth Rs. 7,854 Billion and Rs. 1000 currency notes in circulation were 6,326 million in number with worth Rs. 6,326 Billion. The combined worth of these high currency note accordingly was Rs. 14,180 Billion (i.e 86.38% of the total currency amount in circulation). From this it can be very easily imagined how impactful was this decision of Demonetization taken by the current BJP Government in power in India.
ANALYSIS:
Although the outcome and acceptance of STEP-1 (PM Jan Dhan Yojana) that was directed towards the poor Indians was well appreciated by the mass across India but STEP-2 (Income Tax Declaration Scheme) that was directed towards Rich black money hoarders and corrupt people was not well appreciated and this Income Tax declaration scheme actually brought out only few thousands of crores of Rupees out of the undisclosed money of corruption that had worth Lakhs of crores of Rupees. Government closely watched all through a long time period to know the response of the mass to their moves to clearly understand as who was supporting genuinely beneficial national drives. Strongly committed Government officials along with honest Indians hated to see that poor people leading lives in miserable conditions still cooperated with good Government drives whereas those who were corrupt and rich did not give heed to those Government drives and readily disregarded the Government’s initiatives. STEP-3 (Demonetization), hence, was inevitable and came by surprise to Indians as an Instruction and not a request.
Benefits of the Demonetization move:
1) Unacceptable Money that includes Fake currency and illegitimately hoarded money in corruption automatically goes out of the monetary system to empower the RBI to better manage the monetary system.
2) Counterfeit money that gets utilized for illegitimate and terrorist activities lost its value in one go.
3) Benefit to Indian democracy is that elections may be expected to be more transparent and fair unlike earlier when black money with the political parties could easily hamper the fair conduct of elections. Such black money vanished with Demonetization.
4) Healthy Banking System: Coming of lakhs of crores of money from cash into the Indian Banking system will now boost Bank deposits. This money when existed as cash in the past had no value for the national growth but now as Bank deposits can be highly productive to boost Infrastructure, job creation, education and other developmental drives.
5) The penalties imposed by the Income Tax Department on the undisclosed as well as black money will boost Government revenue.
6) Borrowing Rates: With huge sum of money flushing into the Banking system, the reduction in borrowing rates(loan rates) may be expected soon. This readily pushes demand driven economic activity and in turn job creation in the country.
7) Government may source funds when required for infrastructure projects at much cheaper rates than before and can readily come up with viable projects. Such projects may boost employment opportunities across the nation and improve the quality of life of Indian citizens.
8) Economic Activity: Transactions of more people & companies shifting to the bank mode will result into a more matured Indian economy that can thrive on legitimate economic activity with products being bought by consumers at the right price governed out of more genuine competition based on value proposition the products offer unlike in the past when their availability was constrained out of cash based illegal settlements with authorities done by monopolistic suppliers and in turn essential goods were being bought at artificial high prices by consumers.
9) Housing: Housing in India, especially in cities, will now become more affordable for people. With flushing out of major black money that was being used in buying of flats and independent houses the prices will come down. Lot of transactions in buying and selling of houses were done through cash settlements between buyers and sellers. These cash settlements not only artificially inflated the prices of houses but also induced huge tax evasions done by Builders and property Sellers. Salaried class in cities could not afford to buy houses at those inflated high prices involving huge amount of cash money. With flushing out of huge cash through Demonetization, prices of houses in the affordable housing segment in several places may get correction upto 30% lower rates. Lower borrowing rates as expected will increase affordability even more.
10) An additional interesting expectation may be that this Demonetization drive will cut the teeth of many bad people who were earlier cash rich from black money gained out of past corruption and largely exploited poor people. The economic downfall of such corrupted people along empowerment of poor through the emerging employment opportunities and passing of benefit to farmers may not only reduce gap between rich and poor but also reduce exploitation of people especially poor farmers living in Indian villages.
11) Technology at its best: Technological means being developed in India in Buying(example: Paytm, Mobikwik, Netbanking,Cards,NEFT/RTGS etc) and Selling (example of online Retailing: Snapdeal,Flipkart,Paytm etc) have got a huge boost post Demonetization move of Indian Government. The resulting immediate benefits expected in this space are: More fair competition among suppliers/service providers, more variety of products, more deeper penetration of technology across India, faster technological innovations, less fraud, better customer service and more transparency.
12) GST(Goods and Services Tax) : The impacts visible post Demonetization is readily and automatically creating a more empowered and penetrated Banking system that is automatically creating a healthy ground very suitable for launch of the much awaiteds GST(Goods and Services Tax).
Challenges:
1) There is incomplete penetration of Banking facilities in suburban/rural areas and also, cash shortage in banks across the country. Most of the transactions of buying and selling in such places happen through cash. Such a scenario reduces the economic activity till all this stabilizes and many residents might feel challenged with no money temporarily. Some daily wage workers may lose earning opportunities especially in the construction sector because cash payment to workers is the most common payment mode in such a sector.
2) Temporary slowdown of India's GDP growth may happen because cash money either genuine or black has been lubricating Indian economy from a long time. Sudden stoppage of such cash along with constrained availability of new cash from Banks & ATMs and also incomplete penetration of Banking services to all consumers across India may reduce demand for Goods and Services. Lesser demand will force producers to produce less and hence, lesser revenue further amounting to less tax being collected.
3) Black money already existing in real estate, gold or properties abroad may have to be looked for through means other than Demonetization.
4) Places of worship in India are exempt from extensive Tax scrutiny associated with Cash. Demonetization won't serve much purpose here.
5) Rs. 2000 new bank note is an even bigger currency and after some time a scenario having involvement of such big value bank notes in corruption and criminal activities may again emerge.
6) In the recent past, India came out well even during Financial crisis similar to the sub prime Financial Crisis of 2008 due to its internal consumption much of which was lubricated by Cash based transactions that also included back money. Elimination of much of cash from monetary system increase India's vulnerability to Financial instabilities across the Globe.
7) Although there will be Tax Revenue gained through Tax & Penalty on those keeping black money but there may also be loss of Tax Revenue from Industries because of reduced economic activity associated with stoppage of several cash transactions. Limited cash availability in Banks/ATMs and reduced demand of products being bought by people largely through cash would exacerbate the problem further. Although there are several benefits of Demonetization both monetary and non monetary for India but the monetary benefits at the end of this Financial Year would be Net Positive or Net Negative is still questionable.
8) Sudden Demonetization of cash prevailing in the form Rs.500 & Rs.1000 comprising of 86.38% of the total cash value prevailing in the country as of 31 March 2016 may put deflationary pressure on the prices of goods and services. Such deflation or negative inflation happens when prices of goods fall when their supply exceeds demand because of the reduction in money availability, credit or consumer spending. Shortage of money in circulation may result into such deflation. In such a scenario the producers need to reduce the prices significantly to make people buy those goods. By doing so companies earn less revenue and in order to survive they may react by closing manufacturing units and laying off workers resulting into massive unemployment. These laid off workers accordingly would have to reduce their own spending which would result into even more weak demand and extended deflation hurting rest of the economy too.
In all, this quick decision of Demonetization taken by the active Government was a huge step aiming for a better India. If such a step was inevitable then its delaying and its rolling out only after consensus of all may not have served the purpose at all because by that time almost all the corrupt people of this country would have adjusted cash in segments which are always going to be out of the possible reach of any law. Also, those who are complaining that planning before Demonetization was not done properly should understand that 100% planned execution is only possible post involvement of all stakeholders of cash decision across India including opposition parties, media and NGOs etc. Such stakeholders may also include many badly corrupt people across India including several Politicians and officers. Involvement of a big number of such stakeholders would have converted to lesser effectiveness of this decision. Confidentiality was the key here for maximum impact. Decisions such as this demonetization need to be taken with practically possible planning if not full planning. This national drive definitely may not dilute whole of nation's black money but undoubtedly impacts a significant portion of it and that in a single go is nothing less than great. Some good decisions have time of essence and their debatable worthiness matters less than their effective rolling out. Demonetization is one of such decision. Let us all accept it in the way it has come to us and try from our side to manage funds through bank modes.
I will be happy to receive comments on this post and welcome discussions on this topic. This article is just to explain some logics as they are and in no form I am biased about a single kind of drive. In the challenges section, I have clearly enlisted those areas if not taken care well might create some dissatisfaction among citizens. Let us hope for the best.
Disclaimer: These are just my opinions based on understanding of this subject gained during my MBA and interest in Economics. You may notice that this article is academic in nature and in no way it is intended to challenge any of the readers.
regards,
Devesh Sharma