Demonetization-A Historical Step for India’s Economy

Posted in Finance Articles, Total Reads: 713 , Published on 08 December 2016

The initiative of demonetization taken by the Prime Minister of India Shri Narendra Modi on 8 November 2016 is a historical step in the history of India’s economy. Demonetization is a process in which the currency which is in circulation in the economy seizes to exist i.e the currency is no longer a legal tender. This is done to bring new currency in circulation by replacing the old currency. The policy to issue currency in the economy is regulated by Reserve Bank of India under Reserve Bank of India Act, 1934.

There are huge reserves of black money present in the economy which is beyond anybody’s imagination. To curb the flow of this black money, circulation of Rs. 500 and Rs. 1000 notes have been stopped with effect from 8 November 2016. In lieu of this, a new currency of Rs. 500 and Rs. 2000 has been introduced from 10 November 2016. The main reason to stop the circulation of Rs. 500 and Rs. 1000 is that most of the black money is reserved in these high denomination notes only. The seizure of circulation of these currency notes will render the reserves of black money useless. In order to make that black money good, the currency shall need to be exchanged as per norms prescribed by RBI. This will bring the black money into circulation. Apart from this, circulation of fake currency notes in the economy also affects the economy. Black money and fake notes are used to finance activities like terrorism. Hence demonetization will not only put a check on black money and fake currency but also terrorism and other disruptive activities.

History of demonetization in India

This is not the first time that demonetization has taken place in the country. According to a report by Reserve Bank of India, demonetization took place in the country in the year 1946 and 1978. The maximum denomination of currency paper printed by RBI was Rs. 10000 which was printed in 1938 and 1954 but discontinued first in 1946 and again in 1978.

Prior to 1978, currency paper 1000, 5000 and 10000 was in circulation but all these currencies were demonetized in 1978. In 1987, Rs. 500 currency paper and in the year 2000, Rs. 1000 currency paper was re-introduced. But this is the first time in the economic history that Rs. 2000 currency has been circulated in the economy.

Economic aspects of demonetization in India

Every aspect has two sides- pros and cons. Demonetization has been appreciated by certain masses while on the other hand there are many critics to this historical initiative. Taking a dig at the criticism received by the masses, following points may be taken into consideration:

- Declining cash transactions and heavy losses incurred by businessmen

There are many shopkeepers and businessmen who transact only in cash instead of credit. Such businessmen have been adversely affected by this initiative as buyers do not have valid currency available to pay for the items of basic necessities. In India, following types of currencies are available- coins of 1,2,5,10 denominations and paper currency of Rs. 1,2,5,10,20,50,100,500 and 1000. Of these, Rs. 500 and 1000 currency paper is no longer a legal tender. Therefore for payment of bigger amount, currency in smaller denomination is available which is difficult to carry physically. For example, the payment which could have been in a single 1000 rupee note now requires 10 notes of Rs. 100 or 20 notes of Rs. 50 etc which is difficult to carry in pocket or vaults. Due to demonetization, the demand of lower currency is huge due to which it is not readily available in banks and market. Hence businesses have suffered heavy losses due to this step.

- Economic activities affected in the short run

Due to unavailability of currency in the economy, many economic transactions have been halted. This has led to slowdown in consumption and economic growth in the short run. Banks are unable to grant loans as the focus has been shifted to absolving the problem of exchange of old currency and providing new currency. This may lead to slump in interest rates due to which investing in banks may no longer seem attractive.

- Only 25% of the average daily cash demand is being met

According to banking sources, in many areas only 25% of the daily cash demand is being met due to which there are long queues outside banks and ATMs. In many areas, there is not even a single bank branch due to which people have to come to nearby branch. This has affected daily routine and normal life of many people, especially the poor households who are daily wage workers.

- Rs. 500 currency paper being available in two variants

Variance has been observed in the currency paper of 500 denomination. According to the RBI, such variation has been due to heavy rush and huge demand. An important aspect to be noted is that printing of currency requires huge investment in the form of currency paper, ink, printing machine etc. Such defects will escalate the economic costs involved in printing of new currency.

- Hospitals unwilling to accept old notes- Timely medical services not being available to the needy

Many hospitals have refused to accept the old currency due to which people are being deprived of timely medical services which is adding woes to the problems faced by the common man due to the initiative of demonetization.

- Slowdown in the economy globally

India is no longer a closed economy. Due to globalization, it has links to other economies as well. Demonetization has affected import and export payments and movement of goods. This could lead to slump in the economic activities in the short run.

- Tourism affected

Demonetization has caused problems to foreign tourists as well who have not been able to arrange new currency. Foreign tourists are a source of foreign currency reserves flowing into the economy. Affecting foreign tourism could affect forex reserves in the short run.

One cannot keep a blind eye to all the negative impacts cited above but the initiative has many positive aspects which may overshadow the dark side of the step taken by the government.

The bright side of the initiative may be cited as follows:

- Curbing black money and corruption

Before the dawn of 8 November 2016, hoarders of black money and corrupt people should not have even imagined about the sudden step taken by the government. This has rendered crores of stock of black money useless as most of the black money may be found in notes of higher denominations. Examples abound where many businessmen and industrialists have been caught red-handed with huge amount of black money being saved in their secret vaults. Such amount is undisclosed in books of accounts. Surat based diamond merchant being caught with cash worth Rs. 6000 crores, Pune based businessman being caught with Rs. 1.12 crore are instances that proves that the government had aimed at the target perfectly. Such reserve of black money would have to be deposited in bank accounts for conversion to valid currency in order to be useful. This will put a check on black money and will increase the circulation of money in the economy. Secondly, such black money is used to finance terrorism related activities. Hence such activities will also breathe their last that harms not just life and property but also entire economy.

- Realizing the dream of Digital India

Keeping in mind the difficulties faced by the masses by standing in long queues outside banks and ATMs, mobile banking and internet banking get a major boost. In present scenario, affording a mobile phone is no longer a dream for any common man as every phone is now a smart phone and is available according to the affordability of the people. Internet services are also being provided by telecom companies at affordable rates through which one can access banking services through mobile from anywhere. Similarly, debit and credit cards are also being distributed to customers at a faster pace through which a customer can make transactions without requirement of paper currency. With this, the economy is advancing towards a ‘Cashless’, ‘Boundary-less’, ‘Paper-less’ economy i.e. ‘Digital India’.

- Curb on black money, terrorism, corruption to result in economic growth

Black money and corruption deprives the economy of the valuable currency which should have been used for development purposes. This affects the circulation of money in the economy. There are a few neighboring countries that pump in fake currency notes in the economy and this is used to finance terrorist activities. Demonetization will put a check to all such activities of disruptive nature. This will lead to bringing more currency in circulation which will ultimately lead to economic prosperity and in turn eliminate poverty, unemployment and other evils prevailing in the society.

- Bringing more people in the gamut of banking industry

Highlighting the extent of banking services present in all areas of the country, it may be inferred that banking services are readily available in metros and other developed cities while many rural areas are still deprived of a single bank branch. Even after ‘Pradhan Mantri Jan-Dhan Yojana’ there is vast section of people who still do not hold a bank account. In today’s scenario, every household requires money for survival. In this era of demonetization, such section of people would have been worst hit. However, their woes would have motivated them to have atleast one bank account in any nearest bank. This will help enhance the business of banks and will add more stakeholders to its business. Having a bank account will help banks mobilize deposits from poor households which will ultimately increase the circulation of money in the economy.

- Checking unaccounted money

There are huge reserves of unaccounted money available with many people in the country which is not listed in books of account nor can their source be traced. This unaccounted money promotes tax evasion as people disclose lesser amount in their books of account while earning huge amounts from undisclosed sources. Hence such evasion of tax can be curbed and it will be easy to check such unaccounted sources of money.

All the aspects listed above depict that the initial phase of demonetization is full of challenges. But every change experiences friction initially. In the short run there shall be some slowdown in the economic activities but in the long run, this initiative shall reap the desired objectives of economic growth and corruption free country. All the difficulties being faced by the masses are like ‘kadwe ghoot’ which one will have to bear initially in order to reap the ‘sweet fruit’ in future.

This article has been authored by Aprajita Gupta, Manager at a Public Secctor Bank



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