Demonetisation and its Impact on Economy and Common Man’s Life
Demonetisation and its Impact on
Economy and Common Man’s Life
By:
Table of
Contents
- What is demonetization?
- Demonetizations in the other countries
- Previous Demonetization in India
- Demonetization in 2016:
- Scale of demonetization effort in 2016
- What are the possible reasons for demonetization? The reasoning given by government are:
- What are the short term effect of demonetization on businesses and daily life?
- Does demonetisation affect black wealth held in cash?
- How long will it take for normalcy to return?
- Will GDP growth slow down?
- Could things have been managed better?
- Why Private sector was not provided the role in demonetization?
- Expected benefits of Demonetization to common man
- Demonetization to make loans cheaper soon:
- Demonetization to control role of black marketers, black money and end corruption
- Demonetization will benefit poor and middle-class citizens of India
- Demonetization will stop corruption in admission to schools and colleges
- Demonetisation to stop corruption in realty sector
- Demonetisation to hit terrorism, drug and fake currency rackets
- Caution for common man:
- Don’t get trapped by people who want you to deposit their money into your account
- Demonetisation and its impact on Indian Economy
- Government revenue to improve
- Real estate and Inflation will moderate
- Banking system and financial inclusion will improve
- Impact on financial assets and asset allocation
- Will demonetization control generation of black income?
- Review Land and Land-use policy
- Rationalize Tax Rates
- GST for commercial transactions
- Legal reforms for speedier trials in corruption cases
- APMC reforms required on urgent
- Political Funding
- Demand for cash should be declared illegal
- Improve Banking infrastructure
- What was the need of Rs. 2000 note?
- The Way Forward:
What is demonetization?
Demonetization is the act of banning or taking back of a
currency unit of its status as legal tender. Demonetization is necessary whenever there is a change of national
currency. The old unit of currency must be retired and replaced with a new
currency unit.
Demonetization will impact all
aspect so daily life of common man. At macro level, it will impact financial,
trading, political and social systems in life.
Demonetizations in
the other countries
Demonetization 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. Such a step, for example, was
taken when the European Monetary Union nations 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.
Zimbabwe, Fiji, Singapore and Philippines were other countries to have opted
for currency demonetization.
In India’s case, the
move has been taken to curb the menace of 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
demonetization of high-value currency. It was first implemented in 1946 when
the Reserve Bank of India demonetized the then circulated Rs 1,000 and Rs 10,000
notes. The government then introduced higher denomination banknotes in 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
government’s move to demonetize, even then, was to tackle the issue of black
money economy, which was quite substantial at that point of time. In January
1978, the Indian government demonetized Rs 1,000, Rs 5,000 and Rs 10,000 notes which
was quite substantial at that point of time. The move was enacted under the
High Denomination 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. The main difference
between then and now is that currency of higher denomination was barely in
circulation, unlike the Rs 500 and Rs 1000 note today.
Demonetization in 2016:
On November 8
evening, Prime Minister Modi, in his televised address to the nation,
made Rs 500 and Rs 1000 notes invalid, saying that it was aimed at curbing
the “disease” of corruption and black money which have taken deep root. People
holding notes of Rs 500 and Rs 1,000 can deposit the same in their bank and
post office accounts from November 10 till December 30. All notes in lower
denomination of Rs 100, Rs 50, Rs 20, Rs 10, Rs 5, Rs 2 and Re 1 and all coins
continued to be valid, and new notes of Rs 2,000 and Rs 500 were introduced.
There was no change in any other form of currency exchange be it cheque, DD,
payment via credit or debit cards etc.
Following the
announcement, there were huge crowds outside ATMs across the country as people
lined up to withdraw currency of smaller denominations. Banks were advised
Sunday to increase the Cash Withdrawal limit at ATMs from the existing Rs 2000
to Rs 2500 per day in the recalibrated ATMs. The weekly limit of Rs. 20,000 for
withdrawal from Bank accounts has also been increased to Rs 24,000 and the
limit of Rs 10,000 per day has been removed. The exchange limit over the
counter has also been increased from the existing Rs 4000 to Rs 4500.
Scale of demonetization effort in 2016
It is expected that even if 50% of the around 14 lakh crores of
old notes are legitimate, the remaining 50% or around Rs 7 lakh crores of
unaccounted money will see around 60 to 80 % thereof or approx. Rs 5 lakh
crores coming to the government in the form of extinguished RBI liability and
taxes and penalties. This Rs 5 lakh crores is enough to take care of India’s
entire fiscal deficit for one year or more.
What are the possible reasons for demonetization?
The reasoning given by government are:
1)
To tackle black money in the economy. The move is estimated to scoop out
more than more than Rs 5 lakh crore black money from the economy.
2)
To lower the cash circulation in the country which "is directly
related to corruption in our country”.
3)
To eliminate fake currency and dodgy funds which have been used by terror
groups to fund terrorism in India.
In the short term it will be a logistical nightmare for RBI to
manage the cash replacement in banks and smooth functioning of the banking
system.
It has clearly caused considerable inconvenience as people with
perfectly legitimate quantities of old notes of Rs. 500 and Rs. 1,000 have to
queue up at banks to exchange them into new notes. Tragically, many deaths have
also been reported. In addition to inconvenience, the shortage of cash has also
disrupted business in the cash-based informal sector, which is where the
majority of the population is employed.
Slowdown in consumer spending due to limited cash availability
will hurt small shops. Farmers, fishermen, vegetable sellers, small shopkeepers
without card readers or e-wallets, taxi drivers, truckers, etc., have all been
affected with loss of livelihood which may be irretrievable in some cases, for
example, loss of daily wages for casual labour, or lower sales for vegetable
vendors.
Severe liquidity issues in cash based sectors like Real Estate and
other non-essential products and services.
GDP will decline in the next 2 quarters due to reduction in
overall spending
Much of the public enthusiasm about demonetization comes from the
expectation that those with hordes of cash will not be able to exchange it in
the banks for new notes, and will therefore lose their ill-gotten money. This
group includes businessmen, or politicians (either on their own behalf or on
behalf of political parties), or bribe-taking bureaucrats. The public will
certainly applaud their loss. However, much of this may be laundered.
Since the notes will be valueless after 30 December, holders of undeclarable
cash will be willing to offer 30-40% commission, or even more as the deadline
approaches to offload the cash. Intermediaries will organize large numbers of
individuals who can take smaller “explainable” amounts of cash to the banks for
deposit. Since farm income is free of tax, large numbers of people claiming to
be farmers, could make deposits in banks, technically even exceeding Rs.2.5
lakh with impunity.
Black wealth held in cash can also be laundered by purchase of
gold and hawala transactions but that assumes that the suppliers of gold and
the hawala dealers can launder the old notes received before 30 December. Some
of this has already happened as evidenced by the sharp rise in gold prices and
also the hawala rate for the dollar. Inevitably, higher gold prices will
encourage smuggling and divert foreign exchange that would otherwise have flowed
through legal channels to finance gold smuggling. This is bound to put pressure
on the rupee.
It has been reported that given the capacity constraints at the
two printing presses which can print the high-value notes (assuming three shift
operation), it will take until May 2017 to replace all notes. It may not be
necessary to replace all notes because there
will be some switching to digital payments, which is desirable, and some of the cash hoards will be cancelled
in any case on 30 December. Even so, the cash-availability situation is
unlikely to ease very quickly.
The 50-day horizon mentioned by the Prime Minister probably
assumes that a substantial volume of outstanding notes will actually be
cancelled on 30 December. If on the other hand, they are extensively laundered,
the cash shortage and the disruption it causes in the informal sector may be
prolonged.
The negative impact on the various sectors of the economy is bound
to produce lower growth. Estimates for gross domestic product (GDP) growth in
FY17 from financial analysts vary from a low of 3.5% to a range of 5.5-6.5%. According
to my estimate, there will be slow down in 2nd half of this
financial year GDP growth is likely to slow down to around 6% in 2016-17. More
importantly, it will also remain subdued next year. Much depends on what
happens to the investment climate and what incentives government is planning in
coming budget.
Since the slowdown will be concentrated in sectors which are more
employment-intensive, the impact on low-end employment will be greater than on
overall GDP. This raises the issue whether the slowdown should be offset by
counter-cyclical additional expenditure on road construction and railways. Such
intervention will breach the fiscal-deficit target but a temporary deviation
can be justified in the face of the negative-demand shock of the
demonetization. In my view, one way to create employment thrust is by Increasing
income tax slab may also create jobs and services opportunities for labor
intensive activities in retail sector.
In such operation, where surprise element is the most important
aspect. Too much preparation was not possible and feasible.
Building up a larger stock of new notes in advance would certainly
have avoided some of the inconvenience and the associated cash shortage. The
belated provisions made for weddings and farmers, could have been anticipated.
The ministry of agriculture’s request regarding an exemption for farmers
purchasing seeds and other inputs during the sowing season, in order to avoid
disruption in sowing, should also have been addressed promptly, rather than
after several days. The challenge was how to minimize the misuse of these options
by black money hoarders and corrupt people.
Government was keeping close eye on developments in market place.
Every sensible suggestion was considered. The flexibility provided after problems
surfaced is to be welcomed but it could be increased even further. For example,
old notes are allowed to be used in public-sector hospitals but not private
hospitals, and farmers are allowed to use them for purchase of seeds from
public-sector agencies but not private agencies. There is a good case for
allowing flexibility for purchases from the private sector also. The deadline
that has been allowed for this flexibility could be extended. Perhaps the most
important flexibility is to allow cooperative banks to accept old notes. Their
presence in rural areas is much larger than that of commercial banks, and they
are all regulated entities. If enough currency does not exist at present to
supply cooperative banks, they should be allowed to accept the old notes and
supply new currency later.
The biggest problem was trust deficit with private sector due to
past track record and their involvement in large scale corruption and many of
them have close political affiliations.
Cooperative banks were also used by political masters of these banks and
farmers were complaining large scale miss use of cooperative banks by
influential people.
However, in the short run, it will disrupt downstream income flows
in the form of wages to construction labour, purchases of cement and other
construction materials, including steel, paint, glass, etc. This will have
downstream effects on both employment and income.
Expected benefits of Demonetization to common man
Those having legitimate income will deposit it in banks and apart
from the initial hassles associated with the banking system, they will have
nothing to worry about. However, those having unaccounted money will face
several problems as follows:
·
Those who choose to do nothing with the money, their notes will
expire worthless. Every note is a liability of the Government (RBI), and thus
notes becoming worthless will benefit the Government by extinguishing its
liability.
·
Those who declare their unaccounted black money, approx. 60- 70%
of the money will go to the Govt in the form of taxes and penalties.
·
There will be a third category who will try to launder their
money, but which will entail severe risks including penalties and prosecution.
However, the money sought to be laundered will anyway enter into circulation
and remain therein.
Demonetization to make loans cheaper soon:
People have deposited over Rs 6 lakh
crore since November 8. Banks would have to release the deposited cash into
the market. Banks would also have to lower the interest rates to release
so much money in the market. Poor and middle classes will get loans at lower
interest rates soon.
Real-estate development will be badly affected because it is
heavily cash-dependent, having long been a favorite asset for holding black
wealth. Sectors such as hotels, restaurants, catering, the fashion garments
industry, etc., which were often paid for in cash from black income, will also
be affected. Some of the disruption, as in the case of real estate, can be
viewed as an unavoidable rebalancing. This will reduce the cost of
non-essential services, land and real estate.
Any attempt to reduce black
money and control of inflation will get support from common man. These are two
factors which affect life of common man adversely. This will also give
strengthen to small traders and manufacturers because they can demand payment
in banks without waiting for cash generation by buyers. People will start
issuing bills against the payments and tax revenue for the government will go
up.
Today, Poor and middle-class people
are forced to give their white money as black for securing admission of their
children to schools. This practice is going to stop after the demonetization.
Schools and colleges can’t force the parents to pay in cash.
People seeking to buy new houses are
forced to convert their white money and give it in black (as cash) to real
estate agents. Such people have destroyed the entire economy. Note-ban is a
punishment for them.
Fake currency note rackets have been
severely hit by the demonetization. Fake notes worth crores have been used
to promote drug business and also buy weapons for the terrorists. Chit fund
companies will also get serious hit.
There are people who are luring the
poor people and asking the latter to deposit their illegal cash in their Jan
Dhan accounts. All transactions are now recorded in banks and any unaccounted
money will make you culprit in the eyes of law. No person should fall in such
trap as not only those giving the money but also those depositing black money
in their accounts would have to face the strict law.
GDP growth is
expected to be negative for around 6 months. However subsequent 2 years will
see sharp revival in growth. Tax revenue is likely to increase sharply.
Government Deficit will see a huge windfall in the next 2 years. This will help in implementation of GST as
well and will make systems transparent at faster rate.
Inflation is
expected to fall sharply with fall in Real Estate prices and transaction costs
thereof. Real Estate is expected to fall by around 20 -40 % and stabilize
thereafter. c. Effect on Gold is a bit uncertain, and may be neutral/ negative.
Real Estate and
jewelry sectors, though battered initially will stabilize in the next 6 months.
Lower black money
will depress demand, but at the same time Gold is a hedge against uncertainty
and those still wanting to park black money may prefer to put it into Gold
instead of cash.
Currency is
expected to strengthen as inflation drops and economy gets a boost.
Banking System will
get a boost, as around Rs 7-8 lakh crores base money (new legal money) will
enter the system, which will further create around 3-4 times more money due to
re-circulation.
Bond prices will
rise as interest rates drop. Equity is expected to benefit the most, because of
a. There will be a
gradual shift from physical assets (real estate/ Gold) to financial assets.
b. The organized
sector (corporates, especially listed ones) will benefit due to less cash
transactions.
c. Lower inflation and
interest rates will benefit listed corporates through lower borrowing costs,
thereby increasing their profitability and valuations.
Thus Asset Allocation
and re balancing thereof will now play an even more important role, making
proper financial planning imperative.
Unfortunately, most of the black money is parked in other assets
like land, property, gold and other stock market. The black money is generated
when there is lack of transparency and someone is allowed to ear supernormal
profit without legal and objective means. People have tendency to save taxes
due to high amount of outgo in taxes.
This is the key question and demonetization does not address this
problem. There have been announcements that more steps will be taken, but these
relate to benami properties and undeclared foreign holdings. What is needed are
steps that will discourage fresh black income from being generated in future
through continued corruption.
The following is a list of steps that can be taken to stop black
money creation, which will have a significant impact over time.
Reducing discretion in both the Central and state governments and
increasing transparency and accountability especially where the financial
amounts involved are large. The biggest area of discretion relates to land and
land use. Persuading states to drastically lower the stamp duty for real estate
sales as high rates of stamp duty are a major incentive to perpetuate real
estate transactions in black money.
Reforming the system of tax administration, including
reorganizing, strengthening and modernizing the Central Board of Excise and
Customs/Central Board of Direct Taxes. Lowering the corporate tax rate to 25%
at one go with exemptions eliminated in the next budget. The present rate is
much higher than in most other jurisdictions. Any negative effect on the fiscal
deficit can be justified given the need for a fiscal stimulus.
Lowering tax rates and simplifying the tax system to improve
compliance. The goods and services tax (GST) to be introduced shortly was an
ideal opportunity, but the proposal finally approved by the GST council has far
too many rates and exemptions. Even if this cannot be changed at this stage,
the council could at least announce a review of the multiplicity of rates with
a view to converging on two rates plus a sin tax. It could also announce an
intention to include alcohol—a major source of evasion and black money—and also
real estate in the GST by 2020.
Pursuing some high-profile corruption cases to a successful
conclusion to send a message to both business and the bureaucracy that
corruption will not be tolerated. A selective approach based on scientific
probabilistic analysis is much better than broad-based action which only
creates fear in the business community. Name and shame can be another approach
to minimize such cases.
Commodity markets is another source of black money generation. Agriculture
is tax free and all transactions in commodity markets are outside the tax
system and APMC licensing conditions provide spate sponsored money poly to
facilitate such transactions. Most of the black money generated in commodity
market is used in politics and underground activity. This is also used in
hoarding of commodities which is leading to food inflation and land price
inflation. This must be stopped with immediate effect.
It is absolutely essential to start making a serious effort at
reforming the system of electoral funding, including introducing transparency
in party finances. Businessmen routinely say that they are forced to generate
black money to meet the demands of the political system and also the demands of
the bureaucracy which has arbitrary powers which can bring business to a halt.
No person should be forced by other person to pay in cash
irrespective of amount. This will reduce the black money generation in daily
life.
With demonetization the load of banks will increase by 2 to 3
times, are the ready to handle this additional load. This should be reviewed in
terms of manpower, IT infrastructure, etc.
Lastly, the
question may arise as to whether the new Rs 2000 Rupee notes will create more
black money or not. While that is always a possibility, it should be noted that
this demonetization would have created a psychological impact especially on
large scale evaders who will definitely think twice before taking such action.
It will be easy for
government to suck Rs. 2000 notes from the system and stop printing these
currency notes in future. Due to this, it will be less painful to demonetize
Rs. 2000 notes in future date.
Demonetization is first step in right direction. can only be a part of a comprehensive strategy
to tackle corruption and generation of black income, and it is likely to impose
substantial pain because of the adverse effect on GDP and low-end employment.
The more important part of the fight against corruption involves the other set
of measures listed above. Progress on these would make a real contribution to
reducing the long- term gain of reducing the generation of black income over
time.
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