Demonetization: An Analysis

Why it is in News?

Recent trends, especially the fourth quarter (Q4) of financial year (FY) 2016-17 saw a sharp decline in the growth rate and is speculated that demonetization might be the cause..

Why it was done?

• Prime Minister Modi announced the demonetization of the then existing 500 and 1000 notes and justified the move on the basis of the following points:
• To tackle black money in the
• economy
• To lower the cash circulation in the economy which “is directly related to the corruption in our country” according to Modi.
• To eliminate fake currency and dodgy funds which have been used by terror groups to fund terrorism in India.
• The Economic Survey 2016-17 describes Demonetization as “A radical governance-cum-social engineering measure, radical and unprecedented step with short term costs and long term benefits where the aim of the action was to curb:
• Corruption,
• Counterfeiting,
• The use of high denomination notes for terrorist activities, and
• The accumulation of “black money”, generated by income that has not been declared to the tax authorities.
• to signal a regime change, emphasizing the government’s determination to penalize illicit activities and the associated wealth.”

Current Scenario

• India’s real GDP dropped sharply to 6.1% in the January-March quarter of 2017, after averaging 7.2% in the first nine months of the fiscal year. This slump lost India the ‘fastest growing economy’ tag allowing China to edge ahead.
• In quarter 4 the whole economy witnessed a sharp slowdown. Most sectors of the economy bore the brunt of the note ban in the fourth quarter of 2016-17 and not in the third quarter, when the thunderbolt move was announced
• Gross Value Added (GVA) also reduced in the fourth quarter than the third quarter.

Sector wise break down

• In Q4, the construction industry saw a 3.7% contraction compared with a 3.4% increase in Q3.
• Despite the new series of Index of Industrial Production (IIP) showed factory output in an improved state, manufacturing growth fell (to 5.3% from 8.2%)
• Construction and manufacturing, crucial sources of jobs, have been most severely affected.
• Services such as trade, hotels and transport slowed to 6.5% growth, from 8.3%.
• However, a good South-West monsoon boosted growth in agriculture GVA to 4.9%, from 0.7%
• Owing to Pay Commission, Government expenditure expanding by 11.3% in FY17 compared with 6.7% in FY16, providing a mini-stimulus to the economy.

Is present government policy good enough?

• Over-reliance on the government is not great news for the long-term health of the economy, or the aspiration towards ‘less government’.
• Given fiscal constraints, a government spending binge extracts a toll on taxpayers.
• The improvement on the agriculture figures is due to the good monsoon. The dependency on monsoon for agricultural growth is definitely neither a stable nor a viable option.
• So revival of private sector is a necessary condition.
• For economic growth to create jobs, demand for goods and services has to fuel investments in new factories and offices.
• But the investment influx for the country still remains at a grave condition. In comparison to FY 2016, growth in new investments slumped from 6.5% to 2.4% IN FY 2017.

How to Handle the Issues?

In the Economic Survey, 2016-17, following suggestions were made:

• Fast and demand driven re-monetization.
• furthering of tax reforms (DTC)
• Bringing land and real estate into GST.
• Reducing the tax rates and stamp duties.
• Acting to reduce anxieties of the investors and tax-payers about over-zealous tax administration.
• Demonetization led to a severe cash crunch which pushed the economy towards cashless economy. The better utilization of Bharat Interface for Bhim (BHIM), a digital payment app can be the resolving factor.
• Extensive programs for all sections of the society to make them capable of understanding and undertaking online banking and transactions.
• Structural changes have to be introduced to make the system more rules-based—reduce the discretionary powers of the bureaucracy.
• Make the tax system simple, transparent and less discretionary.
• Make a greater effort to include the informal sector and ensure effective and quick dispensation of justice.

Conclusion

• Demonetization’s immediate effect was the severe cash crunch and the after effect is – a sharp fall in the growth rate.
• Demonetization had a severe impact on private consumption.
• As the cash crunch eases, consumption will probably revive. But the risk to the recovery is from the credit crunch that demonetization worsened.
• Overall, if the dependency on monsoon does not get dismantled and privates sector revives, then the economy will definitely witness green spots.