Demonetization: An Analysis

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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.

What is Demonetization?

Demonetization is the act of stripping a currency unit of its status as legal tender. It occurs whenever there is a change of national currency: The current form or forms of money is pulled from circulation and retired, often to be replaced with new notes or coins. The opposite of demonetization is remonetization, in which… Continue reading What is Demonetization?

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