The lowdown on one year of note ban

The lowdown on one year of note ban

Context:

November 8 will mark one year of NDA government’s radical plan to demonetize 86% of the currency in circulation in a bid to fight black money, counterfeiting and terrorism.

Background:

• On November 8, 2016 Prime Minister announced that Rs 500 and Rs 1000 denomination notes will become invalid.
• The government introduced new notes of Rs 2,000 and Rs 500 .
• There was also no change effected in any other form of currency exchange like cheque, Demand draft (DD), payments made through credit cards and debit cards.
• The move was taken to curb the menace of black money, fake notes and corruption by reducing the amount of cash available in the system.

What were the reasons for announcing demonetization?

• To counter black money, corruption, fake notes, and terrorism.
• The idea was that unaccounted wealth would come out with the mandatory depositing of the withdrawn notes.
• Stop terrorist funding.
• One of the aims was to bring about a shift from a cash based economy towards more digital or electronic forms of transactions for the benefit of e-wallet and credit card companies.
• One of the objectives was that the quantum of cash operating in the system must gradually come down.
• One of the objectives of demonetization was to put identity on the cash holdings in the economy.
• Destablished the funding of rival political in the run-up to key Assembly elections.

What is the meaning of 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.
• 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.
• The opposite of demonetization is remonetization where a form of payment is restored as legal tender.
• Demonetization can also be referred to as the process of moving people from a cash-based system to a cashless system

Was this the first time the government has introduced demonetization?

• This is not the first time the government is following the policy of demonetisation of high-value currency.
• The first instance of demonetisation by the government was implemented in 1946 when the RBI demonetised Rs 1,000 and Rs 10,000 notes.
• Later, higher denomination bank notes (Rs 1000, Rs 5000 and Rs 10000) were re-introduced in 1954.
• However, Morarji Desai government demonetised these notes in 1978.
• According to data provided by RBI Rs 10,000 note was printed in 1938 and 1954 and was subsequently demonetised in 1946 and 1978 respectively.

What are the consequences of demonetization?

Positive consequences:

• The growth in the direct tax base.
• The switch in the financial holdings of households from cash to bank deposits
• The increased use of digital payment

Negative consequences:

• The main negative economic consequence of demonetisation has been the disruption of unorganized supply chains that are dependent on cash transactions.
• Demonetisation lead to decline in economic growth to a three year low of 5.7 per cent.
• RBI report had revealed that nearly 99 per cent of the scrapped currency notes had come back to the banks, and it would become 100 per cent if cash in the pipeline is accounted for.
• In its biannual economic update in October, the World Bank said disruptions by demonetisation and the Goods and Services Tax (GST) had affected India’s growth momentum.
• The World Bank said growth was expected to slow to 7% in 2017 from 8.6% in 2015, the International Monetary Fund projected the GDP growth at 6.7% in 2017, slower than China’s 6.8%.
• “While the macro-economic impact of demonetisation has been relatively limited, the distribution of costs is uneven as the informal economy is likely to have been hit especially hard,” the World Bank said in a report in May.
• The liquidity crisis that followed demonetisation impacted the investment climate. By June, the economy’s four growth engines, including exports and private investment, slowed down.

What next?

• According to the RBI’s annual report released on August 31, 98.96% of the withdrawn notes had been returned by June-end.
• While defending demonetisation, the government and its then Attorney-General Mukul Rohatgi had said ₹3 trillion would not return to the banks as they were in the form of black money and were unaccounted for.
• RBI data show cash transactions are nearly at their pre-demonetisation levels, though new methods of payments such as UPI have seen a sharp increase in usage.
• However, one upside is that demonetisation forced companies to document transactions. When the Centre initiated action against 2 lakh shell companies as part of Operation Clean Money, their bank accounts came under scrutiny.
• According to the government, it has identified 18 lakh bank accounts in which the amounts deposited during demonetisation did not match the income profiles of the account holders.
• The banks are also starting to compile and release data on the deposits and accounts.