• Monday, Aug 15, 2022
  • Last Update : 04:24 pm

What India’s demonetisation means

  • Published at 12:03 am November 23rd, 2016
What India’s demonetisation means

Common people in India and a few Bangladeshis seem to be quite concerned about the recent demonetisation in India. While the Modi government remains bullish regarding the impact, many remain pessimistic.

Though the government is ordering changing out all 500 and 1,000 rupee notes in circulation (totalling more than 14 lakh crores) by December this year, many are saying it may take another six to seven months.

Whatever might happen in the future, common people are suffering now. Bank executives are under tremendous pressure to manage the situation on behalf of the government.

ATMs are running out of cash, banks are not able to disburse cash, and farmers and retailers are extremely confused and disconnected.

Estimates for black money in India are approximately a whopping 20% of GDP. Some forecast it as high as 60%, and black money is believed to be the primary source of funds for terrorist activities. It is well understood that black money is detrimental to a country’s economy and its people.

The Indian government realised how detrimental this is, that it has outlawed all existing Rs500 and Rs1,000 notes almost overnight. Old notes must be exchanged as quickly as December 30. Considering the fact that almost 86% of currency is held in 500 and 1,000 rupee notes, this is a drastic and consequential move.

The main goal is to obliterate black money. However, it’s not as easy as it may sound. In fact, it’s a painful exercise for not only the corrupt, but for the poorest and most marginalised of people too. All in all, is it worth it?

One thing to consider is the fact that not all black money is stuffed underneath mattresses and stored in trunks buried under soil. In the last five years, it has been found that only 5-6% of black money in India is kept in hard cash.

The wealthy have lawyers, connections, and the ability to act fast. The poor are left standing in lines outside banks for hours. The rural economy of India is based on cash, and the majority of those who live and work in these areas have never opened bank accounts

Even the corrupt and the tax-dodgers are wise enough to turn their cash assets into hard assets, shares, and real estate, etc. There is also the Cayman Islands. Black money is generated through evasion of taxes on income and illegal activities.

In the absence of steps to curb the generation of black money, demonetisation can be a futile exercise, as it proved to be in 1978.

One of the reasons behind such demonetisation is believed to be the flushing out of fake money in circulation.

As per a study done on behalf of the National Investigation Agency (NIA), there was Rs400 crore worth of fake currency in circulation in the Indian economy. This is only a meagre 0.03% of the total currency demonetised in 500 and 1,000 rupee notes. This questions the cost-benefit analysis of such demonetisation.

According to data, 97% of all transactions by volume are done in cash. Summarily, demonetisation has created chaos all over the country, with people unable to purchase daily essentials and, in many cases, life-saving goods and services.

Five people, including one infant, have died as a direct result of this initiative. It was reported that almost 50% of the 202,000 ATM machines in India have stopped functioning, and the majority have already run out of new notes.

In fact, no new currency notes were printed, in an effort to keep the news under wraps. Proof of identity and bank accounts are required in order to convert existing currency into the new notes, but millions of Indians have neither.

Ordinary Indians are taking the biggest hit from this change.

The wealthy have lawyers, connections, and the ability to act fast. The poor are left standing in lines outside banks for hours.

The rural economy of India is based on cash, and the majority of those who live and work in these areas have never opened bank accounts.

Only about 30% of the Indian population has access to the banking system as per data compiled by the banking division of the Finance Ministry.

Consequently, people in rural India who often also suffer from inadequate information have become the worst victims of demonetisation. Millions of people are now left without their purchasing power, as most economic exchanges between farmers or workers in these rural economies are cash-based.

As a result, small businesses will suffer greatly. It has been estimated that the cost of replacing currency in circulation with new notes will be Rs20,000 crores. Besides, far greater losses will be incurred by markets predominantly run on cash, and in lost productivity.

To a certain extent, the arguments for this ban are fair. Because of financing terrorism, the rupee is a quasi-floated currency in some of the markets, and with so much money going untaxed, those who are powerful can easily get by, and those who are not, feel a sense of injustice and despair. This attack on black money does have short-term benefits.

Taxable income will go up. However, fake money once again may re-circulate.

You cannot stop terror by banning notes. Some experts also forecast that GDP growth will substantially decrease. They felt this could cause GDP growth in 2017-18 to shrink to 5.8% from their earlier estimate of 7.3%.

All in all, the economy will be catatonic in the short-term, followed by a period of easing out. Only time will tell if it was all worth it.

Mamun Rashid is an economic analyst.