DEMONETISATION AND ITS OVERALL IMPACT

TH
On 8 November 2016 at 20:00 IST, PM Narendra Modi announced the withdrawal
of Rs.500 and Rs.1000 denomination notes, an announcement that shocked the
whole nation, stock market gained turbulence with an immediate effect and whole
attention of the population shifted from the US president election to PM Modi’s
speech on demonetisation of Rs500 and Rs1000 denomination notes which
accounted for 86.4% by value currency in the flow and 12.2% of country’s GDP. This
was one of the boldest moves in the Indian economy ever. During 50 days of
demonetisation the nation witnessed a huge turbulence, long queue against ATMs
and branches, banks opening till late night and smartphones transforming into
wallet.
Demonetisation is an act of striping a currency unit of its status as a legal tender
i.e. old currency unit has no legal value thereafter. Demonetisation can be done for
reasons like to combat inflation, corruption or to promote trade etc. The process of
demonetisation can be implemented by replacing old currency notes by new ones or
through completely changing old currency by a new currency.
Demonetisation has took place earlier also, nations in European Union adopted Euro
as their currency in 2002 replacing their old currency to promote international trade
while Zimbabwe in 2015 demonetised Zimbabwe dollar facing hyperinflation
recorded at 23,10,00,000%. Venezuela on 16 Dec 2016 demonetised 100 Bolivar
currency unit for security reasons and economic causes.
In post-independent India, demonetisation took place in 1978 scraping Rs.1000,
Rs.5000 and Rs.10000 currency notes, but during 1978 these currency units valued
less than 1% of total currency in flow during that period. While in 2016, demonetised
currency notes valued 86.4% of total currency in circulation and this time objective
of Govt. for Demonetization was three fold: to eradicate counterfeit currency, to
fight tax evasion and black money present in the country and to promote cashless
economy.
Situation Prior to Demonetisation
During the period 2011-16 there was 40% growth in the circulation of notes of all
denominations, while the growth in Rs.500 note circulation was 76% and growth in
circulation of Rs.1000 denominations notes was 109% while economic expansion of
India was 30% showing a disproportionate rise in the high denomination notes which
is a sign of caution for the economy as this will lead to inflation and increase in
unaccounted transactions as ‘value by volume’ ration of Rs.500 and Rs.1000 is quite
high thus making it easy to carry and store large amount of money.
As per Financial task Force (FATF) report, that looks after criminal use of
International financial system, the high value denomination notes are major financial
tools used in money laundering, human and drug trafficking. For example in a real
estate deal just 60-70% payment is made through cheque, DD or other traceable
means and rest amount is paid though cash to evade tax, in cash transactions the
most preferred are Rs.500 and Rs.1000 notes due to less space required to carry or
store them.
As per RBI data for 2015-16, total of approximately 6.5lakh counterfeit notes were
detected in commercial banks of which 2.61 lakh notes were of Rs500 and 1.58 lakh
were of Rs1000 denomination valued more than 90% of total counterfeit currency.
These high denominations are major targets of counterfeit agents due to their high
‘value to volume’ ratio and difficulty to push large volume of counterfeit currency
into India.
Continuously growing problem of black money, corruption and counterfeit currency
is a huge threat to economic structure of the country. Surprised demonetisation was
a tool used by the Government to tackle the above said problem.
A Gradual Plot
Though announcement of demonetization was very sudden, the government has
been sowing the seeds of the same. First in August 2014, government launched
Pradhan Mantri Jan Dhan Yojna(PMJDY), as on 1 June 2016 nearly 22crore accounted
has been opened through the scheme with more than 60% being of rural household.
This step ensured that financial inclusion extends to rural household too. RuPay debit
cards were issued to Jan-Dhan account holders so as to make them survive cash
crunch.
In February 2016, government approved the guidelines for promoting payment
through cards and digital means. In August 2016, the National Payment Corporation
of India(NPCI) launched Unified Payment Interface(UPI), which allowed the users to
transfer funds across two banks.
Income Disclosure Scheme(IDS), a fixed duration window for tax defaulters to
declare their assets, source and paying the tax over the assets with a penalty of 45%
thereafter, and avoid litigation. Rs 62250 crore of unaccounted money was
recovered under IDS.
Demonetisation was the last tool to hammer defaulters which didn’t turned up in
IDS, after ensuring that most of the families do have a bank account to deposit their
money. Due to abolishment of legal tender of Rs.500 & Rs.1000 notes big fishes were
forced to unearth their money followed by tight scrutiny by IT department on
deposits in bank accounts along with transaction history of the accounts so as to
catch suspicious cases, penalty was also harsh on culprits.
Demonetisation and Counterfeit Currency
As per International Association of currency Affairs(IACA) report, the highest
counterfeit prone currencies in the world are British Pound Sterling(£), US Dollar($)
and Euro(€)while safest one being South Korean Won(₩). USD100 bill is among the
toughest currency units to counterfeit yet highest counterfeited currency in the
world. This shows just strong safety features alone does not guarantee immunity
from counterfeit, government agencies need to work continuously in dynamic
environment of competition and technology advancement to safeguard the economy
form getting counterfeit victim.
Indian agencies did commendable job in finding out that Germany based company
Louisenthal which use to supply raw currency note paper to RBI was also supplying
raw material for currency note to Pakistan also and thus MoHome Affairs barred
Louiseuthal from delivering raw material to RBI.
Post demonetisation, only way to use old denomination notes is through depositing
them in bank, thus old counterfeit notes lost their value giving a relief to the
economy for a limited period which can be extended with continuous efforts to
check the flow of counterfeit of new Rs.2000 and Rs.500 notes into the country.
Demonetising old currency units and introduction of new Rs.2000 and Rs.500 notes
will not end counterfeit from its root but it can put substantial barriers to the pace of
counterfeiting with new security features (total 17 security features are there) like
different size of notes, magenta color, color shifting windowed security thread.
On 1 February 2017 BSF seized a consignment of fake ₨2000 denomination notes
having 50% of security features. Demonetization alone is just a short term solutions
to counterfeit currency flow, this process of demonetization needs continuous
supplementary efforts by the government and people, such as a gradual shift
towards digital economy, gradually eliminating all high denomination notes and
getting habitual of high value transaction only through e-payment gateways. A shift
in attitude of people is foremost to fight counterfeit currency.
The Black Money Menace
As per ‘The Drivers and Dynamics of Illicit Financial Flaws from India:1948-2008’
released in 2010 by Global Financial Integrity: tax evasion, crime and corruption
removed gross illicit assets worth $462billion from India.
As per World Bank Data in 2000 the magnitude of parallel economy (Black money)
was 23.01% of India’s GDP. In 2007 this was 20.7% of India’s GDP, however 72% of
India’s black money is held abroad in tax heavens like Switzerland and Mauritius.
Total black money in cash is just 6% of its full size so demonetization alone can
unearth maximum of 6 % of this black money. To put check over black money other
steps have to be taken up by the government. Amendment in DTAA(Double taxation
avoidance Agreement) with Mauritius, Cyprus and Singapore was one such step that
check round-tripping, constituting SIT(Special Investigation Team) on Black Money
being another one. Agreement between Indian Govt. and Swiss Govt. w.e.f 2019,
sharing of information of Swiss Bank account holders between two nations, is more
effective to unearth black money than Demonetization as these cover 72% of
unaccounted wealth.
Idea to unearth Black money present in cash inside the country was 2 fold:
 Government agencies will be keeping close eyes over the deposits and catch
tax defaulters through suspicious money transactions in the bank accounts.
 Big fishes who could not deposit the money due to fear of being caught will
lose all their money through ‘extinguished liability of RBI towards Rs.500 and
Rs.1000 denomination notes’ and that money will get automatically
transferred to government.
Under Section 26 of RBI Act, there is obligation of payment of legal tender by the RBI,
As Rs.500 & Rs.1000 have ceased to be legal tender, so the legal obligation of RBI get
extinguished by the ordinance passed by parliament on 28December 2016. By
removing the liability and making accounting of notes clear, the balance sheet gains
could be used for various purpose like special dividend to the government which
could be used for infrastructure or social development projects and can also be used
recapitalizing banks etc.
Trapping big fishes in demonetization is very difficult in a country like India where
unorganized sector accounts for 80% of Jobs, farmers are tax free, market structure
in not fully automated thus creating lot of loopholes in implementation of
demonetisation. Big fishes divide their cash in to smaller caps and give it to workers
of unorganized sectors, farmers, bought jewellery and other high value items with
backdated bill. Many dormant Jan-Dhan accounts got activated and deposit reached
them up to Rs.49000/- on a single go because Rs.50000/- deposit needs to produce
PAN Card.
Govt. Agencies noted it and took necessary steps while demonetization was in
process such as making it mandatory to produce PAN Card for purchase of gold,
religious institutions were urged not to accept Rs.500 and Rs.1000 notes etc. But
large number of big fishes managed to deposit money into banking system as
loopholes were there in the Indian economy. As on 8 Nov2016 number of Rs500
notes was 1716.5 crore and Rs1000 notes numbered 685.8 crore, combined value
Rs.15.44 lakh crore. On 31 Dec2016, net currency deposited was Rs.14.97 lakh crore
(97%).
Though large chunk of old high denomination currency has been deposited with the
bank, this does not render this money to be legitimate. Black money does not change
its colour merely because it is deposited in bank. It has now lost its anonymity can be
identified by government agencies with its owner.

Corruption Control
In 2011, Germany based corruption watchdog ‘Transparency International” ranked
India 94th among 176 countries. India’s rank has now improved to 76th. It is not at a
satisfactory achievement and a lot has to be done to make India corruption free.
Sudden withdrawal of high value currencies panicked corrupt officials and worked as
a wakeup call for them, but demonetization alone is ineffective over bribes taken in
other forms. Push towards digital economy through demonetization is a strong move
which could reduce corruption.
In a democratic system of government, political party funding is one of the major
sources of corruption. Therefore, any attempt at fighting corruption that does not
first involve bringing transparency to the funding of political parties cannot be
meaningful. Finance Minister’s announcement in budget speech on limiting cash
donation to political parties by a single person from Rs20,000 to Rs2,000 was a good
decision. It’s the moral responsibility of the people more than the government to
make society clean. Without full commitment of the citizens no government can
eradicate corruption from a state.
Towards a Less-Cash Economy
Demonetisation caused a cash crunch and forced government and people both to
push for electronic payment and transfers. Though the main pitch of demonetisation
was towards curbing counterfeit currency and black money but shift towards a
cashless economy came out as necessity.
A cashless economy runs on digital transaction made through cards at PoS(Point of
Sale) or through net banking, NEFT/IMPS etc. Smartphones work as wallet that does
not require cash in physical form; they are linked to bank account through an
interface.
This means of payment brings transparency in the system thus seems to a long term
solution to the economic problems.
Comparison with Major Less-Cash Economies
Cash in circulation in India is higher than many other ‘Less-Cash economies’, in 2015-
16 total of 98% by volume and 68% by value transaction took place in cash in India.
In 2015, the share of cash in circulation as percentage of GDP of India was 12.3%
compared to 3.8% in Brazil and 5.6% in South Korea.
Number of PoS terminals to use cards for payment, per million habitants in 2015 was
1080 in India against 25,241 in Brazil, 16,602 in China and 18,660 in Sweden. Even
the average card holding per person in India is 0.5, while in Sweden it is 2.5, 4.1 in
Brazil and 4 in China.

A Comparison with Sweden Model

Sweden is one of the most cashless economy in the world having cash transaction
just 2% by value of total transaction.
Factor Sweden India
Population 95lakh 126crore
Literacy 100% 74%
GNI Per capita(PPP) $46,680 $5,350
HDI(Human Development Index) 14th 0.907 rating points 130th 0.609 rating points
%population living in rural 14.5% 68%
%adults using smartphone More than 90% 17%
%individuals having internet More than 90% 26%
connection
Cash circulation as %GDP 1.7% 12.3%
At the current stage it is difficult to go as cashless as Sweden because we lack the
basic infrastructure necessary for a cashless economy, a lot of room for
improvement is there for India.
In current scenario there is 2% extra charged levied on payments made through
debit card at PoS terminal thus attracting cash transactions. Neutrality of mode of
payment should be maintained. The country must have a strong cyber security
network to gain confidence of customers for online transactions, and digital
payments need to be made more convenient and attractive, this can be done by
widening infrastructure of digital payment and giving incentives to customers for
using digital payment mode like ‘Lucky Grahak Yojana and Digi-Dhan Vyapar Yojana’
was a step in this direction.
This is true that 100% cashless society is not possible, but an initiative can be taken
for a less-cash drive which will ultimately lead to cash-less economy. However
analysis of other major low-cash economies show that strong infrastructure and
supporting regulations are necessary for transforming into cash-less economy.
Common Man in Demonetisation
India is largely an agrarian based rural economy with 68% population living in rural
areas and unorganised sector constituting more than 80% of the jobs. As per RBI
report, total number of ATMs in rural areas in 2016 is 40,345 which is 18.7% of total
ATMs in the country and number of bank branches in rural areas per 1lakh people is
7.8 branch. UP and Bihar which collectively is home for 25% of country’s population
is having 12.5% of total ATMs in the country. Data above shows that villagers and
unorganised sector was worst hit section having less ATMs and bank branches to
access during the cash crunch.
Digital transaction was main gateway for payments during cash crunch, though rural
household and unorganised sector workers were having Jan-Dhan account and
RuPay card but lack of experience of digital transactions and lack of knowledge of
internet in villages kept them away from getting digitalised. As per IAMAI(Internet
And Mobile Association of India), on June 2016 total mobile internet users in village
stands at 109 million(12.8% of total villagers), and 93% villagers had not done any
digital transaction yet.
Demonetisation was announced during sowing season of Rabi crop. Best time to sow
seeds for best result is during November which got exhausted standing in long queue
against bank branches to get cash exchanged. Though relaxation was there to use old
currency notes to buy seeds from government stores but many other requirements
needs cash like hire a tractor or labour, thus creating inconvenience to farmers.
Old currency notes were acceptable in govt. hospitals while majority populations
prefers private health care services , for mild health issues people prefer private
clinics because of their large presence and moderate cost but many private clinics
neither accepted old currency nor they were having PoS terminals that time.
Though intention was fair but due to lack of preparation while implementing
demonetisation and lack of infrastructure it caused a lot of pain to common man to
clean the economy of the nation.
Impact on Economy and Banking Sector
Demonetization is likely to hit economy in the short term. Growth in the Indian
economy remained healthy at 7.3% in July Sept. quarter. Fall in the economic
activities due to demonetization could last for 2 to 3 quarters i.e. up to March 2017
and growth rate will remain low for a significantly large time.
In the medium run, the Indian economy can grow considerably after curbing the
debilitation caused by counterfeit money, and arise in tax flow, lower interest rates
and higher amount with banks for easy loan to help Indian economy grow stronger.
RBI has CPI growth rate target in mind while deciding monetary policy stance. Target
to keep inflation below or at 5% mark was there up to March 2017. Demonetisation
had a negative impact on inflation with consumer’s spending actively fell to a near
halt. Activities in the real estate sector, which includes a huge amount of cash and
undocumented transactions dipped. Food items inflation accounts for 47.3% of
overall CPI, due to less cash availability with people the demand and supply of
perishable food items fell down.
A change in Repo rate will impact ‘interest rate sensitive sectors’ and industries with
large capital investment. Repo rate, the rate at which RBI lends to commercial banks
for a short term period is the key monetary policy rate for RBI. Though RBI cut Repo
rate by 25 basis points in October 2016, there are still chances to cut down repo rate
further to boost the economy.

Banks saw huge rise in deposits, thus commercial banks reduced their deposit rates
as they reduced lending rates. Loans sanctioned from 1 April are with reference to
MCLR(Marginal Cut of fund based Lending Rates) instead of base rate. It will
translate into lower interest rates on existing floating loans and new loans.

Conclusion
Demonetisation of 86.4% currency by value was a bold step , it needs strong will
power to make such radical steps to refine the current economic structure.
Magnitude of this decision was very large thus implementation became very much
vital. Indian complex economic and administrative structure and lack of adequate
digital infrastructure have many loopholes thus big fishes managed to get their
money into banking system, however this does not mean their money became
legitimate and they escaped from authorities.
Demonetisation alone can’t be a long term solution to the causes for which it was
implemented; it needs to be supplemented by dynamic efforts by the government
and cooperation of the people. It was just one of the many efforts required to keep
the economy healthy and strong for a long term.