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Demonetisation of Old Currency Notes Explained

The past one month or so has seen heated debates and extensive media coverage around the phenomenon of ‘demonetisation’ of old currency notes of Rs 500 and Rs 1000 denomination. Since this issue has affected the entire population and economy of India and has far reaching socio-economic implication, it is a crucial topic for General Studies from the view point of Prelims and Mains. In this post, we will look at the meaning of demonetization and its objectives along with the impact of demonetization and the implementation of this policy. Finally we will summarize the entire discussion on this demonetization exercise.

What is Demonetisation and What are its Objectives?

Demonetisation (D.M) refers to the process by which currency notes in the Economy cease to be legal tender. On 8th November 2016, the Govt of India (GoI) notified that existing currency notes of Rs 500 and Rs 1000 denomination (Mahatma Gandhi series) will cease to be legal tender. All citizens were asked to deposit their cash held in Rs 500 and Rs 1000 denomination bank notes in their bank accounts by 30th December. They could also exchange their cash with new bank notes and notes of other denominations subject to various limits and conditions.

So Why Were Rs 500 and Rs 1000 Bank Notes Demonetized?

As stated by the GoI and RBI and various press releases, the objectives of D.M are as follows:

  1. To fight black money and corruption in the country by preventing hoarding of cash
  2. To fight terrorism by cutting off funding in cash
  3. To prevent counterfeiting of currency notes

Other objectives like transition toward a less-cash economy or push for digital transaction were added later and were not part of the original notification of either GoI or RBI.

Source: RBI and GoI notifications

Demonetisation: Facts and Figures

Before we discuss the implementation and impact of the demonetization process, first let us understand the facts and figures related to this exercise.

As per RBI data as on 31st March 2016, the total value of Rs 500 and Rs 1000 old currency notes in circulation was Rs 14.18 lac crores which amounts for 86% of the entire currency in different denominations in circulation before 8th November.

India has 4 currency printing presses and at their current capacity it will take them an estimated 6 months to replenish the demonetised notes through new Rs 500 and Rs 2000 currency notes.

It is estimated that cash forms just 6% of undisclosed money with tax evaders and cash hoarders. The majority of undisclosed income is held in the form of jewellery, undisclosed properties, hawala money like Swiss bank accounts and others. This entire demonetisation exercise targets this 6% black money or undisclosed income.

India is heavily cash-loving economy with cash transactions accounting for approximately 90% of all transactions taking place daily.

Implementation of Demonetisation of Old Currency Notes

Now that we are aware of the objectives of the demonetisation policy and the facts and figures associated with this exercises, let us analyse the implementation of this profound economic policy till now.

Absolute Secrecy Maintained

Since the original objective of this entire demonetisation exercise was to target the black money in circulation in the economy, absolute secrecy was required to be maintained so that black money hoarders could not get sufficient time to convert their stash of 500 and 100 rs notes to white.

ATMs not Re-calibrated

One of the unintended consequence of the secrecy veil was that banks did not have advance information about the demonetisation policy and hence they could not get the ATMs re-calibrated for the new Rs 500 and Rs 2000 currency notes. This resulted in ATMs running out of cash within 10-15 minutes since they were dispensing only Rs 100 notes instead of high value notes.

Ever Changing Policy

The policy of the Govt. changed on a continuous basis. While earlier it was declared that old notes could be exchanged for new until 30th December, this facility was suddenly withdrawn on 2nd December.

The exchange limit also kept fluctuating from Rs 4000 to Rs 4500 to Rs 2000 to nil over a period of 20 or so days. The daily cash withdrawal limit from ATMs was also changed from Rs 2000 initially to Rs 2500 later.

Harassment to the General Public

Perhaps the biggest drawback of the demonetisation exercise has been the undue hardship caused to the common man, including, the salaried class, the students, labourers, farmers and housewives with small savings and need for urgent cash.

Due to acute shortage of funds, Banks resorted to rationing of cash and shutters have been drawn over most of the ATMs due to unavailability of cash.

Productive workforce that should actually be engaged in doing work is actually standing in unending queues to withdraw their salary from their bank accounts.

Temporary Relief Provided

However the govt. did provide some relief to the public by allowing toll free movement of vehicles for about 20 days, allowing the use of old currency notes at petrol pumps, to pay school fees, for hospital fees, purchase of seeds for farmers etc. It also increased the weekly cash withdrawal limit from Rs 10,000 to Rs 24,000 at banks.

Income Disclosure Scheme Announced

In order to achieve the original aim of the demonetisation exercise i.e. reduce the amount of unaccounted black money in circulation, the govt. launched a income disclosure scheme by which undisclosed income could be declared by 30th September 2017 and which would be taxed at 50% of the declared value.

Impact of the Demonetisation of Old Currency Notes

This requires a separate blog post of its own and will be discussed in detail in the next article.

Conclusion

While the objectives of demonetisation i.e to fight black money, corruption and terrorism are praise worthy and cannot be faulted, the means adopted to achieve this objective i.e. demonetisation of high value currency notes and the manner of implementation of the policy is debatable. It is estimated that almost the entire value of Rs 500 and Rs 1000 currency notes pegged at Rs 14.18 lac crores will come bank into the system by 30th December, then the dividend that the govt. had hoped for by way of at least 3-4 lac crores never returning back into the system may not be realised.

Hence the introduction of the Income Disclosure Scheme by which the govt. hopes to collect about Rs 2.5 lac crores by means of tax.

The need for maintaining secrecy contradicted with the need for proper planning and preparation before such a significant economic decision was taken. As a result ATM’s were not re-calibrated and more importantly, new notes were not available in the economy while the old notes were being withdrawn. This has resulted in great inconvenience for the people, the overwhelming majority of whom have nothing to do with black money.

If only 6% black money is kept in cash, then what is the purpose in disturbing the entire economic scenario to get to this unaccounted wealth? Wouldn’t it have been better to target the big fish who have the majority of the black money through raids on benami properties, high value transactions, and offshore bank accounts?

Since only 28%-32% Indians have access to financial institutions, the rest of the population with Rs 500 and Rs 1000 denomination notes will find it very difficult to deposit their money or exchange it for new notes.

However, some gains will still be realized if the claimed funding to terror organisations is choked and future generation of black money is minimised. There could also be other unintended benefits like increase in digital payments, fall in interest rates and property prices. But this will take some time to be realised.

Your feedback is welcome in the comments below.

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Vimlaksh
 

I am your friend, mentor and guide to help crack the IAS exam. I've cleared the Prelims everytime including the first and also reached the Interview stage. Know more about me

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