Context:

The Reserve Bank of India’s (RBI) Annual Report reveals that almost all demonetized notes have been returned to the central bank.

Introduction:

  • The RBI, in its annual report said that as on June 30, 2017, banks had received Rs 15.28 lakh crore, out of the total Rs 15.44 lakh crore worth of old Rs 500 and Rs 1,000 notes that were withdrawn from the system on November 2016.
  • The number does not include the old notes with District Central Cooperative Banks .
  • It also does not include the notes within Nepal.
  • According to RBI’s report, the total currency in circulation, is about Rs 2 lakh crore short of the pre-demonetisation period.
  • This is partly due to the increase in focus on printing of lower denomination currency notes.

What is the current controversy?

  • With nearly 99 % of banned Rs 1,000 and Rs 500 notes back with the RBI, the question are now being raised about the economic rationale and success of demonetization.
  • Whether it could hurt the economy in short as well as medium term.

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

Backgroud:

  • 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.

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.

How the ground realities do are different from the stated aims of demonetization?

Black Money:

Objective of demonetization:

  • By withdrawing the high currency notes, the government had reckoned that those holding unaccounted cash or black money would not deposit in the banking system, thereby hitting this hoard.
  • The expectation was that notes worth over Rs 4 lakh crore would not return to the central bank.

  In reality:

  • Nearly 99 per cent of banned notes back with the RBI.

Digital Transactions:

Objectives of demonitisation:

  • One of the aims was to bring about a shift from a cash based economy towards more digital or electronic forms of transactions.
  • After demonetization, there was a spurt in electronic transactions through prepaid wallets, debit and credit cards, NEET(National Electronic Fund Transfer).
  • From 671.49 million transactions in November last year, it rose to 957.50 million in December at the end of the government’s deadline on cash withdrawl.
  • July data shows that the number of transactions was 862.38 million, lower than in December.

In reality:

  • There is no evidence of expansion of digitization in any major economy through demonetization.

Cash in circulation:

Objectives of demonetization:

  • One of the objective was that the quantum of cash operating in the system must gradually come down.
  • According to the RBI data, notes issued decreased by 11.79% to Rs 15.06 lakh crore in June 2017, from Rs 17.07 lakh crore in June 2016.
  • As digitilisation increases and the amount of cash circulating in the system declines, the cost of printing currency for both the RBI and the government will come down too.

In reality:

  • The RBI spent Rs 7,965 crore to print new currency notes from July 2016 to June 2017, more than twice the Rs 3,421 crore in the same period the previous year.
  • But, if the currency in circulation does decline consistently, it could offset this huge one-time expenditure and other related expenses.

Anonymity of cash owners:

Objectives :

  • One of the arguments from government’s side has been that the anonymity about ownership of cash operating in the system has ended, with more people depositing it in the banking system.
  • The government claims that it now has details of all those who had deposited cash during demonetization period.
  • One of the objective of demonetization was to put identity on the cash holdings in the economy.

In reality:

  • The Income tax department, through its “Operation Clean Money” project launched in January, has tracked 13.33 lakh accounts with cash deposits of around Rs 2.89 lakh crore, and received over 9 lakh responses so far.
  • If the Income tax department is able to prove that a good proportation of this was not legitmate money, the outcome could meet this objective.

Tax base:

Objectives:

  • One of the stated objective of demonetization was to increase the tax base.
  • For this, personal income tax return have increased by over 25% as those dealing in cash were compelled to deposit it in banks.
  • According to the e-filed ITR forms in FY 2011-12, the number of individuals who an e-filed form was up 81.5% over the previous year.
  • In 202-13, it was up 30.75%.

In reality:

  • The real measure would be not just increasing the number of those filling income tax, but also how it translates into higher revenues.
  • More people may be added to the returns-filling list but if significant number of these people have income below the taxable limit, the gain will be limited.
  • Mutual funds, etc
  • According to the government estimates, the savings in the form of investment in equity mutual funds, life insurance premiums and other products have risen after demonetization.
  • According to the government, assets under management of mutual funds up 54% by June-end 2017 from March 2016.

In reality:

  • The growth in mutual funds, however, has been a story over the past few years.
  • Assets under management of the Indian mutual funds industry have risen sixfold over the last decade, with the Systematic Investment Plan gaining popularity in the last couple of years.
  • In a low-inflation scenario, investors used to higher returns on safer bank deposits have shifted to mutual funds and other instruments, with deposit rates sliding.

RBI payout:

  • The RBI transferred a surplus of only Rs 30,659 crore this year to the government, compared to Rs 65,876 crore last year.
  • Over the last few years, such transfers have given a huge boost to the government as these non-tax revenue receipts help bridge its fiscal deficit.

In reality:

  • After demonetization , huge printing and other costs have been blamed for eating into the central bank’s earnings .
  • The lower payout was also because the RBI transferred Rs 13,140 crore towards its Contingency Fund, unlike in the last three years when there was hardly any bolstering of this reserve.
  • The RBI had to incure a cost on carrying out reverse repo auctions in the post-demonetisation period to absorb excess liquidity when banks were flooded with cash deposits.
  • The RBI had to pay banks, which in turn hit its interest income, besides appreciation of the rupee which would have impacted the value of its assets.

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.

How the government has planned to track evaders?

Although it is not completely clear how the government is planning to check and track tax evaders, the following steps have been taken to achieve the same:

  • Basic identification is made mandatory for any exchange or deposit of cash. Moreover, all the deposits made over Rs. 2.5 lakh will be directly reported to the IT department by the bank concerned.
  • In order to check the conversion of black money into gold or jewellery, government has asked all the jewellers to verify the permanent account number (PAN) of their customers.

What are the pros of this move?

The system is expected to prove positive for the economy in the long run:

  • It will boost the formal economy in the long run as black money hoarders will not able to make their money white.
  • Middle class citizens may get benefitted from the short term fall in real estate prices.
  • This move along with the implementation of GST is likely to make the system more efficient, accountable and transparent.

Conclusion:

For an economy on the path of reform, with many more reforms still to come,  long-term sustainable impact can be achieved only when we strengthen the policy-making process .

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