×

Report card of demonetization after one year

Context

Today marks one year of the decision of the NDA government to withdraw high-value currency notes of Rs 500 and Rs, 1000 and extinguish 85per cent of the value of the currency in circulation.

Background:

  • On November 8, 2016 Prime Minister announced that Rs 500 and Rs 1000 denomination notes will become invalid.
  • 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.
  • The Specified Bank Notes (Cessation of Liabilities) Ordinance, 2016 was issued by the Government of India on 28 December 2016 ceasing the liability of the government for the banned bank notes.

What is the meaning of demonetization?

  • When a currency note of a particular denomination ceases to be a legal tender it is termed as demonetisation.
  • 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.
  • The opposite of demonetization is remonetization where a form of payment is restored as legal tender.

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?

1-To curb black money:

  • 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.
  • Apart from demonestisation, the government has constituted a Special Investigation Team (SIT) to unearth black money, enacted the Black Money ( Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015, to deal with black money stashed abroad, and amended the Benami Transaction Act, 1988 to enable the confiscation of benami property.
  • The government has engaged with foreign governments to facilitate the exchange of information under various double tax avoidance treaties.
  • The main objective of fighting black money is to improve tax compliance and broaden the universe of activity and transactions under the tax net.

In reality: Nearly 99 per cent of banned notes back with the RBI.

2- Digital Transactions:

  • 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).
  • One of the important objective of demonetization was to make India a less-cash economy and thereby, reduce the flow of black money in the system.

In reality:

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

3- Cash in circulation:

  • One of the objective was that the quantum of cash operating in the system must gradually come down.

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.

4- Anonymity of cash owners:

  • 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. 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.

5- Tax base:

  • One of the stated objectives 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 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.
  • 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.

6- 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 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.

7- On counterfeit notes:

  • Another stated aim of demonetisation was to detect and eliminate counterfeit notes. The growth in detected counterfeit notes after demonetisation has not been unusually large, shows RBI data, even as counterfeits of the freshly issued notes have already emerged in the system.

Impact of demonetization:

There’s been much sparring over the last year on the gains from demonetization.

Positive outcomes of demonetization:

  • The tangible benefits may be in the form of less cash in the economy, higher tax compliance, and an initial spurt in digital payments which after the early momentum has seen a dip, indicating a reversal in trend with remonetisation.
  • Describing the decision of demonetization as “watershed moment for the Indian economy”, Finance Minister Arun Jaitley said it not only changed the agenda but also made corruption difficult. He said because it was a “morally and ethically correct” step, it was also “politically correct”.
  • The switch in the financial holdings of households from cash to bank deposits.

Increase in tax base:

  • The government claims that demonetization has widened the government’s revenue base, giving it more resources for welfare projects.
  • There is significant increase in the tax base. The number of tax payers increased from 55.9 million in 2015-16 to 65 million in 2016-17. The 16 per cent increase in 2016-17 is unprecedented.
  • There was also an almost 27 per cent surge in new income tax filers in 2016-17-compared to 20 percent in the previous year and 5 per cent the year before that.
  • Direct tax collection between April and July 2017 increased by more than 19 per cent over the same period in the previous year.

The broadening of the tax base has several macroeconomic implications:

  • The extra resources it generates can be spent on important public goods and welfare programmes, including those pertaining to health and education. Public spending on health, education and physical infrastructure not only boost economic efficiency and growth but also makes a deep on poverty and income inequality.
  • By broadening the direct tax base, a successful fight against black money reduces the reliance on indirect taxes. This is important because indirect taxes are regressive, and should be modest in a relatively poor country such as India.
  • Broader tax base: It can result in authorities lowering tax rates, especially for those at the lower end of the income spectrum. Lower tax rates can then improve tax compliance, leading to a virtuous cycle of an ever-broadening tax base and lower rates.
  • Black money stays out of the formal financial system. Consequently, the more the black money in an economy, the lower the formal financial savings. It has allowed for structurally lower interest rates, with banks slashing their MCLR rates by 90 basis points after the post-demonetisation influx of liquidity
  • Black money seeks alternative destinations through capital flight in the form of export under-invoicing or import over invoicing. Both widen the current account deficit and the balance of payments, thereby creating artificial stress on the external sector and the rupee.

Negative outcomes:

On MSMEs:

  • Demonetization – a move which was initially seen as a “masterstroke” in Indian political history that would have eliminated a parallel black economy in India, has rendered itself to be a volatile, fruitless and almost fatal for most MSMEs in the country. 
  • Demonetization brought many small industries closer to digitalisation, the micro industries had to go through an unstable phase. 
  • According to International Labour Organization (ILO) some of the characteristic features of employment in the informal sector are lack of protection in the event of non-payment of wages, compulsory overtime or extra shifts, layoffs without notice or compensation, unsafe working conditions and the absence of social benefits such as pensions, sick pay and health insurance. 
  • According to ILO one of the foremost reasons for the informal sector to exist in a country is because of poverty and the limited livelihood opportunities and jobs for the working poor. Low incomes and limited access to public institutions prevent the poor from investing in skills that could boost their employability, productivity and ensure their protection from income shocks and risk.

On Rural economy:

  • The negative effect of demonetisation can be seen in terms of big losses to the unorganised sector, farmers and traders
  • The hardest-hit were those in rural areas, where access to banking and the internet are quite low
  • The Reserve Bank of India (RBI) 2016 report on branch authorization policy classified 93% of rural centres in the country as unbanked, with the population dependent on roving banking correspondents and on distant urban or semi-urban branches
  • Access to the internet is equally patchy, with only 3% of households in underdeveloped rural access to internet in a 2016 consumer economy survey
  • The liquidity squeeze led to a pile-up at wholesale markets, leading to a sharp decline in the Wholesale Price Index (WPI) of perishables such as fruits and vegetables in the immediate aftermath of demonetization.
  • By turning farm markets into buyers’ markets, demonetisation may have also contributed to the decline in prices of pulse
  • Rural consumer sentiment too took a hit, with domestic sales of two-wheelers plunging sharply.
  • New project announcements declined sharply in the wake of demonetisation, a Centre for Monitoring Indian Economy (CMIE) analysis showed, hurting the capex cycle.

On job creation:

  • The varied data sets pointing to the continuing lack of employment opportunities for India’s rising workforce.
  • Data from the Centre for Monitoring Indian Economy (CMIE) estimate that about 1.5 million jobs were lost during January-April 2017, even as employment figures of leading listed companies show that a majority of them have been a net decline in their employment.
  • Labour Bureau employment survey also reflect a sharp decline in jobs after demonetization.
  • This lack of job opportunities is mirrored in the data sets for the government’s flagship skilling scheme, the Pradhan Mantri Kaushal Vikas Yojana (PMKVY).

On Economy:

Data released by the Central Statistics Office (CSO) showed the economy grew 5.7% in April-June, the first quarter of the current fiscal year, slower than the previous quarter’s 6.1%. The first half of the last fiscal year, that is the period prior to demonetisationrecorded a real growth of 7.7%.

Way Forward:

  • Government should focus on ensuring growth, job creation and investment. The urgent need is to get the private sector to start investing. One way to avoid winds of deflation is to kick-start private investments.
  • Reviving the investment cycle and tackling bad loans will be the key challenges to be tackled on a priority basis in the current fiscal.
  • Government has launched a multipronged attack on corruption and black money. Government discretion has been reduced particularly in the allocation of natural resources.
  • There is a concerted attempt to improve ease of doing business, and technology is being used to deliver public services without leakages.
  • It is far too early to write-off any of these efforts, and demonetisation. There is a future beyond the present.
Print Friendly and PDF