Demonetisation broke domestic supply chain, and disruption caused by GST compounded problems, meanwhile, with remonetisation, demand rose, and was met by imports.
- It tells about the state and level of expectations about the economy that even a 4.3% year-on-year increase in the index of industrial production (IIP) for August is hailed as a “nine-month high”.
- Prior to the Goods and Services Tax (GST) , distributors and retailers resorted to “destocking”-selling from their inventories rather than purchasing new goods attracting the existing state value added taxes, on which claiming credit under the new regime would be easy.
- The overall industrial output fell by 0.2% in June and went up marginally by 0.9% in the following months, before recovering to 4.3% in August, seemingly confirms this hypothesis.
- The manufacturing sector, which has a 77.6% weight within the IIP, registered a mere 3.1% annual growth in August.
- Out of its 23 subsectors, around 13 posted negative growth including textiles, wearing apparel, leather goods, rubber and plastic products, chemicals, paper, furniture, beverages and tobacco-most of which are highly employment-intensive industries.
What do these trends indicate?
- Manufacturing has clearly taken a hit from the twin blows of demonetisation and GST, one following the other.
- The liquidity crunch resulting from demonetisation basically ended up disrupting domestic production supply chains.
- Small and medium-sized enterprises (SMEs) in manufacturing clusters, paying workers mostly in cash, were the worst affected
- Many domestic manufacturing units, especially SMEs, had shut shop or significantly cut back on production.
What is 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
- 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 card.
- 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 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.
What are the consequences of demonetization?
- The growth in the direct tax base.
- The switch in the financial holdings of households from cash to bank deposits
- he increased use of digital payment
- 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.
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 .