DEMONETIZATION: TO BE OR NOT TO BE?

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Photo Courtesy: Shruti Shirhatti

‘At the stroke of midnight on November 9, 2016, Prime Minister Narendra Modi made a strong decision to demonetize Rs. 500 and Rs. 1000 notes’ – the breaking news which caught all eyes and ears across the nation. It had different reactions from different people : Aam aadmi was seen happy and enthusiastic while political parties bewildered and disturbed, people having white money were standing in long queues while those with black money planned how to escape from this, economists got busy in interviews across media while chartered accountants in attending clients’ phone calls. There were mixed reactions and impacts due to this decision. Non-acceptance of cash further stalled many businesses, left daily wage earners unemployed and serious liquidity issues for the masses. The good side of this however was; some people started adopting cashless options to transact, some postponed high value purchases while some remain close-fisted. The demonetization marks an extremely important phase in the history of Indian economics and therefore requires us to analyse the situation and prognosticate its impacts.

The PM has taken this bold decision owing to the growing menace of black money, counterfeit notes and terror funding. This apart, he has managed to kill a number of birds with one stone. In a speech delivered a couple of days after this decision, he quoted an example of a son and his mother. Son deposited some cash in his mother’s account, who is in an old age home, to safeguard himself. He said that mother would give him blessings as she became cash rich in a single day. I was surprised to hear another case of my friend where farmers benefited from this scheme. My friend’s father runs a retail and grocery shop. He said that customers paid his father excess amount in consideration of goods and his father too repaid the suppliers in excess. Suppliers ultimately repaid this excess amount to farmers. Farmers, who were duped and neglected earlier, became cash rich.

The analysis of this scheme is as follows:

Black Money:

Speaking about black money, this decision deserves applause. The value of cash stashed at homes and lockers became zero within a very short time and people just had two options: deposit or destroy. If they deposit, they would be under income tax department radar and if they destroy, their wholehearted efforts to hide this cash would go in vain. Although some amount of cash could be deposited without bothering income tax authorities, however, people who possess a large amount of unaccounted cash would be having sleepless nights. Hawala trading, unorganized retail, jewellery and real estate businesses were hit massively. Major chunk of black money is siphoned through these sectors. The government has taken various steps like imposing excise duty on gold, PAN requirements, amending various tax treaties, amending Benami Transactions (Prohibition) Act, enacting Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act 2015 and Real Estate Regulatory Authority Act 2016 to monitor and organize these sectors. It also gave a chance to declare undisclosed income before September 30, 2016. Those who didn’t would now be reprimanded before the court of law. Politically too, this decision had many repercussions. Imminent Uttar Pradesh elections are considered the biggest hurdle for many political parties. That could be one of the reasons why political parties remain unhappy and in dire.

Success or failure of the scheme depends on the amount of cash getting deposited in banks. The Wire, an online publication had an interesting article – There May Not Be Any Demonetisation At the End Of It All providing reason why the demonetization would not reap its expected benefits. It stated, “It is also interesting to note that almost the entire Rs 29,000 crore in increased deposits in Jan Dhan accounts – meant for the very poor – have gone into just 3 crore bank accounts out of the total of 25 crore Jan Dhan accounts. This shows that a relatively smaller number of Jan Dhan accounts have been used to launder large sums. If these were genuine deposits, they would have been spread across 25 crore accounts in a more even manner. The tax department has no infrastructure or resource to investigate three crore Jan Dhan accounts where all the fresh deposits have gone. One never thought that Modi’s pet project of financial inclusion would itself become such a robust platform for money laundering.”

Demonetization however is not the ultimate solution to curb black money. It would end one phase of black money and give birth to another. People believe that a person who took bribe earlier is not punished or refrained from taking bribe again due to this step. Corruption, counterfeiting and money laundering would not stop. Hence government needs to take more steps to discourage people from misusing new notes.

Cashless Economy:

The next use of the scheme is developing a cashless economy. Payment banks, online shopping websites and many other businesses offered discounts on credit and debit cards. Many businesses came up with different schemes and pricing techniques. A technique like ‘Buy Now, Pay Later’ was introduced by many companies. Paytm recorded more than five million transactions in one week post demonetization. Undoubtedly people were induced to become cashless. But path towards cashless economy should be treaded cautiously.  We must understand the current state of banking and technological infrastructure & habits of people prevailing in the country. Demonetization alone would not develop cashless economy. Similarly, it was not essential to demonetize to develop cashless economy. These two sentences are very important to understand and analyse cause-and-effect relationship of the scheme.

Finance minister Mr Arun Jaitely said in an interview that country should go cashless. While stating this he mentioned Pradhan Mantri Jan Dhan Yojana (PMJDY) as a major step taken by the government which influenced cashless economy. PMJDY, a program to bank the unbanked, is the most famous and noted government program. The response to it was undoubtedly substantial and laudable. The main purpose was to bring people in the formal banking channel and not to develop a cashless economy. It distributed debit cards to account holders but expecting people to go cashless through this program was not tenable. It neither induced people to change their habits nor compelled sellers to keep card swiping machines. Hence a step between PMJDY and demonetization was necessary to ensure a smooth transition towards cashless economy.

Financial exclusion, financial illiteracy and habits of people are the biggest hurdles in developing a cashless economy. Firstly, we must invest in banking and technology infrastructure on a massive scale to increase the number of bank branches and provide unhampered connectivity to these branches. We need better internet and data connectivity, easy and cheap access to technologies, security and privacy of data to make cashless movement successful. Private banks should also be involved in this entire exercise.  The next challenge is to nudge habits of people. In rural as well as urban areas, we see many people who like transactions in cash. I don’t think it would be easier for them to grasp new technology and change habits instantly. This will require some time and we need to keep patience and equanimity while dealing with them. Some people prefer cash transactions over non-cash ones to avoid tax liabilities. Income tax department should have robust systems and personnel in place to keep watch on these businesses. Certain transactions like selling and purchasing property is predominantly made partly or fully in cash to avoid stamp duty. States should think of reducing stamp duty on property to avoid such transactions.  Growing number of e-tailers and youth in the country give us a positive hope of changing these habits. But sellers must accept cards and e-wallets and consumers must pay from these means. Excessive promotions of online shopping, deeper penetration of smart phones and increasing digital awareness seem propitious for success of cashless economy. This is possible by combining efforts from consumers, producers, sellers, retailers and government.

Economy:

Macroeconomists and consulting firms are however pessimistic on growth rates of India due to demonetization. Some firms forecast that India’s GDP would be reduced by 0.2%, while some firms say that the reduction might be more than 2%. The basic reason is that national income is the function of consumption and is directly proportional to it. N.R. Bhanumurthy, professor at the National Institute of Public Finance and Policy, said, “The extent of its impact on growth will depend on the size of unaccounted money in the economy”. Current chief statistician of India T.C.A. Ananth, however, said that disruption due to demonetization in the economy is unlikely to be significant. CARE Ratings, in its opinion report on November 18, 2016, stated that service sector (mainly trade, hotel and transport) would be affected the most and its losses could not be recovered in the next quarter. It stated that SMEs would have problems in adjusting their production schedules. It also stated that banking would gain due to increase in deposits while agriculture would have least impact.

Stock markets fell drastically and bond yields also tumbled. Until December 31, 2016, there would be disinflationary pressure in the economy since people would consume lesser goods and services. Then from January 2017, we might experience sudden inflationary pressure as there would be no restriction on cash withdrawal. Here, the government and RBI have to perform a balancing act. Everyone would be looking forward for the next RBI monetary policy. Whether RBI will decrease rates or maintain the status quo depends upon various factors and data. There are signals which suggest that RBI will reduce rates.

Mismanagement:

Demonetization is politicized and politicians are attacking the government for its mismanagement. Cash shortage had effects on queues, profitability, services, travels and lives. However, finance minister and RBI governor disclaimed cash crunch in the economy. Rs. 2000 notes are proportional to old Rs. 1000 notes, but Rs. 500 notes are printed lesser than earlier circulation and yet unavailable at many places. We are undergoing through cash crunch as is evident from long ATM queues and there is an extreme pressure on banking systems, even if New Delhi and Mumbai stalwarts deny. Since this was pre-planned, pressure on systems could have been avoided up to certain extent. RBI could estimate withdrawals from a particular area by using predictive analysis. Collating individual bank’s data and census records might have served as a base data for analysis. This could have helped RBI and banks to manage cash at branches and ATMs accordingly.

New updates came up everyday. There were new windows opened to transact and exchange old notes. Earlier district central cooperative banks were not involved in the exchange exercise. But now they were involved. There were no relaxations for farmers and families having weddings. But certain relaxations were granted later. This could have been avoided by soliciting a white paper or guidance note from every ministry and institution (like ICAI, IIM, SEBI, IRDAI, PFRDA, NIPFP, CRISIL, etc.) within a week after the announcement or couple of days before the announcement (under higher level confidentiality). Amendments in Income Tax Act gave another chance to public to pay tax on undisclosed income. These amendments gave politicians and experts new topic to agitate on. As stated in The Wire article, finance minister was now aware of the situation (of money laundering in PMJDY accounts as stated above) and hence new income tax declaration scheme was introduced to plug the loophole.

The scheme is getting unfolded each day and such ebb and flow in implementation affects people’s confidence and creates panic.

Back to basics:

Literally, demonetization means scrapping currency from usage. However, the government is also remonetizing the currencies. Hence, technically we are replacing old notes with new ones. Another important aspect pointed out by many is regarding introduction of Rs. 2000 note. There are two advantages in printing Rs. 2000 notes. First, it requires lesser time and cost for replacing Rs. 1000 notes. Second, if Rs. 1000 new notes were introduced, they might be easily misused while exchanging.

Economist Anil Bokil said in an interview that the government must stop printing Rs. 2000, Rs. 1000 and Rs. 500 notes after two years. He was of the opinion that Rs. 100 should be the maximum denomination & all taxes except customs duty should be abolished and be replaced by banking transaction tax. This model was proposed by Arthakranti Pratishthan a decade before.

In this exercise, lesser the money gets deposited in banks; the higher is profit to RBI. This profit would get transferred to government in various ways. If cash deposited in more, the entire exercise would be waste. Economist Arun Kumar points out, “the bulk of the money comes back into the system it will be seen as the most foolish decision by the government involving all pain and no gain”.

Future:

From next financial year, GST would possibly be rolled out. There is evidence worldwide that after introducing GST, general price level increased in the short-term. Also, both union budget and monetary policy would be in the month of February. It will be interesting to know how both manage the stability, liquidity and growth of the economy coupled with the effects of demonetization. Deputy Chairman of erstwhile Planning Commission, Montek Singh Ahluwalia, in his article published on Friday, November 25, 2016 in The Mint has depicted the good, the bad and the ugly sides of demonetization. The article gives an insight of everything around the topic and suggests ways to recover the economy and manage current transitional problems.

The PM had taken cognizance of the situation and thanked people for showing immense support. He made it clear that criminals would not be spared. However, the challenge before the government is to prevent and/or curb Black Money 2.0 at inception. Government should take necessary steps to rebound and assure the growth story. It should heal the bruises of common man, who waited in line for hours, by whipping against the criminals, corrupts, counterfeiters and terrorists. It must not derail the demonetization’s objectives.

The Wire article concludes with this paragraph, “It is also evident that once full and unrestricted withdrawal is allowed in a few months, a good chunk of these deposits will be withdrawn from the banks and would revert to their earlier character of operating in a cash economy. The complexity of demonetization on such a huge scale is clearly outside the grasp of officialdom.” The entire episode would remain as mystery if this happens.

As the entire exercise was highly covert, cumbersome and complicated; we cannot blame everything and everyone outright. It is our duty to support any government in the fight against black money, counterfeit notes and terrorism. We must also pledge to go cashless from today and create a cohesive environment for it. We must appreciate it even if we need to sacrifice and suffer for a shorter period of time in the hope for a brighter future.

But what if nothing erupted from this as pointed by Economist Arun Kumar? What would be the situation if the entire black money laundered through the system and got remonetized? What if the government failed to stabilize the economy? What are the next plans as indicated by Modi? Will government reduce income tax rates? Will Achhe Din lingo still prevail?

Concluding Remarks:

  • If we trail through entire demonetization log, we come to know that it was not as necessary and useful as government proclaimed. But ‘Earlier the Better’ approach suits here.
  • I do support it as it shows the determination and willingness of the government to do something more.
  • Low denomination is must. Scrapping Rs. 2000, Rs. 1000 and Rs. 500 after two years could be next on the government agenda.
  • Even though many possible failures were pointed out, it would change the behaviour (regarding both black money and cashless). Hence, it would be beneficial in long run.
  • Black money – Would be rated between average and hit (not super hit).
  • Cashless economy – For metros, this day would be nearer but for rural areas, much ground work is required.
  • Economy would be hampered and thus requires lower taxes and interest rates.
  • Though positive in objectives and nature, the success depends on the results. So we need to wait for that day when entire assessment is ready.

Let’s wait and watch what secrets time unfolds before us. Till then, look around for old notes.

-Swapnil Karkare

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4 Comments Add yours

  1. Saumit patki says:

    Its a good start indeed but government has failed in logistics management. first they should have ensured enough supply of 100 notes. And one more important aspect I feel is demonetisation should have been done after financial inclusion.

    Like

  2. Kushal says:

    This move is perfect to “organise” the “unorganised” sector of the indian economy…which has a major share in GDP n employment.
    Like Promoting APMC reforms extensively….would bring a high level of transparency.

    Like

  3. Suchitra Chitrao says:

    Very well written article Swapnil.
    Informative and unbiased.
    Looking forard to more.

    Like

  4. Aditi Verma says:

    Finally I read out a masterpiece on demonetization. You analyzed each and every point affecting the economy very well. Good Work and Keep on writing the trending topics. Looking forward to read more in near future. ☺

    Like

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