In a special broadcast on 8 November, Prime Minister Narendra Modi announced a positive exogenous shock to the country. He declared that in less than four hours, Rs. 500 and Rs. 1,000 bills would be demonetized, thereby withdrawing their status as legal tender.
These were the highest and most popular currency denominations in India, forming 86% of the currency in circulation by value. Indians have until Dec. 30 to deposit all the notes in banks and post offices to get them replaced. Modi’s decision was to tackle the corruption, black money, and fake currency that often finance terror. But Indians are panicking. There are long queues outside banks and ATMs, and the poor, unbanked section of the population is not really sure what it should do with these notes.
The timing of this announcement seems obvious, in hindsight. With the massive rollout of the Pradhan Mantri Jan-Dhan Yojana (PMJDY) in India, citizens’ access to bank accounts is nearly complete. A demonetization move would have been impossible if low-income households were unbanked. PMJDY has provided them with free bank accounts, which will also be used to transfer government payments.
This move by the PM has also followed the income disclosure scheme where people were given a window of opportunity to declare their wealth amassed through various means. It was an appropriate time, therefore, to make credible the threat of a crackdown on black money and corruption within India. The aim is to wash the stock of “black money” out of the economy and get it into the licit, banked and taxable, part of the economy.
Over the years, there has been a lot of black money seeping into the Indian financial system. As a consequential result, the economy has suffered greatly. Not only does black money substantially widen the margin between the rich and the poor, but the same also results in huge ill-gotten amounts of stashed wealth by the rich and powerful elitist class that think themselves to be outside the reach of law.
This is more so a problem, particularly in India, wherein many an unscrupulous businessmen and crafty politicians have stashed their black money in untouchable Swiss bank accounts. Black money-mongers must be basking in the absence of a recovery treaty by both governments. But with this demonetization move, it is time someone cooked their goose really tightly.
This brilliant move by our Government is bound to have negative repercussions on the illegal flourishing hawala trade in India. It is an exemplary laudable step taken to fight corruption and end illegal money from flooding the Indian economy. The only other time this feasible dream became a stark reality was in 1978 with positive results.
While consumers could be cash-strapped for the next few weeks, which could hit spending, the move is a boost to India’s image and economic prospects in the long term. For one, Modi’s masterstroke would mean more people disclose their real incomes and pay taxes, which is good for the government’s coffers. (Only about 1% of the country’s population pays income tax currently). Brokerages have estimated that the clampdown on unaccounted cash could bring in as much as $45 billion for the government. This unprecedented stash of cash could help Modi spend more on education, health, and housing.
India’s banking sector, which is fighting toxic loans and liquidity problems, should also bring in benefits. Some Rs1.5 lakh crore ($22 billion) in deposits have been collected by banks since the demonetisation announcement, the Times of India reported on Nov. 14. Banks can use these funds to address their liquidity requirements. Meanwhile, those with no bank accounts would now be forced to open one in order to deposit the now-illegal notes, in turn helping Modi’s Jan Dhan Yojana (people’s wealth program),
India’s internet startups are cashing in on the opportunity, too. For instance, ride-hailing startup Ola—Uber’s competitor in India—and Paytm, a mobile wallet firm, have seen a surge in new registrations as people move from cash to digital payments. Within 15 hours of Modi’s announcement, Ola saw an increase of 15 times in recharge volumes on its e-wallet. Cash-on-delivery transactions, costly and time-consuming for e-commerce retailers, should drop at least temporarily.
The cleansing of the system will have a therapeutic and curative effect and this step, along with the Goods and Services Tax (GST), will go a long-way in giving a body blow to the parallel economy.
Over time, banks and formal financial systems will gain, the cost of capital will decline and formal monetisation will gain a major boost as popular but yield-poor assets like gold will lose relative importance in the system.
Having closed the voluntary disclosure window for undisclosed money, it has been reported that government will keep a close watch on deposits over Rs 2 lakh in cash. This would mean increased tax net, higher tax collection and a better tax to GDP ratio. As the money gets accounted and more taxes are collected, government might be tempted to reduce tax rates going forward.
Demonetisation would increase the tax net and along with GST result in reduction of black money generation. Along with GST, demonetisation will lead to a higher tax/GDP ratio.
Once these kinds of deposits come into the system, there will be an all-round reduction in interest rates. Big industries in India have access to foreign funds and are able to draw money at international rates. It is the small and medium industries that are paying very high rate of interests. The reduction in interest rates will be very good for our economy.
The move has badly hit Pakistan-sponsored terrorism as funds to terror activities and flow of counterfeit currency have been terminated.
Unquestionably a bold move, I don’t think anybody whether they agree or disagree or would not acknowledge that it is a very bold move, implementation could have been better.
CAclubindia
