Demonetization is the process ofstripping a currency unit of its status as legal tender. Present money ispulled out of market / circulation and is replaced with a new currency.
Sometimes, a country completely replaces the old currency with new currency. Itoccurs whenever there is a change of national currency. This process is calleddemonetization.The most common reasons fordemonetization are:· To fight inflation· To combat corruption; especially to fight blackmoney and tax evasion· To facilitate trade and to make the economy topromote digital payment On the 8th of Nov 2016, the Govt of Indiaunder the leadership of PM Narendra Damodar Das Modi announced that frommidnight 12 AM on words, RS 500 and RS 1000 notes which are currently incirculation will be pulled out and will not be considered as legal tenderanymore. These RS 500 and RS 1000 noted accounted for 80% of the currency incirculation. The citizens where then given time till end of 2016 to exchangethe notes with the newly issued RS 500 and RS 2000 notes.
This action taken by the Govt led to a huge chaos inINDIA which is cash dependent and almost 78% of all Indian transactions are incash. There was huge chaos outside all BANKS and ATM’s to deposit and withdrawnew currency. The Govt also kept a withdrawal limit per day which led toincrease in shortage of change. The small business and daily wage workers wheremost hit; many did not receiving wages on time.
The Indian currency also fellsharply against the US Dollar. The Indian economy is fighting a long battle ofcorruption, tax evasion, black money and digitization of cash transactions. Asper the report of, India stands at 96 in the list of most corrupted countries in the world. Soa smart and challenging move like demonetization was much required to fight thebattle.
Also it was needed to revamp the economy. The citizens of India cameout in support of the move though they had to face hardships like standing inlong Q for hours and days to get their currency exchanged to the new one. Mentionedbelow are some the major reasons why INDIA went ahead with the process ofDemonetization: · To combat the underground economy of India· To remove fake currencies· Fight against tax evaders as only 1% of India’s populationpays tax· Fight against Money Laundering· To promote digital cash transactions and move to cashlesseconomy· To track financial transactions· Eradicate terror activities and their funding· Cut down the system of bribing votes during elections· Remonetizing India· To reduce the lending rate by banks by increasing deposits· Further monetary accommodation Soonafter Govt announcing the decision to Demonetize RS 500 and RS 1,000 notes, thepublic rushed to buy gold and pay taxes using the old currency. The price ofthe gold even shot up to 50% due to the high demand.
Seeing this loophole, theGovt decided that any purchase above RS 50,000 has to be linked with the PANCard. Many jewelers were flouting this norm and hence came under scanner ofGovt Authorities. Thisaction by the Govt pushed the Public and Traders to alternative payment systemssuch as using POS Machines, PAYTM and Mobile Wallet etc. PAYTM saw a bigincrease in their traffic and a 10 times jump in money added to their accountsby users. The transactions increased to 5 million per day and APP downloadswent up by 300%. MobiKwik, another APP like PAYTM also experienced a 20 timeincrease in the money added to their accounts. Theother option which people used was Cash Cards like ItzCash. Other methods like mobilepayments systems linked to e-commerce businesses like Ola Money, FreeCharge,Flipkart Wallet.
Ola Money, the payment portal for popular transportation appOla Cabs, reported a 1500% jump in money added to the accounts in less thanfour hours. Fewcitizens also started investing in BITCOIN. The company was adding 1000 of usersevery month. There was an increased demand for BITCOIN as India has shortage ofsupply, making the lack of liquidity in increase the prices of BITCOIN ascompared with the world market. Mentioned below are thepositive effects of Demonetization on the Indian Market: Corruption Free: The process of demonizationwill reduce corruption in the country as the corrupt cannot keep theunaccounted money at home and will have to be deposited in the bank. Anydeposit above INR 2,50,000 was under scanner of Law agencies and deposits aboveINR 50,000 needed to be linked to PAN card.
If unaccounted money was caught, apenalty of 200% was imposed. This action by the Govt forced the corrupt to giveup unethical practices. Digital Transactions: Nearly 85% of the transactionsin India are done in hard cash. The main aim of the Govt was to push thecountry into an cashless economy which uses digital mode for payment. One ofthe main benefits of this method is, all transactions are recorded and taxevasion is not possible. Reduce Money Laundering: The ban on high currencydenominations was a blow to people who indulge in money laundering.
Now theIncome Tax authorities can easily catch those people who indulge in moneylaundering. Black Money Reduction: People who held unaccountedmoney with them had only 2 options. One is to deposit in the bank and other wasto destroy the money. If deposited in bank, there source of Income fortransactions above RS 2,50,000 was mandatory and if unable to prove source,penalty and punishment followed.
Pay Taxes: Only 1% of India pays taxesas India is an agriculture country and agriculture field is excluded fromtaxes. Also people whose yearly income is 5 lakhs or less PA need not paytaxes. This move forced all people to go and pay taxes with the old currency asthey cannot deposit in the bank or use it for any purpose. Increase in JAN DHAN Accounts: This was a scheme of Govt to make people openbank accounts in order to deposit all cash subsidies directly to the consumerto reduce corruption and leakages.
This move forces citizens to open bankaccounts and deposit all their cash. Less lending rate: All banks received hugedeposits from the account holders due to demonetization. The banks had enoughcash with them which would force them to reduce rate of interest on loans.India is one of those countries where ROI is very high on loans due to thedemand. Fight Fake Currency: This move will stop thecirculation of fake currency.
Most of the fake currency put in circulation isof the high value notes and the banning of 500 and 1000 notes will eliminatethe circulation of fake currency. This move will thus block the funding toterrorists and printing of fake Indian currency by Pakistan. Easy Record of Transactions: Since people have opted to payby digital means, the sellers cannot fake their account book as alltransactions will be recorded and thus forcing seller to show exact sales andthus pay taxes to Govt. Reduce Parallel Economy: Global agencies say thatnearly 23% of the Indian economy is a parallel economy. Demonetization is amove that will fight parallel economy. Increase Govt Finances: With more and more peoplecoming forward to pay taxes, this will help increase the revenue of Govt. Thiscan help fight fiscal deficit target of the country.
It will also help theeconomy to move from Unorganized to Organized sector. Conclusion: Ina single move, the Govt was able to tackle major issues that plague an economy;which is parallel economy, fake notes in the market and terror activities. TheIndian Economy also got a new lease of life, along with huge positiveimplications for liquidity, inflation, fiscal and external deficit in the shortterm. Over the next two-three years, improvement in India’s position ontransparency and corruption in the global stage will further add to itsinvestor appeal. With GST on the anvil, India is now on the cusp of highergrowth in the medium term—to be steered by the organized sectors includingMSMEs and the revival of the private sector capex cycle. Mentioned below are the negativeeffects of Demonetization on the Indian Market: Thoughdemonetization was a brave and mart move by the Govt, it has some demerits too.Most of the demerits which resulted from this action are short term and unavoidable.However, there is no gain without some pain.
Inconvenience to Citizens: The decision to demonetize thecurrency caused huge inconvenience to the citizens. Though Govt and Banks didtheir best to make it convenient for people, there were huge challenges facedby them. People had to come early in the morning and stand in huge Q toexchange their money.
There was a restriction on the amount that can beexchanged per day and that can be withdrawn from the ATM. People also could notbuy anything due to shortage of currency and lower denominations. There was ahalt. But still, people hailed the decision and were ready to face theinconvenience for betterment of the nation.
BiggerDenominations: Most banks and ATM’sgreeted customers with bigger denominations like RS 500 and RS 2000 thus makingit difficult for citizens to shop as the sellers did not have lowerdenominations to return as change. Less Spending: Shortage of cash forced theconstruction and service industry to come to a halt. The builders did not haveenough cash to buy raw materials or pay workers. Most labors don’t have a bankaccount and hence payments had to be made in cash only. Fall in GDP: This was expected by the Govt.There was a fall in GDP due to demonetization as it reduced spending by thecompanies and investment as people were not having enough cash. Themanufacturing sector also came to a standstill.
Huge Expense: There is a huge expense inprinting new currency for distribution to people. Also the old currency notes whichare no longer a legal tender has to be destroyed. No access to Banks: People who are mainly livingrural areas who does not have access to Banks or outside world were also hit.Some of them were not even aware about the process of demonetization, especiallythe senior citizens and people who are not educated and living in rural area. Job Loss: Due to less spending andinvestment by companies, many sectors faced less business and hence employeeswere asked to leave or resign.
Economicslowdown: The major industries like real estate, infra, gold etc havebeen affected and sales would come down and that impacts the growth of theeconomy. Many transactions halt, until the markets get back to normalcy.Markets may see a temporary fall, and temporary recession. At least a yearwould be the span to retain the normalcy. There could be a long-term gain.Conclusion:It is too early conclude if the scheme of the Govt is afailure or a huge success.
The markets are currently picking up and Sensex hasrisen to record heights. The banks have started to reduce lending rates and GDPfigures seem to be picking up slowly. Though all sectors have not completelyrisen back to form; improvements are seen. The exports have increased andimports have also come down.