Demonetization: Effective Or Not?

The act of stripping an existing currency unit of its status and issuing a new currency unit in form of new notes or coins as a “legal tender” is called “Demonetization”. Existing forms are pulled out from the market and retired. Sometimes there is a complete replacement of the old currency with the new form of currency units.

In the Indian history, this act has taken place thrice, the ultimate motive each time being the eradication of black money from the country. In the year 1946, notes with INR 1,000, 5,000 and 10,000 values were taken out of circulation for the very first time in India, almost a year before its Independence from the British. Though all the three notes were reintroduced in 1954. Then for the second time, in the ruling of Morarji Desai (The Janata Party coalition government), the notes of denomination INR 1,000, 5,000 and 10,000 were deemed illegal under “The High Denomination Bank Notes (Demonetization) Act, 1978.

Narendra Modi, the present Prime Minister of India in the name of Bhartiya Janta Party (BJP), tried to make a third time charm by making the sudden announcement on 8th November, 2016 banning INR 500 and 1,000 notes of the “Mahatma Gandhi Series”, to finally wipe off the corruption and black money in India. It was claimed by the government that such an action would crack down on the use of illicit and counterfeit cash to fund illegal activities and terrorism. However, the first outcome was prolonged cash shortage in the following weeks and there was significant disruption throughout the economy. The announcement of demonetization of old notes of INR 500 and 1,000 denomination was made by the PM Modi in an unscheduled live televised address at 20:00 hours Indian Standard Time (IST) on the 8th of November, 2016. In the live stream, he declared the notes of the given denomination of Mahatma Gandhi Series shall be invalid past midnight. And those can be exchanged with new ₹500 and ₹2,000 banknotes of Mahatma Gandhi New Series.

The news had significant impact on the Stock Market Indices as well. The BSE Sensex and Nifty 50 fell over 6% in just a single day after the announcement of the demonetization a day before by the Government of India. There was severe detrimental effects on the economy. Also there was a huge hustle bustle in the country because of the long queues in front of the banks for exchanging notes. To worsen, several deaths are also attached to the name of demonetization because of the rush to get the cash exchanged.

Initially, there were mixed reactions towards the decision. A number of bankers including Arundhati Bhattacharya (Chairperson of State Bank of India (SBI)) and Chanda Kochhar (MD and CEO of ICICI Bank) supported the move in the light that this will help eradicate black money from the country. Accomplished businessmen like Anand Mahindra (Mahindra Group), Sajjan Jindal (JSW Group) and Kunal Bahl (Snapdeal and Freecharge) also appreciated the move and said that it will also foster the growth of e-commerce business. The decision was also praised by N.R. Narayana Murthy (the founder of Infosys). Even the Indian National Congress welcomed the move. All in all the response in the initial stages was positive and the move was seen as a move to evade corruption from the country.

In the later stages, The Indian Supreme Court while hearing one among a slew of cases filed against the sudden demonetization decision in various courts, observed that it "appears to be carpet bombing and not surgical strike" which government repeatedly claims it to be. Many mentioned the move to be “hollow”, “a major mistake”, “witless”, “antipeople”, “badly implemented” and much more. In fact, a parliamentary panel report in 2017 stated that rural households and honest taxpayers were the worst hit by demonetization.

Impact of Demonetization on several sectors is listed below:
Black money
The government had estimated that ₹3 trillion, or approximately 20%, of the demonetized notes would be permanently removed from circulation. However, by 30 December 2016, approximately 97% of the demonetized banknotes, or ₹14.97 trillion ($220 billion) of the ₹15.4 trillion that had been demonetized, had been deposited with the banking system. A Central Bank report released in August 2017 stated that a total 99% of the ₹ 500 and ₹ 1000 notes that were demonetized returned to the banking system, a figure far larger than the government had expected at the time of banning the notes. Therefore, the government failed in its aim of purging black money from the economy. Modi had stated that due to demonetization, corrupt officials, businessmen and criminals — popularly believed to hoard large amounts of illicit cash — would be stuck with "worthless pieces of paper".

Radical groups
Demonetization had badly hit Maoist and Naxalites as well. The surrender rate has reached its highest since demonetization was announced. It is said that the money these organizations collected over the years have now lost their value making them take such a decision.

Cash shortage
The scarcity of cash due to demonetization led to chaos, and most people holding old banknotes faced difficulties in exchanging them due to endless queues outside banks and ATMs across India, which became a daily routine for millions of people waiting to deposit or exchange the ₹500 and ₹1000 banknotes since 9 November. ATMs were running out of cash after a few hours of being functional, and around half the ATMs in the country were non-functional. As of 18 December 2016, there were still long queues at banks and ATMs. Three months after the withdrawal of banknotes, a quarter of the ATMs were still short of cash.

The cash shortage was still ongoing in the month of April 2017, five months after the demonetization. According to a survey, the situation was as bad as 83% of people being unable to withdraw money in Hyderabad, while in Pune, the figure was 69%.

As of 10 December, ₹242 crore in new notes had been seized. Reports in the media noted that although the general public faced a severe cash shortage, some individuals were able to amass crores of rupees in new notes; they thus described the demonetization exercise as being futile.

Stock market decline
As a combined effect of demonetization and US presidential election, the stock market indices dropped to an around six-month low in the week following the announcement. The day after the demonetization announcement, BSE SENSEX crashed nearly 1,689 points and NIFTY 50 plunged by over 541 points. By the end of the intraday trading section on 15 November 2016, the BSE SENSEX index was lower by 565 points and the NIFTY 50 index was below 8100 intraday.

Transportation disruption
After the demonetization was announced, about 800,000 truck drivers were affected with scarcity of cash, with around 400,000 trucks stranded at major highways across India were reported. While major highway toll junctions on the Gujarat and Delhi-Mumbai highways also saw long queues as toll plaza operators refused the old banknotes.

Agriculture
Transactions in the Indian agriculture sector are heavily dependent on cash and were adversely affected by the demonetization of ₹500 and ₹1,000 banknotes. Due to scarcity of the new banknotes, many farmers have insufficient cash to purchase seeds, fertilisers and pesticides needed for the plantation of rabi crops usually sown around midNovember. The demonetization led to unavailability of cash to pay for food products. The reduction in demand that arose in turn led to a crash in the prices of crops. Farmers were unable to recover even the costs of transportation from their fields to the market from the low prices offered. This forced the farmers across the country to dump their products in desperation.

Digital transactions and cashless economy
The demonetization was initially seen by some sources as a significant step towards making India a cashless economy. Prime Minister Narendra Modi appealed to Indian population in his radio address in Dec 2016 to go cashless with slogan - ‘Less-cash’ first, ‘cashless society’ next.

More people began using cards and e-wallets, and the demand for point of sales (POS) or card swipe machines increased. Several e-commerce companies hailed the demonetization decision as an impetus to an increase in digital payments, hoping that it would lead to a decline in COD returns which could cut down their costs.

In December 2016, the government launched an app called BHIM (Bharat Interface for Money) based on the Unified Payment Interface. In September 2017, Google launched its first India-only banking app using UPI called Google Tez that can be used by customers of over 50 banks on the UPI platform, and is available in several Indian languages.

GDP growth
Global analysts cut their forecasts of India's GDP growth rate for the financial year 2016-17 by 0.5 to 3 percent due to demonetization. India's GDP in 2016 is estimated to be US$2.25 trillion, hence, each 1 per cent reduction in growth rate represents a shortfall of US$22.5 billion (₹ 1.54 lakh crore) for the Indian economy. According to Societe Generale, India's quarterly GDP growth rates would drop below 7% for an entire year at a stretch for the first time since June 2011. India's GDP growth for the quarter Jan-Mar '17 was 6.1% as against a forecast of 7.1% by economists. The GDP growth for the entire fiscal year was 7.1%, a reduction from the 8% of the previous year. This drop in GDP was attributed to demonetization by economists. The GDP growth rate for the quarter April - June 2017 dropped to 5.7%, in comparison to 7.9% for the same quarter in the previous year. This drop in GDP growth was attributed to demonetization. This was the lowest growth in GDP since 2014.

Drop in industrial output
There was a reduction in industrial output as industries were hit by the cash crisis. The Purchasing Managers' Index (PMI) fell to 46.7 in November from 54.5 in October, recording its sharpest reduction in three years. A reading above 50 indicates growth and a reading below shows contraction. This indicates a slowdown in both, manufacturing and services industries. The PMI report also showed that the reduction in inflation in November was due to shortage in money supply. The growth in eight core sectors such as cement, steel and refinery products, which constitute 38% of the Index of Industrial Production (IIP), was only to 4.9 percent in November as compared with 6.6 percent in October.

Unemployment
There was a loss of jobs due to demonetization, particularly in the unorganized and informal sector and in small enterprises. Labor union jobs were crashed. Around 1.5 million jobs were lost in first four months of 2017 (i.e) from January 2017 to April 2017 as an effect of demonetization.

Tax impacts
The Finance Ministry instructed all revenue intelligence agencies to join the crackdown on foreign exchange traders, hawala operators and jewellers besides tracking movement of demonetized currency notes. It was reported that the Prime Minister's Office (PMO) and the Prime Minister Modi himself were directly coordinating the raids conducted by the Income Tax, Enforcement Directorate (ED) and other agencies. As of 23 December, PMO received around 700 calls giving information about black money and it directly forwarded the information to various law enforcement agencies for further action.

The number of I-T returns filed between 1 April 2017 and 5 August 2017 grew by 24.7 per cent to 2.82 crore over the same period in 2016, and the advance tax collections between 1 April 2017 and 5 August 2017 rose 41.8% over the corresponding period in 2016. Aarati Krishnan, writing for The Hindu, writes that the impact of demonetization on tax base has been mostly a good news. An analysis of the economic data shows that there has been no substantial increase in the number of new tax payers or direct tax collection due to demonetization.

People left with old notes
The government had initially announced that any person who is unable to deposit the old notes by 31 December 2016 would be given an opportunity to do so until a later date. However, the government allowed only Non-Resident Indians (NRIs) to deposit old notes after 31 December 2016. As a result, many people with legitimately earned old notes were left stranded with old currency notes. This included housewives with hidden savings, soldiers who were on duty during the demonetization period, people who had suffered a bereavement, and persons who had old notes received as wedding gifts before the demonetization. Many people found small amounts of currency stashed away inside quilts, pillows, cupboards, lockers, behind old photographs and wall hangings, in some cases by family members who had died.

Overall it is hard to state if it is effective in totality or not but it sure has its set of significant pros and cons.