Demonetisation of currency in India: Explained

The Indian Government has discontinued the use of old Rs 500 and Rs. 1000 notes. In other words, the legal tender character of the notes in these denominations stands withdrawn. This decision became effective from the midnight of 8th November 2016.

Furthermore, the Government will introduce new notes in Rs 500, Rs. 1000 and Rs. 2000 denominations.

The withdrawn notes are referred to as old high denomination notes (OHD). People can get them exchanged at any of the bank branches or post offices until 30th December 2016. There is no limit on the exchange. But, they can receive only up to 4000 cash in hand in return. The rest of the money will be deposited in their bank accounts and can be withdrawn subsequently.

The new notes have a new colour and design and will be known as Mahatma Gandhi new series of bank notes.

History of Demonetisation of currency

Demonetisation of currency has been done before as well. The country’s first demonetisation took place in 1946 and the second in 1978.

In the year 1946, Rs. 1000, Rs. 5000 and Rs. 10000 notes were taken out of circulation. They were reintroduced in 1954.  The Janata Party demonetised the notes again in 1978. But, the current withdrawal is much larger in scale.

Benefits of Demonetisation of currency:

• Unearth Black money: Banks will maintain proper records of the people exchanging notes and forward their details to the Income Tax department. If the deposit in any account is above 2.5 lakhs, the tax department will tally the amount with the respective tax filing. Accordingly, if there is any unaccounted money, the department will impose a penalty. So, the individual will have to pay tax on the unaccounted money as well as a penalty of 200 %  on the tax payable. Also, storage of black money is mostly done in high denomination notes due to its convenience. This sudden withdrawal could lead to corrupt politicians, bureaucrats, and businessmen sitting on a heap of paper currency of no value.

• Fake currency: According to the data submitted by the Union Home Ministry to Parliament in May 2016, 250 out of every 1 million notes are found to be fake. Moreover, most of the fake currency is in high denomination notes.  Hence, the withdrawal of old currency (OHD) should bring counterfeiting currency notes production to a halt. Also, the new notes will have enhanced security features making it difficult to counterfeit.
• Tackle terrorism: Terrorism is mostly funded by black money and fake notes. This step will squeeze funding for anti-national and illegal activities.
• Boost to formal banking channel: It will bring a huge amount of funds in the banking channel. This could result in the increased use of plastic money and electronic payments in the day-to-day transactions. It will move India on the path of becoming a cashless economy.
• Follow-up on the Income-tax declaration scheme. The Government had launched an Income Declaration Scheme (IDS) this year. Under this scheme, if you declare your undisclosed income or assets by September 30, you will have to pay a one-time effective tax rate of 45 percent on the income. Even though the Prime Minister had warned that he will take a tough stance on Black money after 30^th of September, the response to this scheme was tepid.
• Deflationary impact: Most of the black money is parked in real-estate and gold. The unprecedented crackdown on illegal cash will decrease the demand for real-estate and gold, bringing down the prices.
• Political parties: It is an open secret that political parties disburse cash to voters prior to elections. A huge amount of cash is transported from one location to another for this purpose. Now, they will not be able to use cash over and above the spending limit set up by the Election Commission for campaigning purposes.

Disadvantages of Demonetisation:

• Impact on black money uncertain: There is no data on how much black money is stored in the form of cash and how much has been stored in the form of physical assets like land, flats, gold etc. Hence, the impact on black money is still uncertain. Also, tech-savvy corrupt men can use other alternatives in the future such as bitcoins.
• Political decision: People have also attributed political angle to the decision. The election season is approaching. This sudden decision has paralyzed the funding of the opposition parties while favouring the ruling party (BJP).
• Huge Costs: According to the RBI data, at the end of 2014-15, the share of Rs. 500 and Rs.1,000 notes in total currency circulation was around 84 %.  So, this decision has frozen more than 84 % of the total cash in circulation in the economy. Also, there are costs involved in the printing of new money, including the administrative cost to exchange such huge amount of notes.
• The banking sector will have to improve its infrastructure and security features to deal with the sudden surge in online transactions.

Finally, it has to be noted that demonetisation of currency should be seen as only an incremental step to curb black money. Tax-payers use many sophisticated instruments (like fake companies) to convert their black money into white.  The Government will have to bring back cash stashed in foreign locations as well.

References:

IT Department to keep record of deposits over Rs. 2 Lakhs

We should abolish the notes completely