Demonitisation and its effect on indian economy

DEMONITISATION AND ITS EFFECT ON INDIAN ECONOMY

Presented by-Arijeet Dutta

MBACORE015032

What is Demonetization

• Demonetization is the act of stripping a currency unit of its status as legal tender

• The opposite of demonetization is remonetization where a form of payment is restored as legal tender.

• Demonetization for us means that Reserve Bank of India has withdrawn the old Rs 500 and Rs 1000 notes as a official mode of payment

Introduction• The Indian government launce a surgical attack on November 8, 2016 against

black money in the economy.• Prime Minister of India Mr. Narendra Modi, in an unscheduled live televised

address to the nation on November 8, 2016 declared circulation of all INR 500 and INR 1000 bank notes are void with immediate effect.

• Issuance of new currencies of value INR 500 and INR 2000 in exchange of old void currencies.

History of Demonetisation in Indian economy

It is not the first time that the government launched demonetisation, Historically previous Indian governments had demonetized bank notes. In January 1946, Banknotes of 1,000 and 10,000 rupees were withdrawn and new notes of 1,000, 5,000 and 10,000 rupees were introduced in 1954. The Janata Party coalition government had again demonetized banknotes of 1,000, 5,000 and 10,000 rupees on 16 January 1978 as a means of curbing black money.

• Demonetization has been embraced in the past by several other countries. They include: • Some of the countries have met the purposes and whereas have failed

Country Year Currency valueNigeria 1984 100 Niaira

Ghana 1982 50 cedis

Zimbabwe 2010 $100 000 000 000 000

Soviet Union 1991 50 and 100 ruble

Australia 1996 Full series of polymer bank notes

• In 1996, Australia became the first country to have a full series of circulating polymer bank notes after replacing all paper-based notes

Current Situation

We can’t compare with the previous demonization with current one.

Latest round of demonetization, the common public and bankers are undoubtedly facing hardship since more than 85 percent of currency in circulation has been rendered illegal in one single stroke. Demonetization is surely hampering the current economy and will continue to do so in the near term and will also impact India’s growth but will have positive long lasting effects.

Need for demonetization• High denomination notes are known to facilitate generation/ circulation of

black money • Total number of bank notes in circulation rose by 40 percent between 2011

and 2016• Increase in number of notes of INR 500 denomination was 76 percent and for

INR 1,000 denomination was 109 percent during this period • Infusion of new series bank notes will be monitored and regulated by RBI • The World Bank in July, 2010 estimated the size of the shadow economy for

India at 20.7 percent of the GDP in 1999 and rising to 23.2 percent in 2007• A parallel shadow economy corrodes and eats into the vitals of the country's

economy resulting in: –Inflation adversely affects the poor and the middle classes –Depriving the Government of its legitimate revenues –Forged cash used to fund terrorist activities against India

Phases of Demonetisation

Demonetization

Income Declaration Scheme(Rs.65,250cr disclosed)

Pradhan Mantri Jan Dhan Yojana(25.98cr Bank accounts)

Exchange of Currency

• The Reserve Bank of India laid down a detailed procedure for the exchange of the demonetized banknotes with new 500 and2,000 banknotes

• Citizens will have until 30 December 2016 to tender their old banknotes at any office of the RBI or any bank branch and credit the value into their respective bank accounts.

• Cash withdrawals from bank accounts were restricted to 10,000 per day and 20,000 per week per account from 10 to 13 November 2016. This limit was increased to 24,000 per week from 14 November

• For immediate cash needs, the old banknotes could be exchanged for the new 500 and 2,000 banknotes as well as 100 banknotes over the counter of bank branches by filling up a requisition form along with a valid ID proof. It was announced that this facility would be available until 30 December 2016.

-Initially, the limit was fixed at 4,000 per person from 8 to 13 November 2016. -This limit was increased to 4,500 per person from 14 to 17 November 2016. -The limit was reduced to 2,000 per person from 18 November 2016• All exchange of banknotes was abruptly stopped from 25 November 2016• withdrawals from ATMs were restricted to 2000 per day. From 14 November onwards,

ATMs recalibrated to dispense new 500 and 2000 notes will allow a maximum withdrawal of 2,500 per day.

• However, exceptions were given to petrol, CNG and gas stations, government hospitals, railway and airline booking counters, state-government recognized dairies and ration stores, and crematoriums to accept the old 500 and 1,000 banknotes until 11 November 2016, which was later extended to 14 November 2016 and once again to 15 December 2016. International airports were also instructed to facilitate an exchange of notes amounting to a total value of 5,000 for foreign tourists and out-bound passengers.

• Under the revised guidelines issued on 17 November 2016, families were allowed to withdraw 250,000 for wedding expenses from one account provided it was KYC compliant. The rules were also changed for farmers who are permitted to withdraw 25,000 per week from their accounts against crop loan.

Positive side of demonetisation

• One of the biggest benefits of this move is that it is going to drastically affect the corrupt practices.

• People who are holding black money in cash will not be able to exchange much as they would be in a fear of getting penalized and prosecuted by the authorities

• Enemies of the country which are involved in counterfeit currency and terrorism will not be able to continue it further for quite some time at least.

• The smuggling of arms and dealing with the terrorist will not sustain further as all of the money will be on record now.

• Real estate prices dip to be seen in the long run . • Reduction in inflation

• Reduction in Fiscal Deficit • Reduction in lending rates • Increase in GDP• Secondly, the banking system will improve as it will slowly head towards a

cashless society. • Cashless society will increase credit access and financial inclusion. The

existing white money of people will be known to the government and it will remain with banks so that it can be put on loan, and interest can be generated from it (though interest rates would fall) with a corresponding fall in Inflation. Further Banking System will get a boost, as more than Rs 7-8 lakh crore base money (new legal money) will enter the system.

Indirect impact• Kashmir moved to normalcy - Blow of

insurgency, no more schools being burnt and no stone patters found

• Use of Apps and cards - Initial step towards digitization in India with the involvement of small vendors leading to transparency in the system

• Gold Stock - Declaration in the stock maintained by the jewellers on a day-to-day basis, which if continued would have control over generation of wealth from black money

• Increase in revenue collection by the Government authorities

• Simplification in tax policies and reduction in tax rates in the upcoming years

Negative side of Demonetisation• The liquidity squeeze caused by demonetization

will be negative across sectors with high level of cash transactions. Real estate, jewellery, retailing, restaurants, logistics, consumer durables and luxury brands, cement and some segments in retail/SME lending space will be facing short term instability. Those companies with high level of debt will face more pressure and can face loan defaults.

• Secondly, there will be an added replacement costs of currency. We cannot ignore the increased cost of operating ATMs need to be refilled more often and also it will be a huge burden on banks. Initially, it is very difficult to create a cashless society as more than 50 percent of Indian population is not well versed with card transactions.

Banking About 3 trillion rupees in the form of old INR 500 and INR 1000 banknotes

deposited in the banking system . 500 billion rupees dispensed via withdrawals from bank accounts, ATMs as well as

exchanges over the bank counters . Spike in the usage of debit card and credit card post demonetization was also

reported Business E-commerce E-commerce companies saw up to a 30 percent decline in cash on delivery (COD)

orders. E-payment options like PayTM and BHIM saw a rise

Real Estate Primary transactions may not be impacted, secondary sales may to some extent.

Municipal and local taxes Allow ability of use of INR 500 and INR 1000 notes to pay municipal/ local taxes

resulted in increase in revenue collections. Agriculture Adverse impact on Input-output channels in agricultural sector. Sale, transport, marketing and distribution of ready produce to wholesale centres

or mandis, adversely impacted. Disruptions, breaks in the supply chains feedback to farmers as sales fall. Increased wastage of perishables. Lower revenues that show up as trade dues instead of cash in hand.

Statistics - Approximately• Demonetized Bank Notes – Rs.14.5 laks crs• Printing of Rs.2,000/- cost involved is Rs.3.94 and for Rs.500/- is Rs.3.04.• Total Black Money - • Black Money on Account –Rs.3800 plus crs• Cash & Jewelry on Raid - Rs.440 crs• New 2000/- Notes – 80 crs (Raid)• Income tax raid on 650 plus places [Inclusive of Tamilnadu Chief Secretary Rao] • Issued notice from Income Tax Depart for 3100 persons for declaration on source

of deposit.• Only 4 % to 7 % of black money is in form of cash• Others form of black money in terms of real estate, gold, politician money, deposit

in foreign bank are still not been evaluated

Economist’s View In spite of the initial hiccups and disruptions in the system, eventually this

change will be well assimilated and will prove positive for the economy in the long run.

Black money hoarders will definitely lose out, eventually boosting the formal economy in the long run.

Short term fall in real estate prices might benefit middle class citizens.

This move by the Government along with the implementation of the GST will eventually make the system more accountable and efficient.

Conclusion The government is taking steps to improve liquidity into the system and reduce

inconvenience as much as possible.

The decision of this surgical strike on black money was not taken in a day or two. Rome was not built in a day and similarly, this plan is the result of Prime Minister's meticulous planning and never ending fight against corruption.

As a result, he has successfully made the right stroke at the right time. Further, the penal provisions are hefty enough to ensure that corrupt practices will find it hard to take roots again. Despite certain short term troubles, demonetization is certainly going to give a boost to the Indian economy in the long run. As of now, all of us should stand and support this bold move of our Prime Minister and help those needy, around us.