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October 05, 2017 @ 10:31 AM

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K. J. Somaiya Institute of Management Studies and Research, Mumbai

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Aftermath of Demonetization

Demonetization

Published : Thursday, 5 October, 2017 10:30 AM

Aftermath of Demonetization

MBA aspirants must be updated with General Awareness on current affairs.  General Awareness topics with analytically drawn conclusions will benefit you in XATIIFTNMATSNAP ,CMATMAT, and later in Post exams screening Tests like  WATGD & PI , Essay writing.

Read Current Affairs Topic: Aftermath of Demonetization

In the evening November 8, 2016, the Indian Prime Minister addressed the nation and announced the historic decision of demonetization of currency notes of INR500 and INR1000 denominations which accounted for around 86% of the total notes in circulation. While announcing the demonetization, government assumed to fulfil following objectives:

  • To give a lethal blow to the black economy in the country.
  • To wipe out the fake Indian currency notes (FICN) of INR500 and INR1000 which were allegedly printed in Pakistan and used in illegal and anti-national activities.
  • To disrupt the informal cash centric economy
  • To strengthen the banking system
  • Crackdown on terrorism and Naxalism
  • Increase the tax base

The days ensuing the demonetization were of utter chaos and the serpentine queues at the banks and ATMs were a common sight. Everyone in the country, whether a small or big business or a service professional, all were affected by the sudden removal of 86% cash from the system.

However, now after more than 10 months of demonetization, the process of remonetisation is almost complete and adequate time has passed to check the aftermaths of demonetization. As of now, almost every section of the society is divided into an anti-Modi or pro-Modi camp and that division is evident in the media as well. Therefore any decision by the government is analysed through this prism only. In this piece, we will try to analyse the aftermaths of demonetizations without any pro or anti Modi biases.

Black Money

The first and the foremost objective of the demonetization was to attack the vast prevalent black economy in the country in one lethal blow. The government assumed that those who have amassed the hordes of cashes through illegal activity would not be a foolhardy to deposit the cash into the banking system and make themselves vulnerable to the law enforcements agencies.    

However, the government underestimated them and they were able to innovate ways to change most of their demonetized currency. Consequently, RBI revealed that more than 99% of the demonetized cash was deposited into the banks.

In 2012, the then Finance Minister of India Pranab Mukherjee wrote a white paper on black money in India, according to which, the cash component of undisclosed incomes ranges from 3.7-7.4%. Real estate, jewellery and bullion are more popular modes of hoarding wealth earned through illegal means. Thus, if we consider only the cash, then demonetization was an utter failure but if we see its impact on real estate, where most of the black money is invested, then indeed demonetization made some impact on black economy. 

Fake Indian Currency Notes (FICN)

After the demonetization, the total amount of FICN detected by the banks was around INR11.23 crores. Considering the pain inflicted by the demonetization and its impact on fake currency, it seems that demonetization was an utter failure even on this front.

In contrast, in the year 2015, FICN worth INR 29.64 crores was detected by the RBI while the police and other law enforcement agencies detected FICN worth INR 43.8 crores. Thus the total FICN detected in 2015, a year before demonetization, was INR 73.44 crores. It was also believed that in 2015, only 16 of every 250 FICN were detected. Another joint study by the Indian Statistical Institute and National Investigation Agency in 2015 estimated the amount of FICN at any given time in the economy was around INR 400 crores.   

If FICN worth only INR 11.23 crores was detected by the banks after the demonetization it doesn’t means that only FICN worth INR11.23 crores are present in the economy. It means that out of estimated FICN worth INR 400 crores, only INR11.23 value of FICN reached the banks. Rest was discarded by their handlers.

FICN of new 500 and 2000 notes have been detected by the agencies but these new FICN lack the sophistication old ones, they were just the coloured photocopy of the original notes. Thus, the demonetization seems successful in attacking and wiping out the FICN.

Crackdown On Terrorism And Naxalism    

In the pre-demonetization era, most of the FICN were printed in Pakistan and were channelized into India through Bangladesh and Nepal borders. Pakistan utilised these FICN for funding terror activities. Apart from FICN, hawala channel was used to fund the discontent and terrorism in Kashmir valley. It is true that terror related activities continue to occur post demonetization but some of its affects are quite visible. For instance, bank robberies by terrorists in Kashmir were not reported before demonetization, incidents of stone pelting also reduced which means that terrorists suffered severe kind of cash shortages and their funds choked post demonetization. Demonetization also broke the back of Hawala trade which was a major conduit to fund terrorists in Kashmir.

Considerable decline in Naxalism was also reported in Chhattisgarh after demonetization. According to a statement made by the PM in Parliament, more than 700 Naxals have surrendered within 40 days after demonetization. Thus, the magnitude of impact is debatable, but there is indeed an impact of demonetization on Naxals and terrorism.

Disrupting Informal Economy

The informal sector which is a cash based economy accounts for 45-50% of the GDP and provides near 80% employment. It was severely cripples by the demonetization. Though another intended objective of demonetization was to transform the informal sector into the formal one, any major shift in this regard is yet to be witnessed. As the informal sector runs mainly on cash, demonetization actually choked this employment intensive sector.

The RBI estimated around 1% decline in the growth rate owing to demonetization. When the third quarter of 2016-17 reported 7.0% growth rate, the pro-Modi camp started cheering for demonetization. However, since the data of informal sector is not readily available unlike the organized sector, the third quarter growth didn’t accounted for the informal sector post demonetization. When informal sector data of third quarter was factored in the fourth quarter of 2016-17, the growth rate declined further to 6.1%. In the April-June quarter of 2017-18, the growth further dipped to 5.7%, the lowest in past three years.

The upshot of the argument is that impact of demonetization was severe on the informal sector which had its ramifications on employment generation as well as on the overall economy. In this regard, demonetization cannot be called as successful.

Strengthening Of Banking Sector  

Since all the demonetized currency notes (except the back money) were expected to find their way to the bank coffers, it was expected to recapitalise the banks which were reeling under massive NPAs. The situation of the public sector banks was much worse.   

Demonetization increased the deposits in Banks as currency in circulation was reduced. Post demonetization, around 2.33 crore new Jan Dhan accounts were opened by the banks and total balance in these accounts increased by 63.6% within a month after demonetization.

However, on the flip side, some SME businesses have seen their sales drop 50–80% and could default in their instalments. They would not immediately be classified as NPAs because of some relaxations, but if the delay persists bank NPAs might worsen.

Increase In Tax Base

According to the tax department, number of I-T returns filed for 2016-17 year grew by 25% to 2.82 crore which is primarily attributed to the demonetization. As many as 9.1 million new tax payers were added in 2016-17, an increase of 80% over the previous year.  Also, the advance tax collections of personal income tax (other than Corporate Tax) as on August 5, 2017 showed a growth of about 41.79% over the corresponding period in 2016-17. Thus, the effect of demonetisation is also clearly visible in the growth in direct tax collections.

Near Conclusion

Thus it can be seen that demonetization was a mixed bag of results. While its performance can be called mediocre in wiping out the black money and strengthening banks, it was satisfactory in dealing with terrorism and naxalism. Demonetization was most successful in removing the FICNs from the economy and increasing the tax base. However, its worst fallout was visible in informal sector and employment generation which saw one of the worst decline in the recent years.

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