Introduction
On November 8, 2016, the Indian government announced a momentous decision—the demonetization of all ₹500 and ₹1,000 banknotes from the Mahatma Gandhi Series. Simultaneously, they unveiled the introduction of new ₹500 and ₹2,000 banknotes, set to replace the phased-out currency. This transformative move marked a significant shift in India's economic landscape, triggering widespread claims and counterclaims about its effectiveness.
Understanding Demonetization
Demonetization, is the act of invalidating the legal tender status of currency, and is often employed by nations as a means to recalibrate their economic structures. This move anticipates positive alterations in liquidity and aims to counterbalance prevailing economic conditions.
In India, the Reserve Bank of India (RBI) or the government officially recalls the legal tender status of specific currency notes, disrupting their use as mediums of exchange.
This strategic move aims to combat counterfeit currency circulation and induce positive alterations in liquidity. The Indian government's decision to demonetize high-denomination notes was a pivotal move aimed at combating counterfeiting and money laundering. The abrupt withdrawal of these notes had a profound impact on the nation's economy, sparking debates on corruption, black money, and the challenges faced by various segments of society.
The Impact on India's Economy
Demonetization's ripple effect extended across various sectors of the Indian economy. While targeting corruption and black money, the move significantly altered the monetary landscape, prompting discussions on cashless transactions, tax collection, and the challenges faced by rural households and senior citizens.
Formalizing the Economy & Boosting Tax Collections: Demonetization had a profound impact on India's economic landscape, particularly in formalizing sectors and augmenting tax collections. The Central Board of Direct Taxes (CBDT) reported a substantial surge in the number of taxpayers, growing by 25.1% from 62.4 million in 2015-16 to 78.1 million in 2016-17. This positive shift was attributed to demonetization, which deterred the use of cash and the government's initiatives to simplify tax filing processes.
The expansion of the taxpayer base has yielded several advantages for the Indian economy. It has led to increased tax collections, providing vital resources for government programs and infrastructure projects. The enhanced transparency and reduction in tax evasion have created a more equitable environment for businesses and individuals, fostering economic growth.
Strengthening Financial Inclusion: Demonetization has played a pivotal role in advancing financial inclusion by bringing the unbanked population into the formal banking system. The Pradhan Mantri Jan Dhan Yojana (PMJDY) initiative, combined with demonetization, resulted in the opening of millions of bank accounts for previously unbanked individuals. By August 2022, over 500 million accounts had been opened under PMJDY.
This surge in bank accounts has positively impacted the financial inclusion of the Indian population, offering access to credit, savings, and insurance. The resultant reduction in poverty and improvement in the lives of the economically disadvantaged contribute to overall economic growth.
Reduced Cash Circulation and Surge in Digital Transactions: Demonetization significantly reduced the circulation of high-denomination currency notes, leading to a decline in cash transactions. This paved the way for a surge in digital payment methods such as mobile wallets and UPI. The National Payments Corporation of India (NPCI) reported a remarkable 207% increase in UPI transactions in 2018-19 compared to the previous year.
The increase in digital payments is attributed to factors like convenience, government advocacy for digitalization, and growing awareness of the benefits of digital transactions. Digital payments offer advantages such as convenience, speed, security, and traceability, contributing to a more efficient and cost-effective economy.
Enhanced transparency and Ease of Business: Demonetization acted as a catalyst for innovation and growth in the startup and fintech sectors, giving rise to cutting-edge digital payment solutions. Companies like Paytm, PhonePe, and Google Pay have emerged as leaders, witnessing significant growth during the demonetization period.
In addition to fostering technological advancements, demonetization triggered a widespread financial literacy campaign, promoting digital literacy and encouraging citizens to embrace digital payment solutions. This, coupled with the shift towards digital transactions, streamlined business processes, reducing paperwork and bureaucratic hurdles. India's ranking in the World Bank’s Ease of Doing Business Index improved significantly, jumping 13 positions to 62nd in 2023.
Affordable Housing and Rural Digitalization: Demonetization, coupled with government initiatives like Pradhan Mantri Awas Yojana (PMAY), aimed to foster transparency in real estate transactions and diminish the prevalence of black money, particularly in the affordable housing sector. This strategic move led to increased investments and growth in affordable housing, as reported by the National Housing Bank (NHB). In the year following demonetization, the number of affordable housing units launched in India increased by 50%, accompanied by a 40% increase in their total value.
The surge in the affordable housing segment is a positive development for the Indian economy, addressing the housing needs of millions living in substandard conditions. Simultaneously, demonetization accelerated digitalization in rural areas through initiatives such as Digital India and BharatNet. These efforts improved connectivity and digital literacy, facilitating the adoption of digital payment systems by farmers and small businesses.
Key points regarding the impact of demonetization on real estate and digitalization in India include;
The number of affordable housing units launched in India rose from 2.5 lakh in 2016-17 to 3.75 lakh in 2017-18.
The value of affordable housing units launched in India increased from Rs. 1 lakh crore in 2016-17 to Rs. 1.4 lakh crore in 2017-18.
Digital transactions in rural areas experienced a substantial 60% increase, reaching 160 crore in the year following demonetization.
The value of digital transactions in rural areas increased from Rs. 10,000 crore in 2016-17 to Rs. 14,000 crore in 2017-18.
The impact of these measures is evident in the surge in digital transactions, the increase in fintech startups, and the improved access to bank accounts. Overall, demonetization has played a pivotal role in reshaping India's economic landscape, fostering financial inclusion, and promoting a more efficient business environment.
Counterfeit Currency
The strategic demonetization of high-denomination notes by the Indian government effectively disrupted the circulation of counterfeit currency, enhancing the overall security of the monetary system. This measure posed challenges for counterfeiters in replicating the new currency, leading to a significant decrease in counterfeit notes, as reported by the Reserve Bank of India (RBI). In the year following demonetization, the detection of counterfeit notes in India decreased by 62%, from 25.39 lakh in 2016-17 to 9.92 lakh in 2017-18.
The substantial reduction in the number of counterfeit notes detected demonstrates the success of demonetization in deterring the circulation of fake currency within India. This positive outcome contributes to the nation's economic well-being by making it more difficult for criminals to employ counterfeit currency for illicit activities.
Additionally:
- The value of counterfeit notes detected in India witnessed a remarkable 67% decline in the year following demonetization.
- The share of counterfeit notes in total currency in circulation dropped from 0.02% in 2016-17 to 0.007% in 2017-18.
- The number of counterfeiting cases registered in India declined by 58% in the year following demonetization.
Challenges to Demonetization
The government and the public faced numerous challenges in the demonetization process including limited coverage of banking facilities in villages, low banking penetration, and logistical and cost challenges in replacing high-denomination notes. Some of the more prominent issues are;
Disruption of Economic Activities: The process of demonetization triggered an abrupt and significant disruption in economic activities, especially in a country which relied on cash for a substantial portion of its transfers. Businesses encountered many difficulties in their day-to-day operations, and consumers experienced inconvenience in conducting transactions.
Negative Consequences for Small Businesses: Small businesses, particularly those heavily reliant on cash transactions, faced a lot of challenges during demonetization. Cash flow disruptions and difficulties in adapting to electronic payment systems posed substantial hurdles for these enterprises which had small scale operations.
Cash Shortages and Public inconvenience: Demonetization led to a sudden scarcity of physical currency, resulting in long queues at banks and ATMs. This inconvenience affected ordinary citizens who until then were heavily reliant on cash for daily transactions.
Technological and Infrastructure Challenges: In certain cases, the necessary infrastructure to support a cashless or less-cash economy were lacking. This included reliable internet connectivity, a robust electronic payment system, and widespread access to banking services, which severely limited the success of demonetization efforts in rural India for a long period of time.
Adverse Effects on Agriculture: In agrarian economies where farmers frequently engage in cash transactions, demonetization negatively impacted agricultural activities. Small and medium farmers encountered difficulty in purchasing inputs, selling produce, and managing day-to-day expenses.
Combating Black money
In an effort to combat the issue of black money, the government has implemented a series of measures. Firstly, the Special Investigation Team (SIT) on Black Money was established, and in 2015, the Black Money Act was enacted, imposing a substantial 60% tax rate. Subsequent to the Panama Papers leaks, a Multi-Agency Group was formed, comprising various authorities to investigate and address the matter comprehensively. Additionally, the Lok Sabha passed the Benami Transactions Bill in 2015, with the objective of identifying and seizing properties held under fictitious names, while also prosecuting offenders involved in such transactions.
The government has been actively engaged in amending Double Taxation Avoidance Agreements (DTAA) and engaging in negotiations with several countries, including Switzerland, to facilitate Automatic Exchange of Information (AEOI). Furthermore, the successful implementation of the Income Declaration Scheme (IDS) in the recent budget year resulted in substantial tax collections amounting to Rs. 65,250 crore, marking a significant step towards curbing the prevalence of black money in the economy.
Demonetization and its effect on Terrorism
Demonetization played a pivotal role in disrupting the financial networks of terrorist organizations and unlawful activities. The invalidation of high-denomination currency notes made it more challenging for illicit transactions and funding channels to operate, thereby enhancing national security. A report from the National Investigation Agency (NIA) revealed a 50% reduction in terrorist attacks in India within the year following demonetization, accompanied by a 40% decrease in the value of assets seized from such organizations.
These notable declines in both terrorist incidents and seized assets signify the effectiveness of demonetization in disrupting the funding networks of terrorist organizations in India. This positive development contributes to the increased difficulty for terrorist groups to carry out their activities, strengthening the nation's security. Additionally, there has been a significant decrease in terrorist attacks from 100 in 2016-17 to 50 in 2017-18, a decline in the value of seized assets from Rs. 10,000 crore to Rs. 6,000 crore during the same period, and a 20% rise in terrorist arrests in the year following demonetization.
Conclusion
Demonetization in India, though met with challenges and criticisms, represented a significant economic experiment with far-reaching consequences. It had its hits and misses and has positively contributed to the Indian economy and has been one of India’s most potent weapons against the fight for a corruption free India.
The impact on various sectors, coupled with the government's measures to tackle black money, shaped India's economic landscape in the aftermath of demonetization. The coming months and years would likely witness the full realization of the intended benefits and an assessment of the limitations of this transformative economic strategy.
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