Demonetisation to consolidate government finances and ride the tide of cashless payments & digital economy

Last Updated on February 20, 2017 by Bharat Saini

Prime Minister Narendra Modi’s sudden announcement to demonetize Rs. 500 and Rs. 1,000 currency notes with effect from midnight of November 08-09, 2016, making these notes invalid is a major assault on black money, fake currency and corruption.  Modi said the notes of Rs. 500 and Rs. 1,000, “will not be legal tender from midnight tonight” and these will be “just worthless piece of paper.” Reserve Bank of India (RBI), the monetary authority, explaining the rationale behind the move, said the most important reason for the ban was the abnormal rise in fake currencies of higher denomination, and also the higher incidence of black money in the system.

Beneficial Impacts of Demonetisation in the medium to longer term are as under:

1.  As unaccounted money from India’s shadow economy estimated at more  than 23% of GDP, get mainstreamed due to demonetisation, its fiscal  position will improve. This, in turn, would enable higher capital  expenditure by the government and could help over the longer term  propel economic growth into double-digit levels.
2.  As the black money goes out of the system the money supply will shrink to some degree. This will reduce inflation rate in the absence of any open market interventions by the Reserve Bank of India.
3.  There is likely to be a reset of spending patterns as this move represents  indirectly, a significant push towards a cashless economy. Consumers  today have a plethora of cashless payment options from banks, mobile  wallets and e-commerce firms and most merchants have started  acceptance options at various stages of the supply chain. To ride the tide  of cashless payments, it is imperative to provide incentives to the trader  to switch. As such the government announced, on 23 November, a  waiver of service fee for debit cards till 31 December.
4.  Top e-commerce firms have significantly increased discounting to drive  sales, after the recent withdrawal of high-value currency notes hit the  nascent recovery in online retail. Flipkart and Amazon India began  handing out discounts of at least 50%, even as they pushed customers  towards more cashless transactions. E-commerce companies are also  ramping up their infrastructure to handle more card-on-delivery  transactions and are deploying more point-of-sale (PoS) machines.  Companies are scrambling to ensure more digital and online transactions  as most of them are still unprepared and ill-equipped to handle the  increased volume of online orders.
5.  The move towards non-cash transactions and digital payments would  enhance the ease of doing business.
6.  The greater formalisation of economic and financial activity would help  broaden the tax base, boost government revenue and expand usage of the  financial system. It is possible that this positive effect would soon  outweigh the drag on revenue collection from lower short-  term GDP growth as higher incomes would be declared.
7.  Banks to be the key beneficiary of demonetisation as it is expected to  yield greater use of the formal financial system for the intermediation of  commercial transactions, especially in retail segment.
8.  There is surge in bank deposits as the savings that were kept in different  forms particularly in the form of currency notes, now move into bank  deposits. A surge in low-cost funding may remove a constraint on banks  that prevented lending rates from keeping pace with the RBI’s policy rate  cuts in recent years. Reduced lending rates could encourage stronger  credit growth, supporting the economy. Lower debt-servicing costs  might also speed the resolution of banks’ asset-quality problems.
9.  The NPAs of banks will go down as borrowers deposit specified notes to  repay loans.
10.  Government borrowing costs will also come down as interest rates fall.
11.  The banking system getting a boost and real estate prices falling about  20-25 per cent before stabilizing.
12.  The overall economic impact would include a likely appreciation of the  rupee.
13.  Government finances may also benefit from a proportion of high-  denomination notes not being traded i.e. cash that is not deposited back  in the banking system. This potentially significant amount would be  subtracted from the Reserve Bank of India’s (RBI) liabilities, as RBI’s  liabilities to the unreported amount extinguish by year end; it can then  transfer the gains to the government as dividend, which will boost non-  tax revenues.
14.  Tax revenue will surge as amendment to Income Tax Act proposes  declarant to pay tax @ 30% & penalty @ 10% of undisclosed income, and  a surcharge @ 33% of tax – totaling to 50% on undeclared income that is  voluntarily disclosed till 30 December and 25% of such income locked up  for four years. Thereafter 85% – 75% tax & 10% penalty could be levied  on undeclared income detected by authorities
15.  The move will benefit the poor in particular as the Prime Minister’s  thrust appears to suggest that improvement of government finances  after the move will help government push more welfare expenditure for  the poor sections of the people
16.  Demonetisation to hit terror financing hard as one of the reasons to demonetise currency notes of Rs. 500 and Rs. 1,000 was to curb the circulation of fake currency notes. It is an established fact that the supplier of raw currency notes, the ink and the silver thread is same for India and Pakistan and that in 90% cases, the fake currency had been pumped in through the land route from Bangladesh. Certain security features of Rs. 500 and Rs. 1,000 notes had been compromised. The officials in the security establishment are upbeat that crimes like terror financing would be severely hit by the move.

Modi has taken this decisive step towards leaving an indelible stamp on the nation’s history and to recast the BJP’s core constituency. This is an effort to increase support base for BJP beyond existing class base and forge a new socio-economic coalition beyond its traditional constituency.