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:
- 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.
- 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.
- 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.
- 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.
- The move towards non-cash transactions and digital payments would enhance the ease of doing business.
- 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.
- 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.
- 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.
- The NPAs of banks will go down as borrowers deposit specified notes to repay loans.
- Government borrowing costs will also come down as interest rates fall.
- The banking system getting a boost and real estate prices falling about 20-25 per cent before stabilizing.
- The overall economic impact would include a likely appreciation of the rupee.
- 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.
- 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
- 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
- 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.
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