Impact of demonetization on Indian economy!

Demonetisation perhaps has been the boldest decision by Modi Government.

Demonetization drive has been widely debated ever since the government's surprise announcement in early November 2016 that it would invalidate billions of 500- and 1,000-rupee banknotes.

.Whether it has helped the economic development or not can not be answered in one sentence. Lets have a look at the objective of the move and to what extent it has achieved its purpose……

Economic Affairs Secretary S.C. Garg said the objectives of the note ban such as checking black money, terror financing, promoting digital transaction and weeding out fake currency notes had been achieved. “I think demonetisation has achieved its objective quite substantially."

Objectives:-

1. Black money- The government estimated that ₹3 lakh crore, or approximately 20%, of the demonetized banknotes would be permanently removed from circulation. It was expected to reduce fiscal deficit to that extent. [58]However, according to a 2018 report from the RBI, approximately 99.3% of the demonetised banknotes, or ₹15.30 lakh crore of the ₹15.41 lakh crore that had been demonetised, were deposited with the banking system.
2. Counterfeit banknotes-After demonetisation, there was an increase in the number of counterfeit ₹100 and ₹50 banknotes. The number of counterfeit ₹500and ₹1,000 (demonetised version) banknotes saw an increase in 2016-17 and subsequently a decline in 2017-18. But in 2017-18, there was an increase in counterfeit ₹500 and ₹2,000 (new version) banknotes than the previous year. There has been no significant change in the number of counterfeit banknotes detected. In 2017-18, the number of detected counterfeit banknotes was close to the number before

1. Tax collection- The number of income tax returns filing increased from 43.3 million to 52.9 million between financial year 2016 and 2017 which was not a significant increase compared to increase between 2015 and 2016. The tax compliance had increased with number of income tax returns filing increased but majority of them were from salaried and non-business class.The income tax collections increased in financial year 2017 due to Income Disclosure Scheme 2016. If adjusted for it, the increase in tax collection was modest. The tax-to-GDP ratio has increased due to expanding tax base.

An analysis of the economic data shows that there has been no substantial increase in the number of new tax payers or direct tax collection due to demonetisation

4. Digital payments-The push for the digital payments was one of the stated intention of the demonetisation. There was immediate and sharp jump in the digital payments in November–December 2016 owing to shortage of cash. However after return of the cash, the growth in digital payment had been modest. The currency-to-GDP ratio was 12.1% in 2015-16. It declined to 8.8% in 2016-17 due to demonetisation but increased again to 10.9% in 2017-18. The currency-to-GDP ratio was only marginally lower compared to level before

5. Terrorism and internal security-Initially there was a decrease in the activities and attacks by Maoist and Naxalite radical groups which was attributed to lack of finance following demonetisation. The surrender rate had reached its highest. The activities returned within few months. There was a decrease in the terror activities in Jammu and Kashmir.

6. Banknotes in circulation-On 28 October 2016 the total banknotes in circulation in India were valued at ₹17.77 lakh crore (US$260 billion)The volume of banknotes in the market increased by 2.1%. The banknotes in circulation had further increased to ₹19.5 lakh crore (US$280 billion) in September 2018 and ₹21.41 lakh crore(US$310 billion) in March 2019, 19.14% higher than the level before demonetisation.

Lets now study the other effects:

1. Cash shortage-The scarcity of cash due to demonetisation led to chaos, and people faced difficulties in depositing or exchanging the demonetised banknotes due to long queues outside banks and ATMs across India. The ATMs were short of cash for months after demonetisation.

1. Transportation-The All India Motor Transport Congress claimed that about 800,000 truck drivers and conductors were affected with shortage of cash, with around 400,000 trucks stranded at major highways across India
2. Stock market- As a combined effect of demonetisation and US presidential election, the stock market indices dropped to an around six-month low in the week following the announcement. The day after the demonetisation announcement, BSE SENSEX crashed nearly 1,689 points and NIFTY 50 plunged by over 541 points.
3. Industrial output -There was a reduction in industrial output as industries were hit by the cash shortage. The growth in eight core sectors such as cement, steel and refinery products, which constitute 38% of the Index of industrial production (IIP), was only to 4.9 percent in November 2016 as compared with 6.6 percent a month ago
4. Agriculture -Transactions in the agriculture sector are heavily dependent on cash and were adversely affected by the demonetisation. Due to scarcity of the new banknotes, many farmers have insufficient cash to purchase seeds, fertilisers and pesticides needed for the plantation of rabi crops usually sown around mid-November.
5. Real GDP growth rate-Global analysts cut their forecasts of India's real GDP growth rate for the financial year 2016-17 by 0.5 to 3% due to demonetisation. India's GDP in 2016 is estimated to be US$2.25 trillion, hence, each 1 per cent reduction in growth rate represents a shortfall of US$22.5 billion (₹ 1.54 lakh crore) for the Indian economy.

7. Employment-There was a loss of jobs and decline in wages due to demonetisation, particularly in the unorganised and informal sector and in small enterprises. Migrant workers were adversely affected by demonetisation. According to the Centre for Monitoring Indian Economy (CMIE), demonetisation caused loss of about 15 lakh jobs. The CMIE compared the employment data for January-April 2017 with the figures for the September-December quarter of 2016, when demonetisation was implemented.

8. Deaths[edit]

Several people were reported to have died from standing in queues for hours to exchange their demonetised banknotes. Deaths were also attributed to lack of medical help due to refusal of demonetised banknotes by hospitals. By the end of December 2016, political opposition leaders claimed that over 100 people had died due to demonetisation

Demonetisation could not hit illicit wealth held as real estate, shares, gold, silver and foreign currency. Only smalltime concealers of income keep their money in cash. These include women hiding income from their men, to create a stash they could use to buy gold or in a health emergency. Demonetisation hit such people hard, not the big fish.

Politicians like P Chidambaram and Mamata Banerjee called the demonetisation a big scam which facilitated the conversion of black money. Their argument is fairly simple. They say that the government had expected dividend of close to Rs 4-5 lakh crore, however, the RBI data shows it got just Rs 16,050 crore. So, was it wise decision to lose one per cent GDP for just Rs 16,000 crore? critics ask.

But, would it be fair to see demonetisation from the lens of only windfall margin? Certainly not, the government argues. The demonetisation may not be a grand success as it couldn't achieve stated objective, but calling it a big scam will be a bit of exaggeration and sheer politics.

The government has an entirely different narrative to prove that demonetization has really worked. So what are the government's arguments which made them so confident. Lets dive into the government's logic:

Demonetisation impact on widening of Tax-base:According to the Income Tax, the number of e-returns of Individual taxpayers filed till 5th August 2017 increased to 2.79 crore from 2.22 crore returns filed during the corresponding period of last year, registering an increase of about 57 lakh returns or 25.3 per cent. T

he total number of all returns (electronic + paper) filed during the entire Financial Year 2016-17 was 5.43 crore which is 17.3 per cent more than the returns filed during FY 2015-16.

Demonetisation impact on Direct Tax Collections: The Income Tax Department showed a growth of about 41.79 per cent in the collection of Advance Tax under Personal Income Tax.

Lakhs of shell firms detected: The Prime Minister while speaking on Foundation Day of Institute of Chartered Accountants of India revealed that after the demonetisation over 37,000 shell firms were detected.

14,000 high-value properties under scanner: The Income Tax department released a statement saying the operation clean money exercise which was started after demonetisation has unearthed large number of persons and clusters having suspect transactions. "These include about 14,000 properties of more than Rs.1 crore each where persons have not even filed Income Tax Returns. The investigations are in progress," the statement said.

India's Demonetization Drive: A Necessary Jolt Towards A More Digital Economy?

Salutary benefits from demonetisation in India: IMF -Murray said the demonetisation did cause some temporary disruptions in economic activity, primarily, private consumption and small businesses due to cash shortages. "In the medium term, demonetisation could have possible effects, including through greater formalisation of and the information on economic activities and a more efficient payment system with a greater use of the banking system and digital payments," Murry said.

I would eave it to the readers to draw their own conclusion on Demonetisation in the right perspective. Comments are welcome

Footnotes & References:

1. https://www.livemint.com/Politics/CKnfEoC8fcir06sTImvYoL/Demonetisation-achieved-its-objectives-substantially-says-g.html
2. 5 reasons why Narendra Modi’s demonetisation drive will not curb black money
3. 7 Reasons Why Demonetization Is A Masterstroke By Modi
4. https://www.ijsr.in/upload/62218017Chapter_35.pdf
5. Demonetisation fallout: Demand for cash increases by 7% since note ban, says RBI data
6. https://www.iimb.ac.in/sites/default/files/2018-06/Demonetisation.pdf
7. Demonetisation's 7 benefits apart from failure to eradicate black money
8. From GDP growth to black money, costs outweigh benefits of demonetisation
9. Demonetisation: What India gained, and lost
10. India's Demonetization Drive: A Necessary Jolt Towards A More Digital Economy?
11. Salutary benefits from demonetisation in India: IMF
12. Demonetisation: All cost and little benefit