The Indian Government has taken a big step by demonetizing Rs 500 and Rs 1000 notes in order to curb black money. This is a progressive and path breaking measure for the Indian Economy. Though there has been a demonetisation of currency in the past, the magnitude of the same was not high, owing to the Economic situation of the country. By scraping the present Rs 500 and Rs 1000 notes and introducing the new Rs 500 and Rs 2000 notes as legal tender, the government aims predominantly at checking the black and fake currency.
I see pragmatic yet dubious outcomes of this policy. In this article I would like to focus on:
• Black Money
• Counterfeit/ Fake Money
• Money circulation in Economy
• Banking Sector
• Short term difficulties
• Real Estate
This has been the most overhyped consequence of ban on the notes. It is true that to some extent people might come out and declare their black money, but, most of the people will find a way to get away from surrendering. If their hoarded cash is in lakhs, they would deposit the money in small amounts in different bank accounts. And why would a person with hundreds of crores not want to deposit it in tax haven countries in different currencies? Or they might even store their money in form of gold or bonds. Logically, this doesn’t sound as the ultimate strategy for ending black money.
But, it would be an advantage if the people are willing to declare the black money. This leaves them with 10-20% of what they had. This was a clearly unanticipated move by the government, following an Income Declaration Scheme which ended on 31st September. If crores of rupees earned illegally are hoarded in a safe or in underground pits the owners will now be in pressure to burn it all, which is a boon to the Economy. This would decrease the money circulation and RBI would become rich as they don’t owe to pay the money.
COUNTERFEIT/ FAKE MONEY-
I see the reduction of fake currency as the ultimate winner. With about 400 crores of fake money in circulation at any given point of time, introduction of new notes invalidates the fake notes, which are mainly circulated in 500 and 1000 denominations. 90% of the fake money is said to be in 500 and 1000 denominations. According to the Finance Minister, the new notes would be difficult to forge and this would mean that the chance existence of the counterfeit money is rather less.
As the unaccounted and fake money is exposed to an extent, the circulation of money decelerates. This will cause an inflationary gap in the economy. This will surely lead to a decreased spending, affecting the businesses. The black money holders use the unaccounted money for the purchase of luxury goods, but after this step, the spending on the latter would see a downfall.
The accounting of the total money supply will be correctly known to RBI, which is essential for fiscal and monetary policy making. This is possible because the people who hoarded the black money have only two options: either convert it into white and pay a penalty of 200% or burn it. The counterfeit money can no longer be an issue due to the ban on higher denominations. Therefore, it is possible to ascertain the money supply in the country.
The banking sector would become prosperous post this decision. As the physical transactions would be decreased and more people would opt to deposit cash in their accounts, this results in an increased lending of money. The interests rates go down as a result of increased funds and deflation.
The only bank that underwent a huge expenditure is the RBI. Atleast Rs 12000 crores is said to be spent on the printing of new notes.
Due to a decreased supply and velocity of money, there would be deflation in the economy. As the aggregate demand decreases and the supply is static, there will initially be a deflation. But there wouldn’t be any long term effect as such. A low inflation rate in a way helps the consumption increase as the time flows and makes it easier for low income groups to spend on the essentials, raising their standard of living.
The Economic Growth will be hindered in next couple of quarters due to the short term difficulties. Unavailability of ready cash, limit of cash withdrawal and depositing in bank accounts, and not being accustomed to E-Wallet or online transactions will limit the growth. But, in a long run when the current black money hoarders disclose their income and pay taxes, the income of the country increases leading to a better growth. This should spent on better infrastructure and public amenities.
SHORT TERM DIFFICULTIES-
The decision caused a sense of panic among the common people. Though the government has promised that the value of money that is earned legally will not be lost , there have been problems and disruption of daily routine. The unavailability of new 500Rs notes poses another problem considering the denomination below and above it (Rs100 and Rs 2000).
The people living in the rural and far off areas face significant hardships especially in case of emergencies. And, the readiness of cash availability in the banks at these places is quite low.
The real estate business will become transparent. Usually the transactions take place in form of money, and this a way black money can be converted white by property purchase. Now that this cannot take place, the property prices go down. This will give an opportunity for the middle and low income groups to buy an asset.
Gold is another safe zone for black money conversion. Due to the overnight ban on the notes, the black money hoarders can no longer bet on the gold. Initially, it will hamper the purchase of gold, but in the long run it will see a surge as the people wouldn’t take a risk again on their illegal income.
Though there are a lot of long term advantages to this step, I fear the short term repercussions. The purchasing power parity of the people is hit and the monetary urgencies cannot be met due to the limit in banks. What I don’t understand is, how the common people with savings in their safe accumulated over a long period of time show accountability. If the reason is to track down the big shots, they would already have their money in foreign currency/ bullion. For this cause, I guess tax administration would be a better option rather than banning notes.
Having said that, I see a bright opportunity in fighting the counterfeit circulation. According to the Indian government, Pakistan is using the counterfeit currency to fund terrorism. So, this is a good way to monitor it. It is a great step for fake money check, but I don’t think it is the game changer when it comes to making India white(in terms of legality). Also, if people possess soiled notes, they can exchanged for new notes.
With GST taxation around the corner and now the demonetisation of currency, coupled with global power shifts, it is hard to anticipate where the economy is heading to.