Defending Demonetisation

In News

• Recently, the Union Finance Ministry told the Supreme Court (SC) that demonetisation in 2016 led to a phenomenal growth in digital transactions, shrunk fake currency and saw more income tax payers.

Government’s Response to SC

• Impact of Demonetisation:
  • Bridging formal informal divide: The withdrawal of ?500 and ?1000 banknotes, which had at the time formed more than 80% of the currency in circulation, was a critical part of a policy push to expand the formal economy and thin the ranks of the informal cash-based sector.
  • Transient effect: The overall impact of the withdrawal of legal tender of the specified banknotes on economic growth was just for some time. 
  • Actual growth: On the other hand, real growth rate was 8.2% in the financial year 2016-2017 and 6.8% in the financial year 2017-2018, both being more than the decadal growth rate of 6.6% in the pre-pandemic years.
  • Unaccounted income increase: Income tax authorities detected a significant amount of unaccounted income. 
  • Tax system aware citizenry: Demonetisation nudged the public to be tax-compliant. The number of Permanent Account Numbers (PAN) increased. Income tax payers multiplied while fake currency faded out.
  • Formal economy: It was one of the significant steps in the enhanced formalisation of the economy with the aim of expanding opportunities for millions living on the periphery of the economy.
• Post Demonetisation:
  • The volume of digital payment transactions had increased from 1.09 lakh transactions of value of ?6,952 crore in the entire year of 2016 to 730 crore transactions of the value of more than ?12 lakh crore in the single month of October 2022.

Demonetisation

• Background:
  • The preceding five years had seen a massive increase in the circulation of ?500 and ?1,000 notes.
    • A steep rise of 76.4% for ?500 and 
    • 109% for ?1,000 from 2010-2011 to 2015-16. 
• On 8th November 2016, the Government of India announced the demonetisation of all ?500 and ?1,000 banknotes of the Mahatma Gandhi Series. 
• It also announced the issuance of new ?500 and ?2,000 banknotes in exchange for the demonetised banknotes.
• There were three main economic objectives behind demonetisation:
  • Fighting black money, 
  • Fake notes and 
  • Creating a cashless economy by pushing digital transactions. 

Outcomes of the Exercise

• Black money:
  • Among those targets, the biggest one was tackling black money. 
  • Black money refers to cash that is not accounted for in the banking system or cash for which tax has not been paid to the state.
  • According to RBI data, almost the entire chunk of money (more than 99 percent) that was invalidated came back into the banking system. 
  • Of the notes worth Rs 15.41 lakh crore that were invalidated, notes worth Rs 15.31 lakh crore returned.
  • Thus, data suggests that demonetisation was a failure in unearthing black money in the system. Meanwhile, instances of black money seizures continue.
• Fake Notes:
  • RBI’s annual report, submitted that Rs.15.44 lakh crore worth of currency was demonetised. 
  • The withdrawn money amounted to 86.4% of the currency in circulation at the time. Only Rs.16,000 crore out of the Rs.15.44 lakh crore was not returned. 
  • Only .0027% fake currency was “captured” following demonetisation.
• Digitisation of economy:
  • As per RBI report, demonetisation has made India a lesser cash-based economy. 
  • In the initial days of trouble conducting business in the face of an acute cash crunch, more and more entities had to shift to digital to do business. 
    • After the return of the cash, the growth in digital payment had been modest.
• Supported in the Pandemic:
  • The creation of digital infrastructure post-demonetisation helped India in coping with the pandemic. 
  • As the tools for faceless transactions were mostly in place, it became easier to move towards contactless transactions.

Major Issues associated with the demonetization exercise

• No separate Acts:
  • Demonetisation in 1946 and 1978 were implemented through separate Acts debated by Parliament. 
  • In 2016, it was done through a mere notification issued under provisions of the Reserve Bank of India Act, 1934.
• Central Bank had rejected key justifications:
  • The Central Board of the RBI gave its approval to the scheme but also rejected, in writing, two of the key justifications — black money and counterfeit notes.
• Other:
  • 11 crore people stood in queue to change their own money. 
  • Farming community was at a loss. It was sowing season. 
  • Wholesale markets shut down. Prices crashed. Retail saw a “calamitous” drop in sales. 
  • Industry halted and 15 crore daily labourers were left without work.
  • Some say demonetisation broke the back of the rural economy where cash was dominated and disrupted supply chains. 
  • It is estimated that 1.5 million jobs were lost.

Conclusion

• Many are still to shift or adopt digital payment systems, maybe because it is more convenient to pay cash for purchase of fruits, vegetables or a few items of grocery from a store, or due to other reasons including voucher payment.
• While there certainly has been a discernible uptick in digital payments, it is doubtful whether the elaborate exercise to unearth black money — the stated and primary goal of demonetisation — was worth it. 

Source: TH