Introduction to Demonetization

The effect of demonetization was harsh on the cash driven sector of agricultural laborers and unregistered manufacturing etc. But the liquidity crisis wasn't as harsh as it was shown and pressure was reduced by end of December. To recover from the effects of demonetization we need:

1. Fast, demand driven remonetization

2.Lower tax rates.

3.Bringing land and real estate into GST

4.Stopping the tax administration from becoming over zealous.

The demonetization was a unprecedented step as all other such measures were either introduced during hyper inflation, war, political upheavals or other extreme measures. However India did it when the economy was growing and macro economic fundamentals were still strong.

What next after Demonetization ?

The survey focuses on answering questions like What policy measures does the country need now so the benefits of demonetization are increased and the ill effects are reduced. Though the impact felt on the agricultural sector, rural economy and cash intensive sector is high but the impact of the losses in these sector don't impact the economy as these are not counted in macro economic calculations.

India has seen low Currency to GDP ratio for the first few decades after independence and then this increased as the economy grew in the 1970's. Then the ratio improved and was high till 2000 when inflation increased. Then by 2005 as inflation eased the ratio again became higher. In general the level of high denomination notes is more as they are fueling more consumption and higher standards of living. It is believed that higher the cash the more is the corruption and the more is the use of currency for illicit activities. Countries thus see lower currency to GDP ratio as their development improves.

However India's Cash quantity is very high compared to its corresponding corruption level and so what the country wants is to lower the cash in circulation. The soil rate is another measure of whether a currency is used for transaction or not. Soil rate means the rate at which a note become so spoiled that it has to be returned to the bank. The rate is 33% for notes of low denomination and very low notes of high denomination. This means that the notes of high denomination like Rs. 500/1000 are not getting soiled and so are not used for transactions as much as lower denomination notes. The end conclusion could be that such high denomination notes are used for other purposes like storing as black wealth.

Result of Demonetization ?

The deposits in banks increased and overtime this shall reduce but still the deposits may be higher than pre demonetization era.

Cash in circulation has reduced but can increase overtime but still shall be lesser than during the pre demonetization era.

More money now in formal banking system and so can be utilised for investments and lending. Depositors shall get interest on these.

Less corruption only if compliance becomes easier and less incentive is there for evasion.

Tax base shall widen and tax collection shall increase in long run. This should be met with lower tax rates and efforts to widen tax base further by removing exclusions.

Digitization

The rate of digitization was slow and penetration poor. The sector also faced problems like lack of acceptability given that almost 350 million have no mobiles and 350 million have only feature phones. So only 250 million had smart phones that the payment wallets could operate on. The amount of transaction by the most convenient medium cash were about 98% by volume and 65% by value. This changed after demonetization and was a boon to digital payment modes.

Wallets have a problem of low limits and no interoperability. The government thus launched BHIM UPI app and the BHIM USSD mode but they too have drawbacks like operational complexity.

Aadhar enabled payments systems are so far the best alternative to those who can't operate credit or debit cards and have only Aadhar link bank accounts. The AEPS shall ensure that the resposibility of maintenance of equipment's shall be of the merchants and so the consumer has no inconvenience. The only drawback to this mode is the lack of POS machines and this too shall be overcome soon.

Digitization has many benefits and has received a boost after demonetization. The budget too has supported this by removing all kinds of charges on digital transactions

Maximize benefits and Minimize losses

The pace of remonetization should be high and match the pace of the demand. The limits on withdrawals should go and the public should not face any penalties on cash withdrawals. Both these measures shall help in building confidence of the public. The continuation of these shall lead to encouragement of hoarding cash.

Since the government is likely to make a small one time gain from this action, it should also use this gain into a one time capital expenditure like recapitalization or private investments.

Chapter Review

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Q1:To recover from the effects of demonetization we need:

  • Fast, demand driven remonetization
  • Lower tax rates.
  • Bringing land and real estate into GST
  • all

Q2:Those with black money had what options

  • To declare their cash and pay the tax rate and penalty
  • Not declare their cash and loose their entire income
  • To use money laundering
  • all

Q3:BHIM is

  • missile
  • UPI service
  • biometric authentication service
  • none

Q4:Which digitization mode doesnt offer interoperability

  • Aadhar pay
  • NEFT
  • BHIM
  • digital wallets

  • Q5:What indicates high denomination notes might be used for hoarding

    • poor soil rate
    • high soil rate
    • high corruption
    • low Currency to GDP ratio