Home » Subject » Essay » Advantages and Disadvantages of Demonitization policy

Advantages and Disadvantages of Demonitization policy


NDA government under the leadership PM Modi has once again shown their commitment to fight against the menace of black money. The bold step taken by Centre on Tuesday to demonetize Rs. 500 and Rs. 1000 sprang a surprise on 1.25 billion people in India and has evoked strong reactions not just from the common man but also from his political opponents. This step was lauded by many and was hailed as a surgical strike on black money. The big question which arises here is why only Rs, 500 and Rs. 1000 notes were targeted? Data on velocity of Indian currency shows that high denomination notes of Rs. 500 and 1000 were being used for black-money transactions, terror funding and other illegal activities. In fact, between 2011 and 2016, the circulation of Rs. 500 notes grew by 76 percent and Rs.1000 notes by 109 percent, higher than average currency notes circulation in the country. Even the European Central Bank has recently announced that it will phase out the 500 mega-note, much against the preferences of cash-loving Germans.

Demonetization is the act of stripping a currency unit of its status as Legal Tender and the old unit of currency is replaced with a new currency unit. This is not the first time that government has taken such steps to weed out black money from the economy. In 1946, government withdrew Rs.1000 and Rs. 10,000 bank notes and reintroduced higher denomination of Rs. 500, 50000 and 10,000 bank notes in 1954. In 1977, Wanchoo Committee suggested demonetization as a measure to unearth and counter the spread of black money. In 2016, NDA government also opted for demonetization of Rs. 500 and Rs. 1000 bank note to break the unconsecrated nexus of corruption and parallel economy. With these notes now going out of circulation overnight, the government has created a solid opportunity to clean up the system. This step has demonstrated India's commitment to transition to a rules-based regime. This bold step will give further boost to India's reformist stance, given India's not-so-encouraging performance in latest Easy Doing Business Index due to lack of proper implementation of reforms and delaying of key economic reforms.

If we look at some of the past events and steps taken by the government we will find that this move has been well thought out and it began with a massive push to universalize access to bank accounts, use of Aadhaar in transactions; JAM TRINITY and the push to a cashless economy. This was followed by steps taken to bring back black money stashed away in tax havens or foreign banks abroad and introduction of Voluntary Disclosure of Income Scheme this year. It was an appropriate time, therefore, to make credible the threat of a crackdown on parallel economy and corruption within India.

WHAT WILL BE THE IMPACT OF DEMONETIZATION?

SHORT-RUN IMPACT

Many argues that demonetization move is replete with downside risks as demonetization entail economic costs and it could potentially spiral into an administrative nightmare as people struggle to offload their stock of soon to be worthless banknotes. In fact, the first few months will be painful as short-term liquidity squeeze could be severe and hence economic activity could suffer in short run. Sectors like real estate where a major part of transactions are carried out in cash will suffer and construction activity wills also slowdown in the short-run. Demonetization will be painful for middle-class in short run. A day after the demonetization, there is a situation of chaos and public mayhem as automated teller machines were shut and banks were remained close on the next day for general public. People are queuing to banks and ATMs to exchange their Rs 500 and 1000 notes. In the first few days, withdrawals will be limited to Rs. 2,000 per day per card.

LONG TERM BENEFITS

The benefits of phasing out large paper currency are significant to an economy and even more to a society such as India where corruption has become an acceptable way of life. Following are some of the long term benefits associated with demonetization:

  • It would help in curbing finance of terrorism through fake Indian currency notes and funding of espionage, smuggling of arms, drugs and other contraband into India.
  • The move will give boost to Jan Dhan Account's relevance for poor people.
  • Demonetization would have a deflationary impact in general and more specifically on real estate prices which will make homes affordable.
  • Government's move to demonetization has been dubbed as a decisive move towards cashless economy.
  • Better tax collection possibilities in the economy
  • It will also help in unearthing huge volumes of black money which can help bridge the fiscal gap as the government's revenue collections can go up.
  • It will give further boost to all formal channels of payment which would lead to long term sustained economic growth.

IMPACT ON CASHLESS ECONOMY

With phasing out of Rs. 500 and Rs.1000 currency notes, there is a projected shift in the pattern of consumer spending behavior. Following will be the impact of demonetization on cashless economy;

  • Increase in transactions on debit cards: People will seek to reserve Rs 100 notes for smaller transactions and use debit cards to pay for higher value transactions.
  • Point of Sale (POS) Terminals usage will surge: With increase in cashless transactions, POS terminal usage are expected to increase.
  • Payment Banks and Online payment solutions like Paytm will see surge in number of users.

CHALLENGES AHEAD FOR GOVERNMENT

Indeed PM Modi's bold step will have a net positive effect, still a lot needs to be done in order to tackle black money. The success of latest fight against black money depends on how effectively and substantially it is implemented. There is a huge chaos prevailing in the country after the announcement of demonetization as a vast majority are bearing the brunt of liquidity crunch and inconvenience in day-to-day lives. Therefore, governments need to address the problem of liquidity crunch. Government and RBI need to take steps to ensure efficient cash management at all ATMs in the country. The government should come up with additional economic stimulus and need to end uncertainty on key economic reforms like GAAR etc. that would offset the initial adverse economic impact.

Economy is slowly moving towards cashless transaction channels, therefore, government has to prepare itself for the challenges present in its way. The National Payments Corporation of India (NPCI) will have to speed up adoption of the Unified Payments Interface over the coming months to make sure that there are more banks on the payments platform.

- SHREYA ANURAKTI