Answer: Demonetization is barring some currency denominations/notes to be legal tenders from a particular date. Our PM announced demonetization of 500 Rs and 1000 Rs notes on Nov 8th, 2016, which accounted for ~15.5 lakh crores i.e. 86% of currency in circulation.
1. The only means of exchange of old notes is through banks. That too there was a limit ranging from Rs.2, 000/- Rs to Rs.4, 000/- per day depending on current liquidity situation. Any amount higher needs to be deposited in the bank which can later be withdrawn from ATMs again with the same limit. The main aim behind the limit was to make sure that black money holders would not be able to exchange all the un- accounted money without paying necessary tax (under PM Krishi Kalyan Yojana announced later). Even if we consider 30% of cash in circulation as black money and even if half of it does not come back to banks, government expected to get a fiscal push of approximately 2 lakh crores which can be used for various welfare projects over a period of time
2. Government utilized this opportunity to push for digital transactions so that black money can be curtailed to some extent and traders cannot escape paying indirect taxes once the transaction is digital, which increases government income there by reducing fiscal deficit
Since banks got enormous amounts of deposits, these can be best utilized to solve NPA problem. Banks would want to lend out this money by offering at low interest rates thereby improving economic activity and so GDP in the long run. Once the black money held in cash is curtailed, the artificially created demand will go down, automatically reducing the prices. So purchasing capacity of poor and lower middle class will increase considerably. Many infrastructure projects which are stalled due to lack in investments can be completed by getting funds from banks. Tax revenue increase will be tremendous (already evident). May improve India's ranking in various indices like "Ease of doing business index"
In the short run demonetization will slow down the economy. Even a 1% drop in GDP will out way the positive outcome government gets by removing unaccounted money from economy. The cash crunch has majorly hit the rural poor especially when the farmers were trying to sell their produce. Though black money is not good, in a way it helps to expand economy. So slow down in the short run will be inevitable. Postponement of GST bill is a bless in disguise since it gives the government time to come up with best GST law. But postponement may disappoint investors which will intern hurt already down trodden economy. Speculated increase in spending by low interest rates because of improvement in cash deposits in banks is stalled by recent monetary announcement from RBI which kept interest rates unchanged.
Demonetization is definitely a very positive and bold step to curb black money which was evident from overwhelming positive response in Modi App. But failure to implement it might result in serious injuries to the economy which might hurt citizens trust towards government and even RBI. So government should take all necessary the positive measures to make it a success.
- Anusha Kolli