In a surprise move yesterday, Narendra Modi announced that from midnight onwards, Rs. 500 and Rs. 1000 notes would not be accepted as legal tender anymore. There were certain institutions like the petrol pumps, government hospitals, airports etc that would still accept these notes for three more days but the notes would be worthless otherwise. It was mainly aimed at removing the black money present in the economy. Here is an analysis of what this move means to all of us.
What does it means for the parallel economy?
The parallel economy circulates mainly on the strength of the ‘big’ currency – Rs. 500 and Rs. 1000. If we think of bribes, below the table deals, construction costs paid in cash; all of these are usually big amounts and it would be pretty inconvenient to pay them in smaller denominations. Now that they are not valid currency notes, they need to be either deposited or exchanged. This is a sticky situation for black money hoarders. They either have to let go all of that money or be ready for an investigation into their income sources. However, amounts deposited up to Rs. 2,50,000 will face no scrutiny. If the deposits are found to be disproportionate to the income declared, a 200% tax will be imposed.
In the long run, this removal of black money can help bridge the gap between the rich and the poor.
What other benefits is it posited to have?
When considered along with the Direct Benefit Transfer scheme and even the Jan Dhan Yojana (which ensured that majority of the population has a bank account) we can see that we are moving towards a cashless economy. Currently, only amounts upto Rs. 4000 can be exchanged, the rest is credited to the bank account. So, this way you get back whatever you give in but in the form of a deposited amount in bank amount and limited in way of cash in hand. Those who do not have a bank account will have to create one promoting the formal banking system. A cashless economy means less bribery and corruption and ease in transactions.
Black money is money that isn’t declared. Thus, it could be used in an array of illegal avenues like funding terrorism or paying ‘hawala’. This will be halted too.
This implementation comes in time for elections which can turn into a dirty game in India with money being paid to buy votes. The Election Commission also prescribes ceilings up to which money can be spent on campaigning and black money is used to meet the additional expenses. This practice will also be squashed to a certain extent.
Counterfeit currency also moves out of the economy and even the whole counterfeiting process stops because the new notes are different with improved security measures.
It also leads to renewed faith in the government. They have acted on their promises to combat the black money menace.
Things to be kept in mind
This does nothing to the assets held illegally in the form of gold, stored in offshore accounts and real estate.
Second, though the move towards a cashless economy is appreciated it is going to be difficult for those that are not yet familiar with such systems especially with groups that are not economically well off or with limited access to technology.
There is also this short term confusion as there is a sudden huge demand for smaller denominations and everybody’s cash is stuck, especially the small scale businesses will be stuck in a logjam with fewer transactions. There is a liquidity crunch because even though people have the higher denomination, that is, Rs. 2000 notes, they can’t buy goods of a smaller value with it because there is no change to pay them back. It was reported that fish markets in Kolkata were still accepting old currency because no payment would entail a complete loss as their goods were perishable. There were also some daily wage earners that hadn’t received their wages but were still supportive of this step taken by the Prime Minister. There have been a couple of cases of people dying while waiting for their notes to be replaced. Providing notes for replacement will be even tougher for remote areas. One important group to keep in mind during this time would be the woman of the family who in many families is seen to save up money away from the eyes of her other family members, maybe even abusive ones. All her savings become worthless now.
According to an article published in The Wire, Rs. 500 notes accounted for 45% of the currency in circulation and Rs. 1000 notes for 39% of it in 2014-2015. The cost of replacing these notes comes up to Rs. 11,9000 crores. But now that people will be forced to use legitimate means of transaction, the deficit of the government could be met slowly.
This step was much needed to rejuvenate and revitalize our economy. The fact that all of this was done with the utmost of secrecy is a commendable fact. This is a welcome harsh step after the Income Declaration Scheme. Already we are seeing the effects of such a step what with sacks full of half burnt notes being found right outside Bareilly. There still remain a few questions though - What is going to be done about the black money that is held in other forms? And since our economy is going to take some more time to become completely cashless, how is the problem of black money going to be stopped from recurring in the future? Even Kaushik Basu, Chief Economist of the World Bank, said that the demonetization move was not ‘good economics’; that its ‘collateral damage is likely to far outstrip the benefits’. Many who hoard money and hide it from the government might be likely to continue doing so to save themselves from the hassles that would come from incriminating themselves. The overall effect of this would be a contraction in the money supply in the economy.
The cunning are already finding ways to circumvent this inconvenience. On the day of the announcement of the news there was a rush to buy gold etc and convert money to commodities, driving up commodity prices. Since the exchange of notes is to go on till December without many questions asked, it might give rise to links between parties with unexplained cash in hand and those who are willing to get it exchanged for a small commission. Instances of dealers accepting Rs. 500 and Rs. 1000 in return for Rs. 300 or Rs. 700 have cropped up. This is something the economist Prabhat Patnaik warned about while arguing that the government showed its lack of understanding of capitalism by taking such a step. He pointed out that undeclared businesses are also a source of black money and that they could use it to expand their operations rather than just holding it in cash form. Even they would be left out of the net by and large. Other economists like Vivek Dehejia see no long term adverse macroeconomic effects from this step. There have also been speculations regarding the timing of such a move – right before the elections, especially the UP election, as many parties will not be able to resort to unlawful means. It was a sure shot way of squashing the opposition while earning laurels for the ruling government. Some are considering this to be just a political gimmick because some years back when the RBI had recalled all notes issued before 2005 for the same purpose, this very party had opposed the move. Such demonetization efforts have been planned before but this time it seems quite promising. Yes, the implementation could have been much better but let’s wait and see what the impact of this would be.
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