You are on page 1of 34

Prelims 2017

in 100
Everything for Prelims
Days

Day 38

NOTE: To get All India Ranking (AIR)


of Free Test, Login at:

www.iasscore.in
Economy www.iasscore.in

MONEY
Money is anything that is generally acceptable as a means of exchange and which at the same time acts
as a measure and store of value. Anything - implies a thing to be used as money which need not be
necessarily composed of any precious metal. The only necessary condition is that, it should be universally
accepted by people as a medium of exchange which is guaranteed by the Government of the country.
FUNCTION OF MONEY
Money performs five important functions
1. Medium of exchange

E
For transaction in any economy, money is used in the form or currency or checks as a medium of
exchange. The use of money as a medium of exchange promotes economic efficiency by minimizing the

2.

Measure of value/Unit of Account OR
time spent in exchanging goods and services (barter system).

Money is used to measure units in economy. We measure the value of goods and services in terms of
money, just as we measure weight in terms of kilos or distance in terms of meters.
SC
3. Store of value
Money functions as a repository of purchasing power over time. This function of money is useful, because
most of us do not want to spend our income immediately upon receiving it, but rather prefer to wait until
we have the time or the desire to shop.
4. Standard or Deferred Payment
GS

Money facilitates not only the current transactions of goods and services but also their credit transactions.
It facilitates credit transactions when present goods are exchanged against future payments. In the modem
world, the bulk of deferred payments are stipulated in money terms only.
5. Transfer of value
It involves the transferring of value of any asset to another or to any institution or to any place by
transferring money. This transfer can take place irrespective of places, time and circumstances. Transfer
of purchasing power, which is necessary in commerce and other transaction, has become available because
of money.
CLASSIFICATION OF MONEY
Actual Money - Money which actually circulates in the economy in terms of which all payments are made and
general purchasing power is held as a medium of exchange. In Pakistan, notes and coins of all denominations
are actual money.
Money of Account - In terms of which prices are expressed and accounts are maintained. Normally, actual
money and money of account are the same but sometimes they are different. For example: Paisa is a money
of account in Pakistan but it is not actual money. Now a day, it is no more in circulation.
Notes

1
www.iasscore.in

Metallic Money - Its made of metal such as gold and silver. Coins of all denomination circulating in economy
are examples of metallic money. Metallic money is classified into two categories:
Full bodied money: If the face value of money is equal to its value as a commodity, it is called full bodied
money. If a gold coin of face value Rs. 100/- contains gold worth of Rs. 100/- it will be called full bodied
money or sometimes standard money
Token Money: If the face value of money is more than its value as commodity or intrinsic value it is
known as token money.
Paper Money - Money made of paper is called paper money. It includes different denomination. Paper money
is further classified into following forms.
Representative Paper Money: If paper is issued by keeping hundred percent gold reserve of full bodied
coins or gold bullion, it will be called representative money.
Convertible Paper Money: If paper money can be converted into gold coins or gold bullion on demand
it is referred to as convertible money. This type of money is issued by keeping metallic reserve of equal
amount behind it.

E
Fiat or In-convertible Paper Money: which cannot be converted into full bodied coins or gold bullion on
OR
demand. It is usually issued without keeping metallic reserve behind it.
Legal Tender Money - Money which has a legal approval behind it and people are bound by law to accept it
in all payments. Nobody can refuse to accept it. Legal Tender Money can be classified into:
Limited Legal Tender: which can be given in payments only upto a certain limit. The payee can refuse
to accept it beyond that limit. In many Asians countries 25 paisa coin and coins of low denominations
SC

are limited legal tender. These coins can be given as payments up to 50 rupees only.
Unlimited Legal Tender: Unlimited legal tender means thatmoneywhich can be given in payments up
to any limit.
Optional Money - That form of money which is used as a medium of exchange but it has no legal force behind
it. It includes credit instruments like cheques, bills or exchange and CDRs etc. which are generally acceptable
GS

in payments.
Hot Money- Money that moves regularly and quickly between financial markets so that investors could ensure
they are getting the highest short-term interest rates available. Hot money continuously shifts from countries
with low interest rates to those with higher interest rates affecting the exchange rate (if there is a high sum)
and also has the potentiality to impact a countrys balance of payments.
Commodity Money - Its value is derived from the commodity out of which it is made. The commodity itself
represents money, and the money is the commodity. For instance, commodities that have been used as a
medium of exchange include gold, silver, copper, salt, peppercorns, rice, large stones etc.
Commercial Bank Money - These are the demand deposits which are claims against financial institutions which
can be used for purchasing goods and services.
POSITION OF INDIAN RUPEE
The Indian Rupee is a mixture of the standard money and the token money. Like standard money, it is
unlimited legal tender, and like the token money, its face value is greater than is intrinsic value. The Indian
rupee is said to be a note printed on silver (now Nickel).
Notes

2
www.iasscore.in

MONEY SUPPLY IN INDIA


It refers to total supply of money in circulation in a given countrys economy at a given time. Money
supply is considered as an important instrument for controlling inflation by some of the economists.
Economists analyze the money supply and develop policies revolving around it through controlling interest
rates and increasing or decreasing the amount of money flowing in the economy.
Money supply data is collected, recorded and published periodically by the RBI. These are also known
as Reserve Money.
RESERVE MONEY
M0
(M0) = Currency in circulation + Bankers deposits with the RBI + Other deposits with the RBI = Net
RBI Credit to the Government + RBI credit to the commercial sector + RBIs claims on banks + RBIs
net is foreign assets + Governments currency liabilities to the public RBIs net non-monetary liabilities.

E
In other words, it is the most liquid measure of the money supply. It only includes cash or assets that could
quickly be converted into currency. This measure is known as narrow money because it is the smallest

M1

measure of the money supply.
OR
M1 (also called as the Narrow Money) = Currency with public (coins, currency notes etc.) + demand
deposits of the public.
SC

In other words, Narrow money is a category of money supply that includes all physical money like coins
and currency along withdemand depositsand otherliquid assetsheld by the central bank.
M2
M2 = M1 +Post office saving deposits.
GS

M3
M3 (also called as the Broad Money or Money aggregates) = M1 + Time deposits of public with the
banks.
M4
M4 = M3 + Total Post office deposits (includes fixed deposits with the post offices)
MONEY MULTIPLIER
Monetary multiplier represents the maximum extent to which the money supply is affected by any change in
the amount of deposits. It equals ratio of increase or decrease in money supply to the corresponding increase
and decrease in deposits.

1
Money Multiplier
Required Reserve Ratio

Required Reserve Ratio is the fraction of deposits which a bank is required to hold in hand. It can lend
out an amount equals to excess reserves which equals 1 required reserves.
Notes

3
www.iasscore.in

Higher the required reserve ratio, lesser the excess reserves, lesser the banks can lend as loans, and lower
the money multiplier.
Lower the required reserve ratio, higher the excess reserves, more the banks can lend, and higher is the
money multiplier.
In the above relationship it is assumed that there is no currency drainage, i.e. the borrowers keep 100%
of the amount received in banks.
LIQUIDITY
It describes the degree to which an asset or security can be quickly bought or sold in the market without
affecting the assets price.
Liquidity might be our emergency savings account or the cash lying with us that we can access in case
of any unforeseen happening or any financial setback. Liquidity also plays an important role as it allows
us to seize opportunities.
Market Liquidity refers to the extent to which a market, such as a countrys stock market or a citys real
estate market, allows assets to be bought and sold at stable prices. Cash is the most liquid asset, while

E
real estate, fine art and collections are all relatively illiquid.
The importance of Liquidity
OR
An investor may need both liquid and illiquid assets. We need liquid assets to deal with any unexpected
short-term crisis. But illiquid assets may offer greater chance for capital gains and higher yield.
Liquidity ratio
A liquidity ratio refers to the amount of liquid assets to overall assets. If a firm is highly liquid it has
SC

a high proportion of assets that can easily be converted to cash to pay off any obligations.
Cash reserve ratio
A bank may be required to keep a certain percentage of its assets in the form of liquid assets. It is the
fraction of customer deposits held in cash reserves.
GS

Cash reserves are not profitable. If a bank lends deposits to other customers, it can charge interest and
make more profit. But bank loans are highly illiquid because the bank cannot immediately ask for the loan
back.
FLOW OF MONEY
Atechnical indicatorcalculated by multiplying achangeinshare priceby thenumberofsharestraded. Money
flow ispositivewhen astockrisesandnegativewhen itdeclines. Theindicatoris used to investigate
themomentumbehindapricetrend.
The importance of Money Flow:
Money Flow is an important indicator of volume, a way to represent the inflow and outflow of investors
money for security.
Positive money flow means that investor interest is increasing, raising the demand for a security and,
ostensibly, its price. Negative money flow shows the opposite: Investors are either capturing gains or losing
faith in the value of the security or index, likely leading to declining prices.
A common strategy stock traders implement with the money flow indicator is to enter or exit trades
according to the overbought or oversold readings provided by the indicator.
Notes

4
www.iasscore.in

DIGITIZATION OF MONEY
The advent of the web and digitization has changed the way we work, shop, bunk, travel, educate, govern,
manage our health and enjoy life by automatizing it.
The technologies of digitization enable the conversion of traditional forms of information storage such as
paper and photographs into the binary code (ones and zeros) of computer storage.
A sub-set is the process of converting analog signals into digital signals. But much larger than the translation
of any type of media into bits and bytes is the digital transformation of economic transactions and human
interactions.
With the passing of time the need has been felt in the banking sector and various other transactions due
to increase in the volume and amount of banking transaction and rapidly increasing customers.
To increase the cost of the product and generate more revenue it was realized that digitization and
automation is need of the time especially for Banking Sector.

E
Now, some of the banks are moving towards automated cash receipt/payment through recyclers, account
opening through online with Aadhar validation, cheque sorting and processing for clearing and so many.
PLASTIC MONEY
OR
Plastic moneyis a term that is used predominantly in reference to the hardplastic cards we use every day in
place of actual bank notes. They can come in many different forms such as cash cards, credit cards, debit cards,
pre-paid cash cards and store cards.
SC
5 different kinds of plastic money
A. Credit card
1. Cashless payment with a set spending limit
2. Payment takes place after the purchase
GS

3. Great flexibility because of installment facility


4. Most well-known credit cards: American Express, MasterCard, Visa
B. Charge cards
1. Cashless payment without a set spending limit
2. Payment takes place after the purchase
3. No credit or installment facility
4. Most well-known charge cards: American Express, Diners Club
C. Debit card
1. Card is directly linked to the cardholders bank account
2. Transaction is debited immediately from bank account
3. No credit or installment facility
4. Most well-known debit cards: Maestro, Postcard
Notes

5
www.iasscore.in

D. Customer card/store card (PLCC)


1. Card with payment and credit function
2. Can only be used at specific retailers
3. Well-known customer cards: myOne, Globus, Media Markt etc.
E. Prepaid card/gift card
1. Card is topped up with credit before use
2. No credit or installment facility
3. Open system (American Express, Visa, MasterCard) or closed system (can only be used at specific
retailers)
The recent demonetization by the Government of India targeted towards killing three birds with one stone
black money, political opponents and subtly hard cash transaction.
LESS CASH ECONOMY: VISION 2018

E
Reserve Bank of India (RBI) on June 2016, unveiled Payment and Settlement System in India: Vision
2018 aimed at building best of class payment and settlement system for a Less Cash India.
OR
Vision 2018 revolves around 5Cs: Coverage, Convenience, Confidence, Convergence and Cost.
To achieve these, Vision 2018 will focus on four strategic initiatives such as responsive regulation, robust
infrastructure, effective supervision and customer centricity.
SC

The regulatory framework, based on consultative approach, aims at achieving enhanced coverage of the
payment systems coupled with convenience for end-users.
A key objective would be to ensure a robust payments infrastructure in the country to increase accessibility,
availability, interoperability and security.
The oversight and supervisory framework would focus on strengthening the resilience of both large value
and retail payment systems in the country.
GS

With increasing use of technology-based innovative payment products, the strategic initiatives under
Vision-2018 are expected to reduce paper-based instruments significantly and lead to accelerated growth
in mobile banking and other modes of electronic payments.
To promote mobile phones as access channel to payment and banking services, the guidelines will be
reviewed to address issues related to customer registration for mobile banking, safety and security of
transactions, risk mitigation and customer grievance redressal measures.
The White Label ATM Guidelines will accordingly be examined holistically and targets realigned to meet
present conditions as the same has not resulted in the much needed growth in ATM infrastructure in the
desired geographical segments of the country i.e. Rural and Semi-Urban areas.
Cashless Economy: From Barter System to Cash System and then Less Cash Economy
A cashless economy is one in which all the transaction are done using cards or digital means. The
circulation of physical currency is minimal.
Money in liquid form (in hand cash) guaranteed by the Central Bank and backed by the Government of
India is a promise made to citizen to complete the transactions by using various denominations.
Notes

6
www.iasscore.in

By drawing out liquidity from the market RBI promotes the use of plastic money in the form of cash
cards, credit cards, debit cards, pre-paid cash cards and store cards etc.
India uses too much cash for transactions. The ratio of cash to gross domestic product is one of the
highest in the world 12.42% in 2014 compared with 9.47% in China or 4% in Brazil.
Less than 5% of all payments happen electronically in India which is very less.
Steps taken by RBI and Government to discourage use of cash:
Promotion of Mobile Wallet which will allow users to send/receive money, pay bills, recharge mobiles,
book movie tickets, send physical and e-gifts both online and offline.
No new license will be given to payment banks.
India is liberalizing the FDI norms in order to promote E-commerce.
Government has also launched Unified Payment Interface (UPI) in order to make electronic transfer much
faster and simpler.

E
OR
SC
GS
Notes

7
Economy www.iasscore.in

INFLATION
Inflation refers to gradual rise in the general price level in the economy and a fall in purchasing power of money
over a period of time. In simple words, inflation is nothing but a rise in average price level of all the goods
and services in an economy. Inflation occurs when too much money chases a few goods, that is, even though
money supply increases the supply of goods and services does not increase commensurately.
Types of Inflation

E
OR
SC

On the basis of rate of Inflation, it is categorized into four types


Creeping Inflation: When the rise in prices is very slow (less than 3% Per annum) like that of snail or
creeper. Such inflation is safe and necessary for economic growth.
Walking or Trotting Inflation: When prices rise moderately and the annual inflation rate is of a single
digit (3 10%). Such inflation is a warning signal for the government to control it before it turns into
GS

running inflation.
Running Inflation: When prices rise rapidly like the running of a horse at a rate of speed of 10 20%
per annum. Such inflation requires strong monetary and fiscal measures to control otherwise will lead to
Hyper-inflation.
Galloping or Hyper-Inflation: When price rise is in between 20 100% per annum or even more. Such
inflation brings total collapse of the monetary system because of the continuous fall in the purchasing
power of money.
On the basis of Cause-Based Inflation it is of Five Types
Demand Pull Inflation: When aggregate demand is rising while the available supply of goods is less. This
kind of inflation can be described by too much money chasing a few goods. One of the reasons for
demand pull inflation can be the increase in money supply.
Cost Push Inflation: Also referred to as supply shock inflation occurs due to reduced supplies due to
increased prices of inputs. For example, an increase in price of international crude oil adversely affects
the inputs of almost all the items in a country like India, which neither has alternatives to oil for energy
needs nor has significant amount of domestic oil production.
Notes

8
www.iasscore.in

Comprehensive and Sporadic Inflation: When the prices of all the commodities rises its known as
Comprehensive Inflation. It is also referred as Bottleneck Inflation. On the other hand, Sporadic Inflation
is a sectoral inflation in which the prices of a few commodities rise because of certain physical bottlenecks
which may impede any attempt to increase their production.
Open and Suppressed Inflation: It is said to be open when the Government takes no steps to control the
rise in the price level. It is caused due to uninterrupted operation of the market mechanism. On the other
hand, Suppressed Inflation when the Government actively intervenes to check the rise in the price level.
Mark-up Inflation: It causes due to the peculiar method of pricing adopted by the big business organisations.
When the big business organizations calculate their production costs first and then add to these costs a
certain mark-up to yield the targeted rate of profit.
What causes Inflation?
Inflation can arise from internal as well as external events
Some inflationary pressures direct from the domestic economy, for example the decisions of utility

E
businesses providing electricity or gas or water on their tariffs for the year ahead, or the pricing strategies
of the food retailers based on the strength of demand and competitive pressure in their markets. A rise

OR
in the rate of VAT would also be a cause of increased domestic inflation in the short term because it
increases a firms production costs.
Inflation can also come from external sources, for example a sustained rise in the price of crude oil or
other imported commodities, foodstuffs and beverages. Fluctuations in the exchange rate can also affect
inflation for example a fall in the value of the Rupees against other currencies might cause higher import
SC
prices for items such as foodstuffs from Western Europe or technology supplies from the United States
which feeds through directly or indirectly into the consumer price index.
Due to Demand Pull Factors Inflation can occur such as
Increase in Government Expenditure: this increase results in increased demand for goods and services and
consequent increase in prices. This is because increased government expenditure results in putting large
money in the hands of public, thereby putting to affect too much money chasing too few goods.
GS

Rising Population: It acts as an important factor in pushing up prices because of increased demand
especially when the supply is unable to meet the demand.
Black Money: A large part of the black money is used in buying and selling of real estate in urban areas,
extensive hoarding and black marketing in essential wage goods, such as cereals, pulses, etc. Black money,
therefore, fuels demands and leads to rise in prices.
Changing Consumption Patterns: Increase income bring more demands for food items that people eat
more frequently. For example: Increased consumption of protein rich foods such as pulses, eggs, fish and
poultry were apparently driving up their prices in the economy.
Due to Cost Push Factors Inflation can occur such as
Rise in wages: At times rise in wages, if greater than rise in productivity, increases the costs therefore
increasing the prices too.
Tax increase: Increase in indirect taxes also leads to cost side inflation. Taxes such as custom and excise
duty raise the cost of production as these taxes are levied on commodities.
Increase in administered prices: such as the MSP (Minimum Support Price) for the food grains, petroleum
products etc. also leads to inflation as they have a huge share in budget of common citizens.
Notes

9
www.iasscore.in

Infrastructural bottlenecks: Infrastructural bottlenecks such as the lack of proper roads, electricity, water
etc. raises per unit cost of production. This is one of the prime reasons for inflation in the context of
Indian economy.
Fluctuation due to seasonal and cyclical reasons: Owing to events such as failed monsoons there is a
drop in agricultural productivity, which inevitably results in inflation at times.
Measuring Inflation
There are several ways to measure inflation among which India uses Wholesale Price Index and Consumer
Price Index.
Based on the Population Coverage the inflation indices are developed to understand the levels of inflation
for certain sets of population such as Consumer Price Index (CPI), Producer Price Index (PPI), and
Wholesale Price Index (WPI) etc.
On the basis of items, the inflation indices are developed to understand the levels of inflation for certain
sets/basket of items.
One feature common to all the price indices is the use of Base Year which is a particular year used as

E
a reference to calculate the price rise in a particular year. For Example: 2012 is the base year for CPI and
2004-05 for WPI.
OR
In India, Consumer Price Index (CPI) and Wholesale Price Index (WPI) are two major indices for
measuring inflation in comparison to USA where CPI and PPI (Producer Price Index) are used to measure
inflation.
The Wholesale Price Index (WPI) was main index for measurement of inflation in India till April 2014
when RBI adopted new Consumer Price Index (CPI) (combined) as the key measure of inflation.
SC

A. Wholesale Price Index: (Headline Inflation)


Calculated and released on weekly basis for primary article and Fuel Group, by the Office of the Economic
Adviser in Ministry of Commerce and Industry, Government of India. However, this has been discontinued
since 2012 and now it is released on monthly basis.
GS

The new WPI index is based on the recommendation of a working group set up under the guidance of
Abhijit Sen.
WPI is an important statistical indicator, as various policy decisions of the Government like inflation
management, monitoring of prices of essential commodities etc. are based on it.
Due to two base year for WPI (2004-05) and CPI (2012), the difference in rate occurs for WPI and CPI.
There are total 676 items in WPI and inflation is computed taking 5482 Price Quotations. These items
are divided into three broad categories:
Primary Articles
Fuel and Power
Manufactured Products
One of the major limitations of WPI is that it does not include services such as the health, IT, Education,
transport etc. Also it does not account for the products of the unorganized sector in India, which constitutes
about 35% of the manufactured output of the Indian economy.
We note here that WPIdoes not take into consideration the retail prices or prices of the services.
Notes

10
www.iasscore.in

Points to remember
The decreasing order of three groups of items in terms of weightage is:
Manufactured Products >Primary Articles >Fuel and Power
Among manufactured products, thehighest weightage is of chemicals and chemical products.
B. Consumer Price Index
India also measures inflation at the consumer level by the means of CPI. It is the measure of change in
retail prices of goods and services consumed by defined population group in a given area with reference
to a base year.
Due to wide disparities in consumption basket for different segment of consumers, India has not been able
to evolve a single and comprehensive consumer price index. The four CPIs adopted by India are:
1. Consumer Price Index for Industrial Workers (CPI-IW)

E
Compiled by Labour Bureau, an attached office under Ministry of Labour & Employment. It measures
a change over time in prices of a fixed basket of goods and services consumed by Industrial Workers.


OR
The target group is an average working class family belonging to any of the seven sectors of the economy-
factories, mines, plantation, motor transport, port, railways and electricity generation and distribution.
CPI (IW) is currently calculated at base 2001=100 for 78 centers and prices are collected from 289
markets across these 78 centers.
SC
It contains 120160 commodities in its basket. Basically, this index specifies the government employees
(other than banks and embassies personnel).
The index has a time lag of one month and is released on the last working day of the month. It is used
for wage indexation and fixation of dearness allowance for government employees which is announced
twice a year.
GS

When the Pay Commissions recommend pay revisions, the base is the CPI (IW).
2. Consumer Price Index for Urban Non Manual Employees: (CPI-UNME):
Having 1984-85 as the base year and 146-365 commodities in the basket for which data is collected
monthly with two weeks' time lag.
This price index has limited use which is basically used for determining dearness allowances (DAs) of
employees and some foreign companies operating in India (i.e. Airlines, Communications, Banking, Insurance,
embassies', and other financial services).
3. Consumer Price Index for Agricultural Labours): (CPI AL)
Having 1986-87 as its base year with 260 commodities in its basket. The Data is collected in 600 villages
with a monthly frequency and has three weeks time lag.
The Index is used for revising minimum wages for agricultural labourers in different states.
4. Consumer Price Index for Rural Labourers/workers: (CPI RL):
Having 1983 as the base year with 260 commodities in its basket for which data is collected from 600
villages on monthly frequency with three weeks time lag.
Notes

11
www.iasscore.in

In 2011, the CSO brought a revised CPI, having CPI (Urban), CPI (Rural) and CPI (Urban + Rural) with
2010 as the base price. The combined one would take into account the data from both the indices taking
appropriate weights.
CPI has much larger weightage in comparison to WPI in primary articles which is 57%.
Points to remember
The Reserve Bank of India (RBI) has started using CPI-combined as the sole inflation measure for the
purpose of monetary policy. As per the agreement on Monetary Policy Framework between the
Government and the RBI dated February 20, 2015 the sole of objective of RBI is price stability and
a target is set for inflation as measured by the Consumer Price Index-Combined.
While the CPI (IW) and CPI (AL/RL) are compiled and released by the Labour Bureau, the CPI
(Rural/Urban/Combined) is by Central Statistics Office (CSO)
C. Producer Price Indexes (PPI):
These are indices that measure the average change over time in selling prices by producers of goods and
services. They measure price change from the point of view of the seller.

E
Majority of OECD countries measure inflation based on Producer Price Index (PPI) while only some uses
WPI. Countries like Japan, Greece, Norway and Turkey use WPI.
OR
D. Services Price Index (SPI):
The contribution of the tertiary sector in India's GDP has been strengthening for the past 6 to 7 years and
today it stands approximately at 54 per cent. The need for a service price index (SPI) in India is warranted
by the growing dominance of the sector in the economy. There is no index, so far, to measure the price
SC

changes in the service sector.


The present inflation (at the WPI) only shows the price movements of the commodity-producing sector
i.e. it includes only the primary and the secondary sectors-the tertiary sector is not represented by it.
At present, efforts are being made to develop service price indices for selected services initially on an
experimental basis (covering road transport, railways, airways, business, trade, port, postal telecommunications,
GS

banking and insurance services only).


CORE INFLATION
The concept is used to estimate the inflation by excluding food and energy prices form the basket of goods
and services that represents a typical households' consumption. Such a measure does not include the
volatile items, which may distort the true picture of inflation in the economy.
In mid 2012, RBI Governor threw up the conundrum posed by this "Core" inflation by saying "In our
economy, where food constitutes nearly 50% of consumption basket and fuel has a weight of 15%, can
a measure of inflation that excludes them can be called "Core".
EFFECTS OF INFLATION
As we know Inflation is the increase in the price of general goods and service. Thus, food, commodities
and other services become expensive for consumption. Inflation can cause both short-term and long-term
damages to the economy; most importantly it causes slow down in the economy.
People start consuming or buying less of these goods and services as their income is limited. This leads
to slowdown not only in consumption but also production. This is because manufactures will produce
fewer goods due to high costs and anticipated lower demand.
Notes

12
www.iasscore.in

Banks will increase interest rates as inflation increases otherwise real interest rate will be negative. (Real
interest = Nominal interest rate - inflation). This makes borrowing costly for both consumers and corporate.
Thus people will buy fewer automobiles, houses and other goods. Industries will not borrow money from
banks to invest in capacity expansion because borrowing rates are high.
Higher interest rates lead to slowdown in the economy. This leads to increase in unemployment because
companies start focusing on cost cutting and reduces hiring. Remember Jet Airways lay off over 1000
employees to save cost.
Rising inflation can prompt trade unions to demand higher wages, to keep up with consumer prices. Rising
wages in turn can help fuel inflation.
Inflation affects the productivity of companies. They add inefficiencies in the market, and make it difficult
for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are
forced to shift resources away from products and services in order to focus on profit and losses from
currency inflation.

E
DEMONETIZATION AND IMPACT ON INFLATION

OR
SC
GS

The Demonetization has impacted the inflation negatively. Consumer spending activity fell to a near halt.
Consumers are refraining from making any purchases except essential items from the consumer staples,
healthcare, and energy segments.
The real estate sector, which includes a lot of cash and undocumented transactions, slowed down significantly
as well as Metropolitan and Tier 1 cities reported a fall in house prices up to a 30%.
Notes

13
www.iasscore.in

Food item inflation, measured by changes in the Consumer Food Price Index, accounts for 47.3% of the
overall CPI. Due to 86.4% of the value of the currency notes in circulation going out of the financial
system and re-monetization being slow, the supply and demand of food items fell. It will exert more
downward pressure on inflation.
OTHER RELEVANT TERMS RELATED TO INFLATION
Deflation:
It is a contraction in the supply of circulated money within an economy, and therefore the opposite of
inflation.
A reduction in money supply or credit availability is the reason for deflation in most cases. Reduced
investment spending by government or individuals may also lead to this situation. Deflation leads to a
problem of increased unemployment due to slack in demand.
Deflation is different from disinflation as the latter implies decrease in the level of inflation whereas on
the other hand deflation implies negative inflation.

E
Recession:
It is a situation which is characterized by negative growth rate of GDP into successive quarters. Some of
OR
the indicators of a recession include slowdown in the economy, fall in investments, fall in the output of
the economy etc.
Depression:
It is an extreme form of recession and characterizes a situation in which the recession may have gone on
SC

for too long resulting in depression of the economy.


A common rule of thumb for recession is two quarters of negative GDP growth. The corresponding rule
of thumb for a depression is a 10 percent decline in gross domestic product (GDP).
Inflation Spiral:
GS

An inflationary situation in an economy, which results out of a process of wage and price interaction
'when wages press prices up and prices pull wages up', is known as the inflationary spiral. It is also known
as the wage-price spiral.
This wage-price interaction was seen as a plausible cause of inflation in the year 1935 in the US economy,
for the first time.
Re-flation:
It is a situation often deliberately brought by the government to reduce unemployment and increase
demand by going for higher levels of economic growth.
Governments go for higher public expenditures, tax cuts, interest rate cuts, etc. Fiscal deficit rises, extra
money is generally printed at higher level of growth, wages increase and there is almost no improvement
in unemployment.
Re-flation can also be understood from a different angle-when the economy is crossing a cycle of recession
(low inflation, high unemployment, low demand, etc.) and government takes some economic policy
decisions to revive the economy from recession, certain goods see sudden and temporary increase in their
prices, such price rise is also known as re-flation.
Notes

14
www.iasscore.in

Stagflation:
It is a condition of slow economic growth and relatively high unemployment (economic stagnation)
accompanied by rising prices, or inflation and decline in GDP. It's an economic problem defined in equal
parts by its rarity and by the lack of consensus among academics on how exactly it comes to pass.
Usually, when unemployment is high, spending declines, as do prices of goods. Stagflation occur when the
prices of goods rise while unemployment increases and spending declines.
Stagflation can prove to be a particularly tough problem for governments to deal with due to the fact that
most policies designed to lower inflation tend to make it tougher for the unemployed, and policies
designed to ease unemployment raise inflation.
Skewflation:
It brings sustained price rise in some particular commodities only while at the same time other commodities
can show deflation (lowering price).

E
For Example: In the beginning of year 2010-11 India had inflation in certain food commodities such as
food grains, pulses, and sugar. Later in the year prices of these commodities stabilized but there was price
spike in commodities such as onions, milk etc. that is a condition of skewflation prevailed at that time.
Base Effect:

OR
It refers to the tendency of a small change from a low initial amount to the current amount which is
translated into a large percentage and appears as large.
SC
In other words, Inflation is calculated from a base year in which a price index is assigned the number 100.
For example, if the price index in 2010 was 100 and the price index in 2011 rose to 110, the inflation
rate would be 10%. If the price index rose to 115 in 2012, what would be the best way to assess inflation?
On the one hand, prices have only risen 5% over the previous year, but they've risen 15% since 2010. The
high inflation rate in 2011 makes the inflation rate in 2012 look relatively small and doesn't really provide
an accurate picture of the level of price increases consumers are experiencing. This distortion is the base
GS

effect.
Notes

15
Economic Survey (2016-17)
www.iasscore.in

DEMONETISATION: TO DEIFY OR
3
DEMONIZE?

Context
The unprecedented policy decision by the Government to Demonetize the
economy of the higher denomination currencies (i.e. Rs. 500 and Rs. 1000),
comprises of three broad aspects i.e.
o A money supply contraction (of only Cash)
o A tax on unaccounted private wealth(i.e. Black money)

E
o A tax on saving outside formal financial system.

OR
With the objective of cracking down on Black money, counterfeit (fake currency),
terror activity (fed by the first two) and progressive transition towards a cashless
inclusive digital economy, the bold step of Demonetization has received a
mixed bag of outcomes, though the full range of impacts can only be understood
over one financial year (at least).Hence, the Government's approach is (and
should be) to take further policy actions to minimize short term costs and
SC

maximize long term benefits.

Technical Terms
A. SIT (Special Investigation Team): A team of professional investigators appointed by the Supreme
court to look into the issue of black money (source, destination, ways to bring back money stashed
GS

abroad and ways to stop generation of same)


B. Money: It is the commonly accepted medium of exchange .It also acts as convenient unit of account
(of all goods and services) and a store of value for individuals (i.e wealth can be stored in terms of
money for future use).
C. Fiat Money: Currency notes and coins are called fiat money, which do not have intrinsic value (like
gold or silver).These are also called legal tenders as they can not be refused by any citizen of the
country for settlement of any kind of transaction.
D. Money Supply/Liquidity: The notes, coins, Demand Deposits(saving/current) are considered as money.
E. Black Money: Funds earned on the black market on which income and other taxes have not been
paid or which is the proceeds of criminal activity such as bribery and corruption.
F. Soil rate: Rate at which notes are considered to be too damaged to use and are returned to the
Central Bank. Generally the higher denomination notes have a lower soil rate than the low denomination
notes.
G. Global Financial Crisis: It refers to a global scale financial crisis, which originated from the sub-
prime mortgage market in USA (i.e. banks providing loans on mortgages, which has less commensurate
value) and developed into a full grown banking crisis(fall of Lehman Brothers). The crisis was
Notes

Economic Survey (2016-17) 15


www.iasscore.in

followed by global economic downturn and great recession, from which the world has still not
recovered fully.
H. Indirect tax revenue: A tax which is collected from the ultimate consumer of a particular Good/
Service. The tax burden lies on the final consumer and not the intermediary who transacts (e.g. sales
tax, value added tax, excise duty).It is considered as a regressive tax , as it is charged at the same
rate from both poor and rich(no equity).
I. Real Credit Growth: Increase in Amount of credit disbursed by the banks. Credit typically grows
faster than GDP as the economy develops (more matured).
J. Nominal GDP: It refers to the Gross domestic product evaluated at current market price, whereas
the real GDP evaluates GDP at prices of Base year (i.e a standard year)
K. GDP Deflator: It is a measure of the level of prices of all new, domestically produced, final goods
and services in an economy. It is calculated by dividing Nominal GDP/Real GDP
L. Quantity theory of Money:

E
MV = PY, where [M refers to the money supply ,V is velocity, the rate at which money turns over,
P is the price level ,Y is real GDP ]
OR
If the money supply is reduced, either the remaining stock of money will need to be used more
intensively, or else nominal GDP will fall.
M. Informal Economy: The informal sector, informal economy, or grey economy is the part of an
economy that is neither taxed, nor monitored by any form of government. Unlike the formal
economy, activities of the informal economy are not included in the gross national product (GNP)
SC

and gross domestic product (GDP) of a country. e.g street vendors in Indi
N. Internal Convertibility: The ability of an economy to be able to convert cash into bank deposits and
vice versa. The greater the convertibility , more is the confidence in formal banking system.
O. Negative interest rates policy: negative interest rate policy means financial institutions like banks
will be penalised for keeping money. This will encourage them to lend it for economic activity.
GS

P. Helicopter drop/helicopter money: The idea of a helicopter money drop has been mooted by
Milton Friedman and Ben Bernanke, among others.It means giving everyone direct money transfers.
In theory, people would see this as a permanent one-off expansion of the amount of money in
circulation and would then start to spend more freely, increasing broader economic activity and
pushinginflation back up to the central banks target.

Gist of Economic Survey Chapter


On 8th November demonetization was announced with the aim of the action was fourfold: to curb
corruption; counterfeiting; the use of high denomination notes for terrorist activities; and especially the
accumulation of black money, generated by income that has not been declared to the tax authorities.
It followed a series of earlier efforts to curb such illicit activities, including:
The creation of the Special Investigative Team (SIT) in the 2014 budget;
The Black Money and Imposition of Tax Act 2015;
Benami Transactions Act 2016;
Notes

16 Economic Survey (2016-17)


www.iasscore.in

The information exchange agreement with Switzerland;


Changes in the tax treaties with Mauritius, Cyprus and Singapore; and
The Income Disclosure Scheme.
Demonetisation was aimed at signalling and emphasizing the governments determination to penalize
illicit activities and the associated wealth. Indias demonetization was unprecedented in international
economic history because:
It was highly secretive and sudden
It was carried out in normal economic and political condition exemplified by macro-economic
stability and fastest GDP growth rate. All other sudden demonetisations have occurred in the context
of hyperinflation, wars, political upheavals, or other extreme circumstances.
In India there were two previous instances of demonetisation, in 1946 and 1978, the latter not having

E
any significant effect on cash, but the recent action had large, albeit temporary, currency consequences.
Globally new monetary policy tools like negative interest rates policy and 'helicopter drops' of money have

OR
been employed to stimulate growth and increase money supply. India on the other hand instead of expanding
money supply has squeezed it and it can be called as 'reverse helicopter drop' or 'helicopter hoover'.

Demonetizations Economic Impact in the Short and Medium Run


SC
Calculating impact of demonetization will be a tedious task and require that certain important facts must
be kept in mind.Certain facts which are relevant for understanding the rational of demonetization are:
Currency to GDP ratio was increasing in India and was around 12% in 2014-15. The ratio of high
demonization notes was even higher.
Indias economy is relatively cash-dependent, even taking account of the fact that it is a relatively
poor country (cash component of economy decreases with development).
GS

It may suggest that some of the cash holding was not used for legitimate transactions, but perhaps
for other activities such as corruption.
Soil rates of high denomination notes (11% for 1000, 22% for 500 and 33% for smaller denomination
notes) are lower as compared to lower denomination notes and similar high denomination notes in
US. It indicate that all high denomination notes are not used for transactions but for storing money,
especially black money of about Rs. 3 lakh cr or 2% of GDP.
Based on this assumption demonization would have long term benefit of reducing corruption.
In this assumption few things which must be kept in mind are:
According to Transparency International data cash in circulation in India is relatively high for its level
of corruption. This means that either level of corruption is much worse or cash is being used for
legitimate purpose.
Level of high denomination notes: In Indias case, the denomination/ income ratio has fallen
sharply over the past quarter century because incomes have been growing rapidly and India stands
midway in low income group countries on this count. This also shows that higher denomination
notes have been increasingly used for transactions over time.
Notes

Economic Survey (2016-17) 17


www.iasscore.in

How to Look at Demonetization


Demonetisation should be seen as comprising the following:
A money supply contraction but only of one type of moneycash;
A tax on unaccounted private wealth maintained in the form of cash black money; and
A tax on savings outside the formal financial system.

Benefits of Demonetization
A. Tax on black money
Demonetization offered three options for black money holders:
Declare their income, deposit it and pay tax rate with penalty
Continue to hide and suffer 100% tax rate
Launder their money

E
Anecdotal evidence says that there was money laundering through various methods like:
OR
Retime the accrual of money and then depositing in account
Paying intermediaries to convert black money into white (as commission, payment for standing in
queue, depositing in others account)
SC

Despite these demonetization provided following benefits


In all these cases, black money holders still suffered a substantial loss, in taxes or conversion fees.
Laundering run the risk of punitive taxes and prosecution, in addition to the fees or taxes already
paid because of continuous surveillance and data mining by government on spooky deposits.
The December 30, 2016 Ordinance has declared the unreturned notes as no longerconstituting legal
GS

tender and this will extinguish RBI liability and increase its net worth.
In this sense, demonetisation has affected a transfer of wealth from holders of illicit black money to the
public sector, which can then be redeployed in various productive ways to retire government debt,
recapitalize banks, or even redistribute back to the private sector.
B. Tax compliance
Demonetization has shown states resolve to crack down on black money
Social condemnation: Since this action has commanded support amongst the population,
demonetisation shows that black money will no longer be tolerated by the wider public.
These two effects if combined with other incentive measures can result into behavioural change among
people and greater tax compliance.
Demonetisation could also aid tax administration in another way, by shifting transactions out of the
cash economy and into the formal payments system.
As a result, the tax-GDP ratio, as well as the size of the formal economy, could be permanently
higher.
Notes

18 Economic Survey (2016-17)


www.iasscore.in

It will channel more savings into financial system. It will help banks in providing more loans at lower
rates.
In the longer-term, if demonetisation is successful, it will reduce the equilibrium cash-GDP and cash-
deposits ratio in the economy. This will increase financial savings which could have a positive impact
on long run growth.

Early Evidence of Potential Long Term Benefits


Though it will take several years to see the impact of demonetization on illicit transactions, on black
money, and on financial savings, there are some signs pointing to change.
A. Impact on Digitization
One intermediate objective of demonetisation is to create a less-cash or cash-lite economy, as this is a
key to channelling more saving through the formal financial system and improving tax compliance.
Watal Committee has recently estimated that cash accounts for about 78 percent of all consumer

E
payments.And there are many reasons for this situation. Cash has many advantages:


It is convenient, accepted everywhere, and
OR
Its use is costless for ordinary people, though not of course for society at large.
Cash transactions are also anonymous, helping to preserve privacy, which is a virtue as long as the
transactions are not illicit or designed to evade taxation.
SC

In contrast, digital transactions face significant impediments.


They require special equipment, cell phones for customers and Point-Of-Sale (POS) machines for
merchants, which will only work if there is internet connectivity.
They are also costly to users, since e-payment firms need to recoup their costs by imposing charges
on customers, merchants, or both.
GS

At the same time, these disadvantages are counterbalanced by two cardinal virtues.
Digital transactions help bring people into the modern wired era.
And they bring people into the formal economy, thereby increasing financial saving, reducing tax
evasion, and levelling the playing field between tax-compliant and tax-evading firms (and individuals).
In the wake of the demonetisation, the government has taken a number of steps to facilitate and
incentivize the move to a digital economy. These include:
Launch of the BHIM (Bharat Interface for Money) app for smart-phones based on the new Unified
Payments Interface (UPI) which has created inter-operability of digital transactions.
Launch of BHIM USSD 2.0, a product that allows the 350 million feature phone users to take
advantage of the UPI.
Launch of Aadhar Merchant Pay, aimed at the 350 million who do not have phones. This enables
anyone with just an Aadhar number and a bank account to make a merchant payment using his
biometric identification.
Reductions in fees (Merchant Discount Rate) paid on digital transactions and transactions that use
the UPI.
Notes

Economic Survey (2016-17) 19


www.iasscore.in

There have also been relaxations of limits on the use of payment wallets.
Tax benefits have also been provided for to incentivizedigital transactions.
Encouraging the adoption of POS devices beyond the current 1.5 million, through tariff reductions.
As a result of all these number of digital transactions has increased considerably. Data from the National
Payments Corporation of India (NPCI) show that RuPay-based electronic transactions increased by about
Rs. 13,000 crore in case of POS transactions and about Rs. 2,000 crore in e-commerce, an increase of
over 300-400 percent.Same has been the case with debit card, credit card and AEPS (Aadhar-Enabled
Payments System) transactions.
The success of digitalization will depend considerably on
The inter-operability of the payments system. The Unified Payments Interface (UPI) created by the
NPCI is the technology platform that will be the basis for ensuring interoperability. But to ensure this,
individual banks should facilitate not thwart inter-operability.
As digital payments increase the security features of these e-payment systems will need to inspire

B.
trust, to ensure this trend continues.
Impact on Real estate sector E
OR
Demonetization can have profound impact on real estate prices as black money was used evade taxes
on property sale and have resulted into inflated prices. According to Knight Frank and Survey
calculations real estate prices in eight major cities has started declining post demonetization.
Reduction in real estate prices is desirable as it will lead to affordable housing for the middle class,
SC

and facilitate labour mobility across India currently impeded by high and unaffordable rents.

Short Term Impacts


A. Impact on cash/money
The true extent of the cash reduction was much smaller than commonly perceived, and the true peak
of the monetary as opposed to the psychological shock occurred in December (35% shortfall),
GS

rather than November (25% shortfall).


The shortfall is now narrowing rapidly. At end-December 2016, effective currency was only about
65 percent of estimated demand, but this is likely to rise to about 86 percent of transactions demand
by end-February.
B. Impact on GDP
Demonetisation is potentially:
An aggregate demand shock, because it reduces the supply of money and affects private wealth
(especially of those holding unaccounted money and owning real estate);
An aggregate supply shock to the extent that cash is a necessary input for economic activity (for
example, if agricultural producers require cash to pay labour);
An uncertainty shock because economic agents face imponderables related to the impact and duration
of the liquidity shock as well as further policy responses.
To analyze the impact of demonetization on GDP in a macro-assessment on five broad indicators are
focused:
Notes

20 Economic Survey (2016-17)


www.iasscore.in

Agricultural (rabi) sowing;


Indirect tax revenue, as a broad gauge of production and sales;
Sales generally, as a measure of discretionary consumer spending, and two-wheelers in particular as
it is the best available indicator of rural and demand of the less affluent;
Real estate prices; and
Real credit growth
The high frequency indicators present a mixed picture.
Agricultural sowing, passenger car sales, and overall excise taxes bear little imprint of demonetisation;
And sales of twowheelers show a marked decline after demonetisation;
Credit numbers were already looking weak before demonetisation, and those pre-existing trends were
further reinforced after November 8.

E
Dual Dimension of Cash

OR
SC
GS

Effect on Economic Activity (Informal economy and formal economy)


Informal economy has been effected by cash crunch
Formal economy would have minimal direct impact but indirect impact, as workers who had been
laid-off will buy fewer products like FMCG products, two wheelers.
Conversely, some participants in the informal economy have shifted into the formal payments
systems (such as kirana shops installing POS terminals).
Also, in the cash intensive economy, the liquidity shortage has led at least transiently to a greater
recourse to informal credit (such as kirana shops allowing regular customers to pay at a later date).
It is also to be noted that recorded part of the economy will underestimate the impact of
demonetization because of most of informal economy is unrecorded or data from formal sector is
used to estimate for it.

Supply Side Effects


What are the possible supply side shocks?
It is likely, for example, that uncertainty caused consumers to postpone purchases and firms to put
off investments in the third quarter.
Notes

Economic Survey (2016-17) 21


www.iasscore.in

Similarly, there was clearly a wealth shock in the initial months, as cash assets were turned into the
banks (from where they were difficult to withdraw),
Demonetisation could also affect supplies of certain agricultural products, especially milk (where
procurement has been low), sugar (where cane availability and drought in the Southern states will
restrict production), and potatoes and onions (where sowings have been low).
But as the economy is remonetised, restrictions are lifted and conditions normalise, the uncertainty and
cash crunch should dissipate and spending might well rebound toward the end of the fiscal year.
However vigilance is needed against agriculture products price shooting up.
Based on all these factors it would be reasonable to conclude that economic activity has been affected
adversely, but temporarily, by demonetisation in between and percentage points relative to the
baseline of about 7 percent and will be around 63/4 and 71/2. Over the medium run, the implementation
of GST, follow-up to demonetization and other structural reform measures should take the trend rate of
growth of the economy to the 8-10 percent range that India needs.
All these relatively benign outcome would materialise, however, if and only if remonetisation is effected

E
expeditiously (it has been estimated that around 90 percent of transactions demand can be met before
the end of current financial year), and decisive policy actions taken to clear away the uncertainty and
OR
dispel fears of an overzealous tax administration. Only then could the effects of demonetisation prove
non-permanent in nature.

Redistribution to the Government


Demonetisation will also redistribute resources.
SC

The most important redistributive effect is that it will shift resources from the private sector to the
government. The impact on the overall economy will then depend on how the government responds.
Demonetisation will affect the fiscal accounts in the following ways.
Wealth gain: The RBI/government may receive some gains from the unreturned cash
GS

Income taxes could go up as black money was deposited in bank accounts


There are also reports of increases in tax payments at state government levels and accelerated
payments to discoms.
Against this are three negative effects:
Costs of printing new notes over and above normal replacement.
The costs of sterilizing the surge in liquidity into the banking system via issuance of Market
Stabilization Scheme bonds.
If nominal GDP growth declines, corporate and indirect tax revenues of the centre could decline but
so far there is no clear evidence.
Markers of success
Though the benefits of demonetization will become visible in long term, but there are markers which will
indicate future success. These are:
Changes in the use of digital payment methods across the three categories of digital access identified
earlier, namely, smart phone users, regular phone users and the phoneless, respectively.
Notes

22 Economic Survey (2016-17)


www.iasscore.in

The cash-GDP ratio, which should decline as more saving, is channeled through the formal financial
system and black money falls.
The most important marker of success will be taxes. The number of new income tax payers as well
as the magnitude of reported and taxable income should go up over time.
To the extent that demonetisation has also raised the costs of non-compliance with indirect taxes, we
should also expect to see an increase in registration under the service and excise taxes and under the
states VATs.These should drift up steadily in the future.
Maximizing long-term benefits, minimizing short-term costs
Moving forward, the emphasis must be on maximizing demonetizations benefits while minimizing its
costs. Certain steps which should be taken to achieve this are:
The most important effort must be to replenish the cash shortage as quickly as possible.
The government windfall arising from unreturned notes should be deployed toward capital-type

E
expenditures rather than current ones.


permanently higher expenditures. OR
Since the windfall will be one-off its use should be one-off and not lead to entitlements that create

In the medium term, the impetus provided to digitalization must continue.


The transition to digitalization must be gradual; take full account of the digitally deprived; respect
rather than dictate choice; and be inclusive rather than controlled.
SC

To increase trust in digital payments, cyber security systems must be strengthened considerably.
One key need is to ensure inter-operability of the payment system, which will be at the heart of
increasing digitalization going forward, building upon the newly created UPI.
Measures to complement demonetization with other non-punitive, incentive-compatible measures
GS

that reduce the incentives for tax evasion should be taken.


Demonetization was a powerful stick which now needs carrots as complements. A five-pronged strategy
could be adopted:
A GST with broad coverage to include activities that are sources of black money creationland and
other immovable propertyshould be implemented;
Individual income tax rates and real estate stamp duties could be reduced;
The income tax net could be widened gradually and, consistent with constitutional arrangements,
could progressively encompass all high incomes;
The timetable for reducing the corporate tax rate could be accelerated; and
Tax administration could be improved to reduce discretion and improve accountability.
There must be a shift to greater use of data, smarter evidence-based scrutiny and audit, greater
reliance on on-line assessments with correspondingly less interaction between tax payers and tax
officials, greater coordination between different tax authorities
Big Data and the digital age, and the promise they offer, should also be embraced by the tax
administration.
Notes

Economic Survey (2016-17) 23


www.iasscore.in

Conclusion
As it is unwise to predict the range of impact of Demonitaization beforehand(many macro economic data
are not available and there is a gestation period for economic policies to show impact, which are dependent
on many other complex variables), the endeavor should be to minimize the short term costs and increase
long term benefits by -faster and prompt demonetization- facilitating internal convertibility -creating
capital assets out of the extra revenue-facilitating and incentivizing digitization-reforming tax administration
to incentivize and encourage genuine tax payers, while at the same time strengthening cyber security to
generate trust among people.

Impact of Demonetisation

E
OR
SC
GS
Notes

24 Economic Survey (2016-17)


www.iasscore.in

E
OR
SC
GS

Supplementary Reading

A. Experience of demonetization around world


1) Ghana 1982 -
Measures: Demonetisation of 50 cedi notes in 1982; no exchange facility for long; freeze on
bank deposits
Rationale: Excess liquidity and inflation
Notes

Economic Survey (2016-17) 25


www.iasscore.in

Effect: Loss of confidence in the banking system


2) Brazil 1990
Measures: Collor Plan: monetary contraction by freezing all deposits above certain limit .Deposits
upto a ceiling denominated in the old currency (cruzado novo) were converted to the new
currency (cruzeiro) at parity.
Rationale: To fight hyperinflation
Effect: Contraction of output; price moderation only very gradual due to uncontrolled re-
injection of liquidity
3) Australia (1988,2015)
Measures: Introduction of next generation notes with tactile features.
Rationale: Prevent counterfeit
Impact: The first country to have a full series of circulating polymer bank notes
4) Singapore(1999,2004)
E
OR
Measures: The Portrait notes, the fourth series of currency notes, were launched in September
1999 with sophisticated security features (1999).Discontinued issuance of S$10,000note and
instructed banks to stop re- circulating it since October 2014; but still remained legal tender
(2004).
Rationale: Mitigate higher money- laundering risks associated with large-value cash transactions.
SC

B. Concept of Cashless Economy


Acashless economyis one in which all the transactions are done using cards or digital means.
The circulation of physical currency is minimal. India uses too much cash for transactions.
Most of the cash in advanced economies is floating around in the world underground economy.
The potential benefits of cashless economy are as follows:
GS

o Faster transactions: With the cashless system, typically three times more people can be
served using a cashless system than could have been if they were paying cash. No need for
queues outside ATMs, no cashout during long holidays, no waiting for a deposited cheque
to be credited, and no risk of carrying currency notes in the wallet.
o Managing staff entitlements: Free Vends, corporate cash, loyalty and hospitality spend are
all entitlements which can be programmed on to the card, this can be refreshed, daily, weekly
or monthly.
o Increased Sales: It has been demonstrated that with the introduction of a cashless system
can increase sales by as much 20%.Vending and Catering purchases are often dictated by the
amount we have in our pockets. With the introduction of a cashless system this is never a
problem; the value on the card is available 24 hours a day, 7 days a week.
o Cash collection made simple! : Time spent collecting, counting and sorting cash costs
money. The cashless system offers a choice of top-up options including Payroll deduction,
Credit & Debit card and Coin & Note. Removing all the cash from your site removes the
security issues relating to cash handling significantly and reduces the risk of vandalism and
theft from your vending and catering points of sale.
Notes

26 Economic Survey (2016-17)


www.iasscore.in

o Reduces Cash in Circulation: A cashless system prevent too much of cash in the circulation
thereby curb armed robbery cases and cash related crime.
o Job Creation: The licensing and establishment of payment agencies will create jobs and
new business opportunities.
o Curb on black money: Cash transactions and black money are directly linked, since a cash
trail is nearly impossible to track. As such, electronic transactions and the ease of audit they
afford should make the governments job much easier in terms of curbing illegal transactions.
However, the biggest threat to cashless economy is Plastic card fraud. Plastic card fraud
involves the compromise of any personal information from credit, debit or store cards. The
personal information stolen from a card, or the theft of a card itself, can be used to commit
fraud. Fraudsters might use the information to purchase goods in your name or obtain
unauthorised funds from an account. Plastic card fraud can also include card not present fraud,
such as the use of a card online, over the phone or by mail order, and counterfeit card fraud.

E
C. Concept of Digital Inclusion
Digital inclusionis the ability of individuals and groups to access and use information and


communication technologies.
OR
Digital inclusion is a much broader category that addresses the other two
o Digital Divide
SC
o Digital Literacy
Digital inclusion has three broad facets: access, adoption, and application. These facets show
the ultimate goal of creating
digitally inclusive communities.
o Access: Availability,
affordability, design for
GS

inclusion, and public access.


o Adoption: Relevance, digital
literacy, and consumer safety.
o Application: Economic and
workforce development,
education, health care, public
safety and emergency services,
civic engagement, and social
connections.
In order to achieve these goals, digital
inclusion can be promoted in four
significant ways:
1. Digital Infrastructure - By providing free
access to public access technologies
(hardware, software, high-speed Internet
connectivity) in their communities.
Notes

Economic Survey (2016-17) 27


www.iasscore.in

2. Digital Content - By providing access to a range of digital content to their communities.


3. Digital Literacy - By providing digital literacy services that assist individuals navigate, understand,
evaluate, and create digital content using a range of information and communications technologies.
4. Social Programs and Services - By providing programs and services around key community need areas
such as health and wellness, education, employment and workforce development, and civic engagement.

Relevant Questions
1. Critically examine the long term and short term benefits of demonetization. What steps should be
taken to ensure that long term benefits are incentivized.
2. What are the impediments in adoption of digital payments system in India? While analysing the
recent initiatives to increase digital transactions suggest steps which should be taken to increase them.
3. Critically examine the recent steps taken to curb black money, with special focus on demonetization.
What other steps must be taken to curb the menace of black money

E
4. Critically discuss the steps taken by Government for faster transition to digital economy
5. What do you mean by informal economy? How can a transition to formal economy ensure financial
OR
inclusion?
6. What do you mean by liquidity? Discuss the fiscal and monetary control on liquidity.
SC
GS
Notes

28 Economic Survey (2016-17)


Trending Topics www.iasscore.in

ZERO DEFECT, ZERO EFFECT SCHEME


Micro, Small and Medium Enterprises (MSME) sector has emerged as a highly vibrant and dynamic sector
of the Indian economy over the last five decades. MSMEs play crucial role in providing large employment
opportunities at comparatively lower capital cost than large industries.
It also helps in industrialization of rural & backward areas, thereby, reducing regional imbalances, assuring
more equitable distribution of national income and wealth.
On India's 68th Independence Day, PM Modi urged the industry, especially the MSMEs of India, to manufacture
goods in the country with "zero defects" and to ensure that the goods have "zero effect" on the environment.

E
Vision:

OR
To enable the advancement of Indian industry to a position of eminence in the global marketplace and
leverage India's emergence as the world's supplier through the 'Made in India' mark.
Mission:
To develop and implement a 'ZED' culture in India based on the principles of:
SC
1. Zero Defect (focus on customer)
Zero non-conformance/non-compliance
Zero waste
2. Zero Effect (focus on society)
GS

Zero air pollution/liquid discharge (ZLD)/solid


waste
Zero wastage of natural resources
Implementation Structure:
Benefits of ZED
Credible recognition of the industry for international
customers seeking investment in India.
Streamlined operations and lower costs.
Superior quality, reduced rejection and higher
revenues.
Increased environmental & social benefits.
Additional employment generation.
Other benefits as announced by the Government
from time to time\.
Notes

1
www.iasscore.in

Make in India and ZED


The announcement of Make in India and Zero Defect Zero Effect put in perspective the governments' intent
to change the course of economy by focusing on manufacturing as an engine to sustained growth. In order to
build the ecosystem to implement the idea, three important components emerged as the vehicle for this new
transformation:
1. The Ease of Doing Business in India.
2. The confidence in quality of source material, components and services.
3. Making available competent human resource to drive the change.
While the Department of Industrial Policy and Promotion took the responsibility of creating an atmosphere
of Ease of doing business, Quality Council of India(QCI) along with the M/o MSME started exploring the
idea of creating a holistic scheme to engage the MSME sector, long considered as a propellant for sustained
growth, by improving their quality and competitiveness.
The ecosystem around ZED model is calibrated to make aware, assess, rate, counsel, handhold, re-assess &

E
certify MSMEs and ensure that they rise up the ZED ladder, thus enhancing their competitiveness in the global
marketplace and making them an important cog in the wheel in the "MAKE-IN-INDIA" campaign. It also, as
OR
a consequence, provides career opportunities for the youth in India.
SC
GS
Notes

2
Trending Topics www.iasscore.in

LEMOA
India and USA has signed Logistics Exchange Memorandum of Agreement.
Key features of LEMOA agreement are:
LEMOA formalises an ad-hoc arrangement already in practice and furthers India-US military-to-military
cooperation. The agreement provides access to each other's military facilities for fuelling and logistic
support on a reimbursable basis.
The core of both agreements is a regularization of the ability of naval ships and aircraft of both countries
to dock in each other's bases for taking on supplies like fuel. Indian and US naval ships and aircraft have

E
often used each other's naval and air bases before. Base usage and taking on supplies will now be much
easier for naval ships and aircraft under both flags.


OR
These activities are limited to joint military exercises, training, port calls and humanitarian missions and
other military activities that both sides mutually agree to undertake.
It does not give the US automatic access to Indian military bases or to logistical support, but simply
smoothen existing practices.
SC
The advantage over the current situation is precisely following: Though the US does currently use Indian
military bases and logistics during joint military exercises - this is managed on a case-by-case basis, which
is simply more cumbersome. LEMOA does not necessarily give anything that the US does not already
get, but it makes the process more regularised.
LEMOA helps grease the wheels on the bureaucracy underlying defence collaboration, including
reimbursements for military logistics sharing.
GS

Significance of LEMOA
India will be the main beneficiary. While Indian naval ships and aircraft increasingly venture further away
from their home, India has no bases and in some cases not even agreements with foreign governments
along the Atlantic and Pacific. The US navy and air force, on the other hand, has a global network which
is now accessible to Indian ships and aircrafts.
US warships and aircraft now have additional sites to use in India, but they already have many bases
around the region at their disposal.
Indian arrangements with the US for such access open up new options in beefing up India's logistics
capacity for missions in the Indian Ocean.
In one of the more concrete benefits, LEMOA strengthens India's outreach to areas that were not
typically within its reach. With one aircraft carrier in operations, India's capacity to undertake far sea
operations has been fairly limited. Signing LEMOA opens up opportunities such as gaining access to US
military bases in Djibouti and Diego Garcia.
Notes

3
Trending Topics www.iasscore.in

AIM AND SETU


The government has established the Self-Employment and Talent Utilisation (SETU) scheme and the Atal
Innovation Mission (AIM) in the Niti Aayog.
While the AIM would focus on inviting aspiring entrepreneurs to solve India's contemporary socio-economic
problems via 'grand challenges' that offer substantial awards to incubate and scale up winning ideas, the SETU
scheme's resources would be devoted to strengthening incubators and setting up 'tinkering labs' where ideas
can be shaped into prototypes before they are ripe for funding.
An overarching supervisory body with about ten members is being formed to oversee the allocation of funds
under the schemes to line ministries. The panel would include secretaries from the departments of science and

E
technology, biotechnology, industrial policy and promotion as well as the ministry of micro, small and medium
enterprises.
OR
Half of the funds under SETU would be earmarked for strengthening existing incubators in the country,
backed by different departments, so that the support mechanism for budding entrepreneurs is more robust.
The rest, Rs 500 crore, would be used for setting up tinkering labs, where students can literally potter about
and create prototypes and models of their ideas with the ability to demonstrate basic functions.
SC
GS
Notes