Demonetization is not a new concept in India.

It has been done in the past but

not in such a large scale. For example, the 10,000 rupee note was demonetised in
1978. However, only the very rich had these notes and the general population
of the country remained unaffected by this move.

Demonetisation of 500 and 1000 rupee notes on November 8, 2016 by the

NDA government has impacted almost everyone. This is because 500 and 1000
rupee notes are in wide circulation and used by about 85 percent of the population.
Hence, its effects are widespread and far reaching, unlike the previous instances of
demonetisation.

The current government opted for demonetisation to obliterate counterfeit

money, end corruption and black money, disrupt terrorist activities, and gradually
move towards a cashless society. The move has also however affected not just
the daily lives of the populous, but will also result in short-term slowdown of
the economy, reduced revenue, and decreased GDP growth. Analysts however
believe that demonetisation will result in positive impact over the long term.

Demonetisation thus has its pros and cons. These are listed below.

Pros of Demonetisation

 Demonetisation is going to be a death blow on corruption. The exchange of

hoarded cash by people with black money will end or will be minimized. Hoarders
will be afraid to exchange black money as doing so may trigger penal action,
monetary penalties, and/or criminal prosecution.

 The society will gradually move towards a cashless one. Improvement in the
banking systems and digitization of money will lead to sharp decrease in cash
transactions. Cashless economy will be beneficial for all as it will be marked by
financial inclusion and increased and easy access to credit.

 The interest rates will fall with a fall in inflation caused by demonetisation. Also,
higher deposits in banks will lead to increased ability of banks to give loans at lower
 interest rates, which in turn will decrease the price of commodities, real estate, etc.,
as well as enhance access to such commodities by those who could not previously
afford it.

 Tax collected via IT department search and seizure activities as well as

voluntary disclosure will fill the government coffers. Increased tax revenue can
help offset the fiscal deficit. Also, better tax compliance and increased tax collection
in a cashless economy will result in a less complex tax system. Such a system will be
marked by tax savings which will increase the disposable income of the population.
This will result in increased spending by consumers and economical growth of the
nation in the long term.

Cons of Demonetisation

 The banking system is currently flush with huge deposits. All analysis of the positive
impact of demonetisation on the banking sector as well as the eventual transition
towards a cashless society is based on the fact that banks will have large sums to
lend. However, after the government eases the limits on cash withdrawals it
remains to be seen whether consumers keep their money in banks or take them
out.

 The cash crunch caused by demonetisation has and will continue to affect
sectors that are largely cash based. For example, jewelry, real estate, retailing,
logistics, restaurants, luxury brands, consumer durables, and cement, etc. will face
short-term downturn and reduced revenue.

 The transition to a cashless society post demonetisation is going to require a

tremendous effort and will be not easy.

 Most consumers and households in India prefer transacting in cash for purchase
of durables as well as essentials. Most Indians also prefer to save cash at home. Also,
over fifty percent of the populous does not know how to transact in card or other
forms of digital payments.
 The banking infrastructure in India is way behind other emerging
markets. Access to ATMs and point-of-sale terminals is limited and typically
available mostly in towns and cities and in organized sector. Rural India has limited
access to even banks.

 Access to internet, especially broadband connection, is limited to urban areas.

Also, even if internet connections are available, it is not very reliable.

 Nearly 80 percent of Indians have mobile phones. However, nearly 65 percent of

such mobile phone users do not access the internet from their phones. Also, most
of those who do use internet on their smartphones often use it to access WhatsApp,
Facebook, etc., and not for shopping or banking.
To be honest, if properly implemented, with due preparation,
demonetization could have been a good policy with some positive effects.
However, in reality this policy has been implemented in a hurry, without
much or any thinking and cost benefit analysis. The way it has been
implemented, it has failed to achieve most of its objectives, has caused a lot
of negative side effects, and hence, it has become a huge failure.

The Demonetization is a big failure because it has miserably failed in achieving most of
its objectives, if not all. Let's look at how the policy failed in each front.

First, the Govt. said it will end Black money and Corruption. Well, it turns out that the
super corrupt are not even affected by it since they store most of their money in kind, not
in cash. Only about 5% of the black money is kept in cash so the Govt. might have
targeted that portion of black money with this move.

But because of the tax-limits (2.5 lakhs, 200% fine, etc.), the corrupt ones have
exchanged/converted their money through other channels such as laundering their
money through the poor, through donations in the temples, through Jan Dhan accounts,
etc. Consequently, by RBIs account, nearly 90% of the money have already been
deposited and in the coming days, pretty much all the money will be deposited in the
banks and will get turned white. This means that this move will “white-wash all the black
money” rather than wiping the black money out of the system.

Second, as of Dec 6, 2016, the public exchanged and deposited about 13 lakh crore worth
of scrapped 500&1000 notes at different banks. We are still 20 days away from the
deadline to deposit and exchange. So if the trend continues, it has been estimated that
over 17 lakh crores of rupees will get into the banking system. From the given evidence
and available estimates, we can tell that banks have accepted in this rush the Fake
Currencies as well. So even the fake currencies will become white now! So this policy
failed in this, as well. We might end up legitimizing nearly 2 lakh crores of rupees that
would have otherwise been fake and illegitimate..

Third, the Govt. said this move will curb terror funding. Nobody knows how much
terrorism is done with the help of cash (500 & 1000) notes. In fact, a number of terrorist
attacks have happened after the demonetization. It is unrealistic to imagine that the
terrorists will stop and find other ways to do what they do. Evidence suggests that the
terrorists have already laid their hands on the new currency.

Fourth, the Govt. said that this move will generate revenues and increase the banking
system's landing capacity. Well, we may not gain much in terms of tax revenues because
the money has been deposited by mostly by people with less than 2.5 lakh rupees, which
is untaxable, or they are already taxed, that is, salaried money. So there is nothing really
appreciable here.

Similarly, the banking system cannot keep this money because people will take out their
money as soon as it is available. Unless people keep the money in long-term fixed
deposits or bonds, banking system cannot lend this money. Thus, this move may not
significantly increase the banking system’s ability to lend more.

So considering all the logical goals, this scheme has proved almost entirely a futile
exercise.

Now the Govt. is talking about cashless economy? Let me ask you why would we even
want that? Even in the USA more than 60% of the transactions happen in cash. So why
do you think you want to make our society cashless?

With less than 50% people having bank accounts, even less people with dependable
electricity connection, and probably less than 20% people with reliable internet access,
India is still (too) underdeveloped a nation for such an exercise.

Furthermore, cashless economy has both advantages as well as disadvantages. One

advantage is that they money will be traceable and the government can get revenues out
that. Alright.

But the disadvantages are that (a) we don't have proper electricity in most of the country
and we don't have decent internet connection for 80% of the country; (b) online
payments are costly, they have 2.5% surcharge, and if VISA/Master Card etc. are
involved, the transaction fee or surcharge directly goes to a foreign company so how do
we benefit from this?; and (c) online fraud is real and risky.

Our ordinary hard-working people, poor, semi-literate, illiterate workers will save their
money in bank accounts and by a single case of fraud they can lose their lifetime savings.
What security arrangements does the Govt. have in mind?

So considering all these aspects, I think that the demonetization, as of now, seems a BAD
move.
Black money, by its very nature, is hard to estimate accurately; therefore
the gains from demonetization of Rs. 500 and Rs. 1000 notes are also
difficult to quantify. Thinking about the following ten questions will enable
us to have a clearer account of what this will (or not) achieve.

India has more cash (12% of money supply) than other countries (3% in UK
and 10% in the US), but it remains a small part of the total.

1. Of the stock of black money in India, do we know all the forms it is held
in? We know some of it is held in Indian Rupees (INR), some in foreign
currency, property and gold and jewellery. Is this an exhaustive list?
Relatedly, of the known forms of holding "black money", do we have an
estimate of how much is held as rupees versus foreign currency?

2. Of the four forms listed above - Indian rupees, foreign currency, gold and
jewellery and property - INR are most likely to lose value over time (for
example, due to inflation). The remaining three are known to appreciate in
value, so why would anyone keep the bulk of their black money in Indian
rupees? According to this report, cash is the least preferred form of holding
'black money'.

3. Earlier this year, this report made an argument in favour of phasing out
the Rs. 1000 note. According to RBI data cited in The Wire, 39% of cash in
circulation is in the form of Rs. 1000 notes, whereas another 50% is in the
form of Rs. 500 notes. Would not the demonetization of Rs.1,000 notes
alone have achieved almost as much, with much less inconvenience?

4. Of the current stock of black money, much is hoarded as Indian rupees.

Post-demonetization, there are reports of cash-hoarders buying gold and
jewellery, leading to a big increase in the price of gold. Doesn't the
demonetization move provide a windfall profit to those who invested their
black money in gold?
5. If the government believes that black money is held predominantly in the
form of notes of large denomination (Rs. 500 and Rs. 1,000), why introduce
a new note of a higher denomination (Rs. 2,000 note)? This question has
been raised repeatedly, but there have been only lame answers (on NDTV
India's Muqabala, one commentator said that the largest denomination in
any country should be such that one can buy a pair of shoes!).

6. Earlier, the BJP had said that much of the black money was stored
abroad, but the so-called "surgical strike on black money" is only on
domestic black money held as Indian rupees. Does this mean that the
government has given up on black money held abroad?

7. If this is aimed at undermining terror financing, we need to know to what

extend it was thus financed, especially by counterfeit currency. Estimates
cited in Business World, suggest fake currency was 0.002% of Rs. 1,000
notes, and 0.009% of Rs. 500 notes.

8. Looking ahead, if this is a push towards a cashless economy, is the

necessary regulatory framework, the legal safeguards for those who go
cashless (hidden costs, data protection and privacy) in place? We
need greater awareness about the concurrent safeguards. Note also that
cashless is possibly regressive as poor people are likely to have frequent
but small value transactions (so commissions as a percentage to total may
be higher).

9. Has the government formulated a plan to leverage this for longer term
gains by expanding the income tax base? Of all the cash that gets
deposited into bank accounts over the coming weeks, how will the
government determine what is black or undeclared, and what is
not? Raghuram Rajan and Mohan Guruswamy have also suggested that
focusing on a wider tax base is likely to be a more rewarding, longer term,
solution.
10. Finally, is someone calculating the costs of the demonetization? For
instance, if we queue for an hour to withdraw Rs. 4,000, we're actually
getting Rs. 3,900, if we value one hour of our time at Rs. 100 per hour.
Various legal economic activities (especially cash-intensive, asthis has
pointed out) have been hit - some for a day, others may be longer
(vegetable trade, farmers who are unable to buy inputs required for
sowing). Breakdown of POS (Point-of-Sale) and ATM machines, rumour-
mongering and hoarding, price rise due to shortages and other disruptions
have been reported from metros. In the final analysis, these costs need to
be factored in.

The demonetization of Rs. 500 and Rs. 1,000 notes will end up being a
"surgical strike" on one form of black money: cash held as Rs. 500
and Rs. 1,000 notes, but not gold, property, US dollars, etc. Even of their
cash holdings in 500 and 1000-rupee notes, people find ways
ofsaving them. Only the current "stock" is hit, as an economist from
the Delhi School of Economics said, "the scheme looks back, not ahead." It
won't block future opportunities, is unlikely to hit black money held in other
forms (property, forex, gold or sent abroad).

Its most significant effect may be psychological (e.g., fear of such move
against gold in the future), but the direction and size of those effects are
harder to quantify. In the end, since we don't know the breakup between
the various forms of black money (India vs. abroad, INR vs. USD vs. gold
etc.), it is difficult to say whether this will be a net gain.

(Reetika Khera teaches at IIT Delhi)

Link : http://www.ndtv.com/opinion/can-modis-surgical-strike-on-black-money-deliver-10-points-
1625100

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