DEMONETIZATION - ECONOMY

News: Govt yet to submit affidavit, SC adjourns demonetisation hearing

What's in the news?

       The Supreme Court on November 9 adjourned to November 24 its hearing on petitions challenging the Centre’s decision to demonetise currency notes of Rs 500 and Rs 1,000 denomination in November 2016.

       A five-judge Constitution Bench of Justices S A Nazeer, B R Gavai, A S Bopanna, V Ramasubramanian, and B V Nagarathna deferred the hearing on Attorney General R Venkataramani’s request for more time to file a comprehensive affidavit explaining the details. 

What is Demonetisation?

       Demonetization is the act of stripping a currency unit of its status as legal tender. It occurs whenever there is a change in national currency.

       The current form or forms of money is pulled from circulation and retired, often to be replaced with new notes or coins. Sometimes, a country completely replaces the old currency with a new currency.

Demonetisation in India - Backdrop:

       India opted for demonetization two times before the 2016 monetisation.

       The first instance of demonetisation by the Government was implemented in 1946 when the RBI demonetised Rs.1,000 and Rs.10,000 notes.

       Later, higher denomination bank notes (Rs.1000, Rs.5000 and Rs.10000) were re-introduced in 1954.

       However, the Morarji Desai government demonetised these notes in 1978.

       According to data provided by RBI, Rs.10,000 note was printed in 1938 and 1954 and was subsequently demonetised in 1946 and 1978 respectively.

       In 2016, the government through notification under RBI Act 1934 demonetised the ₹.500 and ₹.1000 notes.

       The RBI’s annual report, submitted that ₹.15.44 lakh crore worth of currency was demonetised. The withdrawn money amounted to 86.4% of the currency in circulation at the time. Only ₹.16,000 crore out of the ₹.15.44 lakh crore was not returned. He said only 0.0027% fake currency was “captured” following demonetisation.

Positive effects of Demonetisations in the economy:

1. Impact on Black Money and Corruption:

       It is argued that steps taken by the government of demonetization can help curbing black money in the country.

       Corruption will also be automatically reduced by removing black money from the economy.

2. Impact on Counterfeit Currency:

       The Biggest positive impact of the demonetization will be on the counterfeit/fake currency as it is currently thrown out of the system fully.

3. Lower Inflation:

       Inflation arises due to higher liquidity in the market. Because of demonetization there is less liquidity and less cash flow in the market that's why inflation becomes down.

       As the black money goes out of the system the money supply will shrink to some degree. This will reduce inflation rate in the longer absence of any open market interventions by the Reserve Bank of India.

4. Impact on Banks and Financial Institutions:

       As per directions of the Government, people have to deposit their money with the banks which will increase the liquidity of the banks for the short term. This liquidity can be used by banks for lending purposes for the long run.

       As the liquidity of banks increases, they are expected to enhance the borrowing cycle by lending money at a lower rate of interest.

5. Online Transactions and other modes of payment:

       The Government wants to go cashless, demonetization has a positive impact on digital transactions and other modes of payment.

       The value of transactions through the Unified Payments Interface (UPI) crossed $100 billion in October 2022. UPIs were only introduced in the post demonetisation period in the country and their rapid growth is truly stellar. This is an innovation of global scale and quality.

6. Check on hawala transactions:

       As per Central intelligence reports the call traffic by hawala agents dropped by 50% in India.

7. Formalisation of the economy:

       Increase in online transactions, and GST have led to formalization of the economy.

Negative effects:

1. Slowdown in economy:

       GDP decreases because circulation of currency is less because of the cash crunch in the country. The GDP formation could be impacted by this measure, with reduction in the consumption demand.

       An IMF report states that the disruption caused by cash shortages dampened consumer and business sentiments, leading to a decline in high-frequency consumption and production indicators, such as sales of two-wheelers and cement output, respectively.

2. Impact on Purchasing Power:

       The move of demonetization has affected the purchasing power. This mainly affects those assets that are used as long term investments like Real Estate, Vehicles and core sectors of cement and steel.

3. Impact on Real Estate Sector:

       Demonetization smashed the real estate market and it will result in more than 50% drop down.

4. Impact on Tourism:

       Cash Crunch badly hits the tourism sector. It is very difficult for people to get money from the banks and ATMs. The travel and hospitality industries are facing a tough time.

5. Not much achievement of declared objectives:

       The government claims to have achieved the objectives but return of about 99.3% of canceled notes to banks is proof that elimination of black money, corruption and increased IN tax compliance did not happen at ground level.

       Since a huge number was returned back, if black money existed in cash all of it was efficiently laundered.

The Court's argument on objectives of Demonetisation:

       A Constitution Bench on October 12 questioned whether the government and the Reserve Bank of India (RBI) realised their stated objectives of choking black money, terror financing and fake currency through the policy to demonetise ₹500 and ₹1,000 notes in 2016.

       Attorney-General R. Venkataramani termed the case “academic” in nature as things had long settled.

Key takeaways:

       The issue needs to be examined on the doctrine of proportionality too as 86% currency notes were rendered invalid by the decision.

What is the doctrine of Proportionality?

       Proportionality means that the administrative action should not be more drastic than it ought to be for obtaining the desired result.

Does demonetization serve its purpose?

1. Counterfeit currency:

       Demonetising 85% of the currency in circulation removed the legal tender status of the old Rs 500 and Rs 1000 notes.

       The measure removed all currency notes in circulation of those two denominations, genuine and fake.

2. Tackling Black Money:

       Transactions of more than 3 lakh registered firms are under the radar of suspicion while one lakh companies were struck off the list.

       The government has identified more than 37000 shell companies which were engaged in hiding black money and hawala transactions.

       About 163 companies which were listed on the exchange platforms were suspended from trading due to the pending submission of proof documents.

3. Impacts on terrorism, Naxalism, and trafficking:

       Due to demonetisation, terrorist and Naxalite financing has stopped almost entirely. The surrender rate has reached its highest since the demonetisation was announced.

       According to the Nobel laureate Kailash Satyarthi and several others working to fight human trafficking, the note ban had led to a huge fall in sex trafficking.

       Since demonetisation, no high-quality fake currency notes were found/seized by intelligence operations, including at the Indo-Bangladesh border.

       Furthermore, it also affected the hawala operators and dabba trading venues.