Remembering Demonetization and the year that was

Last Updated: Fri, Dec 01, 2017 19:41 hrs

The decision of Demonetization – with currency notes of denominations Rs. 500 and Rs. 1000 losing legal sanction from midnight of 8 November 2016 - was entirely unsuspected. The present Indian government pulled off arguably one of the most significant economic reform measures in its tenure with demonetization.

This move aimed at boldly combatting the black money, counterfeiting, parallel economy and cutting financial support to terrorism was albeit likely to have significant repercussions.

The Intent 

Arguably in the last two years, the government took a number of steps to curb the menace of black money in the economy, initially by setting up a Special Investigation Team, and then passage of Black Money Act.

These were followed by amending Double Taxation Avoidance Agreement between India and Mauritius and India and Cyprus as also reaching an understanding with Switzerland to get information on certain bank accounts held by Indians. Introduction of “Benami” Transaction Amendment Bill in Parliament provided the necessary tools to the government to crackdown on black money within and outside India.

Demonetization aimed at curbing black money that is in the form of physical and hard cash. There does not seem to be a reason why we should not curb this menace.

The Impact to Business

FY 2016–17 witnessed the economy advance by 7.1 percent, below the forecast of 7.6%, and below 8 percent in FY 2015-16. While one may attribute poor economic performance in the second half of the year to demonetization, it is difficult to discern how much of the slowdown was exclusively because of it, as signaling of a slowdown in economic activity was discernible since early 2016.

Short-term growth impact was felt with the cash crunch resulting in a sudden contraction of demand, adversely affecting growth and employment in sectors with linkages to the unorganized economy, such as agriculture, construction and some service sectors. The commodities and agricultural sector, including the market for consumer durables, felt the heat.

The real estate sector has seen a significant negative impact, particularly in the repurchase market. Resale transactions in the real estate sector often have a significant cash component as it reduces incidence of capital gains tax. Black money was responsible for sharp appreciation of properties.

The luxury goods market got affected, as demonetization impacted an erosion of real wealth of such users. Automotive sector and Gems, Jewelry & gold sectors have as well seen the heat of demonetization.

Businesses in the fin-tech sector including payment banks, mobile wallets, electronic transfer providers, etc., have seen gains. The technology and financial services sectors are expected to gain in the medium to long term.

Investors are optimistic about the medium to long-term economic outlook of India given its strong economic fundamentals, the government’s continued efforts to increase foreign investment inflows, and economic resilience amid global uncertainty.

What we gained?

Demonetization has to viewed against the backdrop of other economic gains, because any impact on economic activity and GDP will be temporary, and the long-term benefits such as an increase in cashless activity will be more permanent.

There has been significant jump in value of digital transactions during October 2017 vis-à-vis during November 2016, as evident from RBI data for Electronic Payment Systems viz. Real time Gross Settlement (RTGS) 17%, National Electronic Funds Transfer (NEFT) 57%, Immediate Payment Service (IMPS) 131%, National Automated Clearing House (NACH) 48%, Point of Sale (POS) 50% and Prepaid Payment Instrument (PPI) recorded growth of 147%.

Cumulatively all Electronic Payment Systems transactions increased, in volume by 44% and in value by 21% during October 2017 vis-à-vis during November 2016.

Demonetization has given the needed push to small businesses to adopt technology for transactions and to be transparent about their funding and operations. It will bring clear view of every transaction and promote cashless transactions.

The government has been successful in encouraging the unbanked population to become part of the banking system with the use of non-cash and digital payments.

The government acknowledges that demonetization has helped in dismantling & crippling terror funding Fake Indian Currency Notes (FICN) network, in Jammu and Kashmir, North-eastern states and Naxalite hit states. The government has in their internal assessment found significant decline in the terror sponsors instigation of local youths for stone pelting in Kashmir.

Summing Up

Inevitably, demonetization step will help identify and unearth assets in the form of cash, however a significant amount already invested in real estate and/ or gold, etc., may not be unearthed immediately. 

We will have to wait to see the effect of the various steps taken by the government on the future generation of black money. The behavioral change in people towards cashless transactions could be a game changer for India. 

Dr Rajendra Kumar Sinha is Professor and Chairperson at the Centre for Excellence in Banking with IFIM Business School, Bengaluru.