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BIWEELY - DEMONETISATION IN INDIA

Questions for Practice

1. Trace the evolution of currency system in India before and after

Independence
2. By highlighting the major demonetisation of currencies in Indi, Discuss its
objective
3. What are the aim of Demonetisation of High Value Currency in 2016?
Critically analyse its impact on Indian economy since its introduction
4. What are the concerns with government’s latest demonetisation decision?
Also discuss the Judiciary view about it.

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Demonetisation in India
The Supreme Court recently upheld the government’s decision to demonetise
currency notes of Rs 500 and Rs 1,000 by a 4:1 majority.

A Brief History of Currency in India

 History of currency in India traces its roots to almost 6 BC. They were believed to be
minted by the Mahajanapadasie republic kingdoms of ancient India.
 The first Indian minted coins were essentially of Silver and were punch of different
shapes and figures including that of humped bull, swastika and other symbols, were
called Puranas, Karshapanas or Pana
 The Mauryan Emperor Chandragupta is credited to been the first royal to have a royal
standard inscribed to the his currency which came in different standards namely Gold,
Silver, Copper and Lead(Arthashastra)
 The Indo-Greek Kushan kings introduced the Greek custom of engraving portrait heads
on coins..
 The Kushan Empire and its system of intricately designed coinage also influenced a large
number of local tribes, dynasties, and kingdoms, which began issuing their own coins.
 The practice continued well in to the advent of Turkish and Mughal Sultanates in India
 The 18th Century saw the introduction of the paper currency notes in India by the
British Raj with the Bengal Bank, Bank of Hindustan and the General Bank of Bengal –
the first banks in India to issue paper currency.
 The Mutiny of 1857 saw the British establishing its complete fiefdom over the whole of
India and with it the ‘rupee’ became the official colonial currency with the head of the
King of England replacing the native designs and symbols.
 The Reserve Bank of India was empowered as the first Central Bank of India and
empowered to issue government of India currency notes. Post-Independence, Reserve
Bank of India was nationalized w.e.f 1st January, 1949.
 The highest denomination note ever printed by the Reserve Bank of India was the Rs
10,000 note in 1938 and again in 1954.
 The banknotes issued during this period contained the symbols representing science
and technology, progress and orientation to Indian art forms.

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 In the year 1980, the legend Satyameva Jayate -- 'truth alone shall prevail' -- was
incorporated under the national emblem for the first time.
 In October 1987, Rs 500 banknote was introduced with the portrait of Mahatma Gandhi
and Ashoka Pillar watermark.
 Mahatma Gandhi (MG) series banknotes - 1996 were issued in the denominations of Rs
5, (introduced in November 2001), Rs 10 (June 1996), Rs 20 (August 2001), Rs 50
(March 1997), Rs 100 (June 1996), Rs 500 (October 1997) and Rs 1,000 (November
2000)

A Brief about Demonetisation

 Demonetization is the process

through which a nation's
economic unit of exchange
loses its legally enforceable
validity.
 Currencies that are terminated
are no more legally considered
exchanges and have no
financial value.
 Demonetization is a process by which countries opt to reintroduce defunct currencies
as legal money. It arises whenever the official currency is changed.
 The existing kind or types of currency are withdrawn through circulation and
supplanted with new currency. Occasionally, a nation can totally swap its old coinage
with a newer one.
 Reasons behind Demonetization: Whilst demonetization is exceptional, governments
around the globe have used it because of several reasons.
 If problems like hyperinflation happen in any country, then the government
considers demonetization as a solution to take back control and minimise the
adverse situation
 Some negative situations or actions like counterfeit currency, terror, and tax
fraud can all be eliminated with demonetization.
 Demonetization is also used to introduce a new monetary system in some
circumstances.

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History of Demonetisation in India

 Indians like many other flourishing civilizations across the globe were quiet used to use
of multiple currencies at a given point of time.
 Withdrawal of currencies by victorious rulers or successors seemed to be the order of
the day.
 Nonetheless, in the age of coins, the concept of demonetisation would have failed to
capture the imagination of historians and experts alike was the fact that the coins in
themselves were precious metals and carried certain intrinsic value.
 The Demonetisation by Muhammad Bun Tughlaq
 History does record certain fascinating tales. In the 14th century medieval India,
Muhammad Bin Tughlaq of the Tughlaq dynasty attempted the best recorded case
of demonetisation in coinage era
 To tide over the shortage of gold and silver metal coins, he introduced a token
currency system wherein brass and copper coins (tankas) could be exchanged for
gold and silver coins in pre-determined ratio
 The Demonetisation of 1946
 The pre-independence government of India banned the much in circulation Rupees
1000 high denomination notes on 12th January, 1946. The rationale behind the
exercise was unearth black money on account of tax evasion by businesses which
had made a killing by supplying materials to the allied forces in the just concluded
Second World War.
 The Demonetisation of 1978
 One of the major actions of the erstwhile Janta Party government under the Prime
Ministership of Morarjee Desai was the demonetisation of Rupees 1,000, Rupees
5,000 and Rupees 10,000 currency notes on 16th January, 1978.
 Higher denomination banknotes of Rs 1,000, Rs 5,000 and Rs 10,000 were
reintroduced in 1954 and all of them were demonetised in January 1978

Demonetisation of 2016

 On November 8, 2016 announced that 500 and 1,000 rupee notes would be withdrawn
from circulation in a bid to tackle corruption.
 The aim of the action was fourfold:
 to curb corruption;

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 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;
 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 a regime change, emphasizing the government’s
determination to penalize illicit activities and the associated wealth.
 In effect, the tax on all illicit activities, as well as legal activities that were not disclosed
to the tax authorities, was sought to be permanently and punitively increased.
 India’s demonetisation is unprecedented in international economic history, in that it
combined secrecy and suddenness amidst normal economic and political conditions.
 All other sudden demonetisations have occurred in the context of hyperinflation, wars,
political upheavals, or other extreme circumstances.
 But the Indian economy had been growing at the fastest clip in the world on the back of
stable macroeconomics and an impressive set of reforms

Impact of Demonetisation

The impacts of demonetisation are summarized in economic survey as follows:

 On Money/interest rates
 In the short term, the cash declined sharply; Bank deposits increased sharply. In the
long term, the cash will recover but settle at a lower level.
 Deposits will decline, but probably settle at a slightly higher level. RBI’s balance
sheet will shrink, after the deadline for redeeming outstanding notes.
 Loan rates could fall further, if much of the deposit increase proves durable.
 On Financial System Savings
 Increased in the short term and will increase in long term to the extent that the cash-
deposit ratio falls permanently.

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 On Corruption
 In the short term, the stock of black money fell, as some holders came into the tax net.
In the long term, the corruption and black money could decline if “incentives for
compliance improve“. In the long term, the formalization would reduce the flow of
unaccounted income.

 On Private Wealth
 In the short term, the private sector wealth declined because some of the high
denomination notes did not return to the system; and the prices of real estate fell. In
long term, the private wealth could fall further if real estate prices continue to decline.

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 On public sector wealth

 In short term, there was no impact on public sector wealth. However, in long term, the
RBI’s wealth will increase due to extinguished liability of RBI towards unreturned
notes.
 On formalization / Digital transactions
 The demonetisation has set off the digital revolution and many new users adopted
digital payments for the first time. In long term, some of them would return to cash
mode but digital revolution will continue.
 On real estate
 In short term, the prices declined and wealth fell. In long term, the prices could further
fall because people have invested unaccounted income in real estate.
 On broader economy
 In the short term, there were job losses, decline in farm incomes, social disruption,
particularly in cash intensive sectors. In long term, the economy should stabilize with
remonetisation.

Benefits of Demonetisation

As per Economic Survey 2017, the immediate benefits of Demonetisation are as follows:

 Tax on black money

 Demonetisation of large denomination notes is not exactly the same as demonetisation
of black money. But those with black money faced three difficult choices. They
could:
 declare their unaccounted wealth and pay taxes at a penalty rate;
 continue to hide it, not converting their old notes and thereby suffering a tax rate
of 100 percent; or
 Launder their black money, paying a cost for converting the money into white.
 Tax compliance
 Demonetisation can also be interpreted as a regime shift on the part of the
government. It is a demonstration of the state’s resolve to crack down on black
money, showing that tax evasion will no longer be tolerated or accepted as an
inevitable part of life. As a result, the tax-GDP ratio will increase
 Increase in formal savings

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 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.
 Digitalisation
 One of the intermediate objectives of demonetization is to create a less-cash economy
in India. This would ensure that the savings are done through formal financial system
and tax compliance.
 The survey notes that India has very high predominance of cash consumer
transactions relative to other countries.
 The Watal Committee recently estimated that cash accounts for about 78% of all the
consumer payments.
 However, the survey also points out to impediments to digital transactions which
include – lack of internet connectivity, lack of smart phones which are needed for
mobile transactions, lack of enough POS (points of sales), lack of digital literacy and
cybercrimes
 Real estate cleansing:
 Demonetisation led to a deep cleansing of real estate sector. This sector served as the
centre stage of shadow economy.
 With the eradication of black money following demonetisation real estate sector lost
its sheen for speculative investment through black money.
 Prices in the real estate sector have crashed and housing is becoming more affordable
for the middle and the lower sections of the society

Negative impact of Demonetisation

 A Deep Hurt to Economic Sentiment:

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 Economic activity is driven by economic sentiment and if economic sentiment is hurt,

economic activity must suffer.
 The idea of banning nearly 86% of the currency in circulation led to a serious cut in
monetary base of the country: the monetary base declined from Rs 22.5 trillion to Rs
13.7 trillion and this caused a deep hurt to economic sentiment in the domestic
economy.
 Large -scale lay off in unorganized sector:
 Nearly 90 percent of the workforce in India is engaged in the informal sector in order
to earn their livelihood and they are highly cash dependent and cash sensitive.
 A huge cut in liquidity following note ban led to an instantaneous cut in production
activities.
 Consequently, there was a large scale lay off in unorganized sector and daily wage
earners lost their jobs immediately after demonetization.
 Dent in GDP growth:
 Massive lay-off and declining economic sentiment implied a significant dent in GDP
growth.
 According to most estimates including one by Prof. Manmohan Singh, the former
Prime Minister of the country), there was nearly a 2 percent decline in country’s GDP
growth as a consequence of demonetisation
 Slump in Real Estate:
 Demonetisation has led to slump in real estate sector of the economy. This sector has
been one of the prime GDP drivers in the Indian economy.
 Demonetization has cleansed this sector of black money transactions. But at the same
time, purchase and sale in this sector has touched the rock-button. Construction
activity has been severely hit while inventory has piled up.
 Opportunities of employment have dried up. The hope of revival of this sector is
rather bleak and remote. Stagnation of real estate sector is bound to be a serious
bottleneck in the overall growth process of the Indian economy.

Recent SC verdict over Demonetisation

 Taking up the batch of 58 petitions challenging various aspects of the government’s note
ban decision, the Supreme Court had initially wondered if it had not become merely an
“academic debate” given the passage of time.

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 It later decided to go into the issue, with the

About Section 26(2) of the Act
petitioners contending that the procedure
 It states that “on
prescribed in Section 26(2) of RBI Act, 1934, was recommendation of the [RBI]
not followed. Central Board, the Central
Government may, by
 Congress leader and Senior Advocate P
notification in the Gazette of
Chidambaram, appearing for one of the India, declare that, with effect
petitioners, referred to the Preamble of the from such date, any series of
bank notes of any
Reserve Bank of India Act, 1934, which said the denomination shall cease to
right to regulate the issue of banknotes is entirely be legal tender save at such
office or agency of the Bank
with RBI.
and to such extent as may be
 It also generally operates the currency and the specified in the notification”.
credit system.
 He said when earlier governments had demonetised currency — in 1946 and 1978, they
had done so by way of a law made by Parliament.
 He also accused the government of withholding documents related to the decision-making
process from the court and raised doubts about whether the quorum as required for the
RBI Central Board meeting was met.
 In its majority 4:1 judgment, it was held that the Centre’s notification dated November 8,
2016, was valid and satisfied the test of proportionality. “We find that the three purposes
are proper purposes and there was a reasonable nexus between the objects and the means
to achieve the objects. Action cannot be struck down on the basis of the doctrine of
proportionality
 The court further observed that the central government’s decision was after RBI board’s
approval which shows in-built safeguard against centre’s powers.
 It cannot be said that there is excessive delegation of power under the RBI Act to the
Centre which is answerable to the Parliament.

The Way Ahead

The government should take necessary measures to remove the negative impact of
demonetisation on Indian economy and for this, the government can formulate a special
committee which comprise of experts from various sectors. The government should from
time to time publish the data regarding demonetisation to develop awareness among the
people about the progress.

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