What is Demonetization and Why it will Fail!
Demonetization is the act of stripping a currency unit of its status as legal tender. Demonetization is necessary whenever there is a change of national currency. The old unit of currency must be retired and replaced with a new currency unit. In economics demonetization is one of the tool to curb counterfeit and black money. Demonetization is an excellent tool to curb counterfeit money. The excellent example is in 1996 Australia released the world’s first long lasting and counterfeit-resistant polymer (plastic) banknotes. It replaced all paper-based notes, which the government systemically made non-tender for legal purposes. To curb black money no country implemented it successfully till now
Demonetization is the act of stripping a currency unit of its status as legal tender. Demonetization is necessary whenever there is a change of national currency. The old unit of currency must be retired and replaced with a new currency unit. In economics demonetization is one of the tool to curb counterfeit and black money. Demonetization is an excellent tool to curb counterfeit money. The excellent example is in 1996 Australia released the world’s first long lasting and counterfeit-resistant polymer (plastic) banknotes. It replaced all paper-based notes, which the government systemically made non-tender for legal purposes. To curb black money no country implemented it successfully till now.
The Indian rupee (INR) is the official currency of the Republic of India. The Reserve Bank manages currency in India and derives its role in currency management on the basis of the Reserve Bank of India Act, 1934. On 8th November 2016 at 8:15 pm IST PM of India announced the invalidity of the currency notes of 500 and 1000 Rs from the midnight. The execution of demonetization of currency in India is on same line as USSR did in January 1991 known as pavlov reform after the name of the then Finance minister Valentin Pavlov. The same characteristics of exchange of notes in limited time period and in limited amount. The most resourceful people were able to park their money at the cost of the poor and illeterate people. The after effect was that within 2-3 months. Consumer goods prices rose by 300%. It was a total failure resulting in the loss of confidence in government action. In December 1991 USSR was disintegrated. I am not linking the disintegration of USSR to the demonetization policy but it may have played some role.
One of the biggest economy in world USA by its Coinage Act of 1965 prohibits demonetization of currency of all US coins and currency regardless of age. Whatever US does need not be correct; but the question is why not the economist of such a big economy thought in this direction.
History is taught to learn from the mistakes of the past. All the countries in the past who have taken demonetizaion as step to fight counterfeit and black money has failed miserably.
HISTORY OF DEMONETIZAION IN INDIA
First time demonetization was done in Pre Independence era in year1946. Post Independence the HDN currency of 1000, 5000 and 10000 Rs was demonetized in 1978 to curb counterfeit and black money. On 14 January, R Janaki Raman, a senior official from chief accountant’s office in RBI, was informed about the government’s decision to demonetise high-denomination notes and told to draft the ordinance. After the ordinance was drafted, it was sent to President N Sanjiva Reddy for assent. It was through the All India Radio’s (AIR) 9 am news bulletin that people were informed about the policy decision. The difference between today and past is that the current descision is dictatorial without the assent of President of India. This jeopardise the constitutional nature of our deomocracy where the head of the country is side lined in the name of secrecy. IG Patel, the then RBI governor, was not in favour of the step. He felt that many in the government perceived the step as a measure targeted at the “corrupt predecessor government or government leaders”. In his book, Glimpses of Indian Economic Policy: an Insider’s View, Patel writes that when the then finance minister HM Patel told him about the step, he asserted that steps like these rarely have striking results. He added that most people in possession of black money rarely keep their ill-gotten earnings in the form of currency for long. Thinking that black money is stashed away under mattresses or suitcases is naive, he said. “Black money stashed as high-value currency is much less than black money as untaxed income, part of which might be splurged in conspicuous consumption or used for investment in real estate, commodities, stocks, benami lending or plain graft to secure political or administrative goodwill,”
The same is the view of our previous RBI Governer Raghuram Rajan that “ steps like these rarely have striking results”
Did it work
Not in entirety, say economists, because high denomination notes returned eventually. And, such notes, as we know are the basis of corruption and illicit deals related to unaccounted money. The Rs 500 note was introduced in October 1987 and Rs 1,000 note was introduced in November 2000. The move was then justified as attempt to contain the volume of banknotes in circulation due to inflation. But in current scenario Rs 2000 notes has been introduced even before 500 and 1000 rs notes have been drained out completely.
Abhiroop Sarkar, Professor at Indian Statistical Institute, says the 1978 move had no effect on the circulation of black money. “That’s because people don’t stack black money in cash. Rather, they stash it in undisclosed accounts in Swiss Banks. So demonetisation won’t affect the big fish,” he explained to IANS. Here, it’s pertinent to mention that touts made most of the move in initial days. As people didn’t want to deposit their money in banks fearing tax problems, they fell for the touts instead. Anil Harish, a senior advocate told TOI, “At places like Crawford Market and Zaveri Bazar, people were selling Rs 1,000 notes for as little as Rs 300.” The same is happening today where at 20% to 30% discount the money is getting exchanged.
WHAT IS BLACK MONEY
In India black money is created by two means.
Tax evasion by the businessman. The businessman can again be classified in two categories. Small and average normal businessman and big corporates. Both of them evade tax due to wrong policies of the government. The small businessman are at the receiving end. The big corporates are generally friends of political parties and mostly are involved in funding of elections. The tax evasion can be stopped by using the technology at the right place. With the new Income tax software in place and linking of Adhaar card and Pan card with all the bank accounts can easily curb it but obvious with the political will.
Corruption by the government officials (politicians and beuracrates) is the biggest source of black money. Till the government takes any tough steps to stop the corruption, the generation of black money cannot be controlled; to stop it is a day dream.
REALITY OF COUNTERFEIT MONEY
According to a study done by the Indian Statistical Institute, Kolkata, in 2015, the only reliable and comprehensive exploration of the subject, at any given point of time ₹400 crore worth of fake notes were in circulation in the economy. This is merely 0.025% o f the total budget outlay of ₹19.7 lakh crore as announced this fiscal year.
For the acutal figures which is unearthed the National Crime Records Bureau (NCRB) data says more than 1,80,000 fake currency notes of Rs 1,000 denomination (totaling Rs 18,00,00,000 ) were seized in 2015 by agencies like National Investigation Agency (NIA), CBI) and Directorate of Revenue Intelligence (DRI) among others. (Refer Appendix V)
6.9 pieces counterfeit notes per million NIC(Notes in circulation) are floating, on an average. Such numbers could have two extreme interpretations: (a) without any jugglery of numbers, this ratio could be simply higher at around 17 per million NIC if it is assumed that counterfeiting in lower denomination notes (less than 100 rupee) is negligible, which is more realistic.. Then the vis-à-vis position of outstanding fake notes works out to be of much higher rate, namely as high as about 44 pieces of counterfeit notes per million pieces of NIC
For detail visit: https://www.rbi.org.in/SCRIPTs/PublicationsView.aspx?id=14947
THE COST OF CURBING COUNTERFEIT MONEY
Replacing all the Rs. 500 and Rs. 1,000 denomination notes with other denominations, as ordered by the government, could cost the Reserve Bank of India at least Rs. 12,000 crore, based on the number of notes in circulation and the cost incurred in printing them. It includes the new prining cost as well as old currency cost which will be destroyed (source thehindu). This is just the printing cost. To add on will be the transportation cost and social cost. Social cost is the inconvenience to the common people, bank employees, transport employees etc. It is the intangible cost which cannot be quantified.
Is it sensible public policy to flush ₹12,000 crore down the drain to purportedly remove about ₹400 crore of fake currency.
SOME STATISTICAL FIGURES
WHY TO DOUBT THE INTENTION AND SECRECY OF THE PROJECT
TIME REQUIRED TO MAKE CASH FLOW NORMAL
Given the several time-consuming processes required to circulate the new money, it may be difficult for the country to meet the prime minister’s fifty-day deadline.
PROBLEMS IN IMPLEMENTATION AND PAIN OF COMMON MAN
WHY TO DOUBT THE EXECUTION CAPABILITY OF GOVERNMENT
The failure of the government on above points whether treated as election jargons or implementation issues shackels our faith in government.
Since only 6% of the total cash is in form of black money, and counterfeit currency is .025% of our total GDP demonetization does not help. Instead the following steps would have
Its not a bold decision its a suicide.
The poets rightly says “Lamho ne khata ki sadiyon ne saza pai”
In terms of value, the annual report of Reserve Bank of India (RBI) of 31 March 2016 stated that total bank notes in circulation valued to ₹16.42 lakh crore(US$240 billion) of which nearly 86% (around ₹14.18 lakh crore (US$210 billion)) was ₹500 and ₹1000 banknotes. In terms of volume, the report stated that 24% (around 22.03 billion) of the total 90266 million banknotes were in circulation.
The annual report of Reserve Bank of India (RBI) of 31 March 2016 stated The increase in gross financial assets was driven primarily by a turnaround in small savings and increases in investment in equities and mutual funds, tax-free bonds by public sector units and currency holdings. From the table below of the 10.8% of saving 1.4% saving is in form of currency (it means cash and not bank deposit). This saving is accumulated over the period of time in the form of cash. Many people are afraid that these small savings in form of cash will come under income tax scrutiny as we know how honest our government department officials are and government because of its inability to curb corruption they had taken this step.
Changes in employment of direct and contract workers based on the latest four survey results (in thousand)
As per the statistical data maintained by the National Crime Record Bureau (NCRB), the total number of counterfeit currency (recovered and seized) and the face value thereof during the last five years i.e 2010, 2011, 2012, 2013 and the current year up to September 30, 2014 is as under:-