Demonetization: The Saving Grace for a Hopeful Economy

Long since has the stage been set, beginning with the Jan-Dhan Yojana to bring over 255 million individuals[1] under the banking system, the Gold Monetization Scheme as an alternative to hold physical  gold, the Income Declaration Scheme meant to provide a single window for people to declare their unaccounted wealth and now, the masterstroke of demonetization. With these measures, the government aims to fight the evil of black money, combat corruption, bridge the financial gap prevalent in the country.

It has been fifteen days since the measure was announced; unsurprisingly, it has created apprehensions in the minds of many. The way forward requires the government to set stricter laws to ensure that unaccounted wealth is prevented from raising its ugly head again. Moves such as a stricter tax regime, both, direct and indirect, not just in terms of simplification, but also in terms of accounting and payment. Specifically, wholesale traders who use cash even today to transact do so to avoid a paper trail that can allow their actual income to be determined. While the Direct Tax Code simplifies the payment mechanism, elimination of cash to transact and  the usage of digital money will ensure accountability for actual tax dues. One can expect the Government to clamp down hard on cash available for use in the economy by implementing a ceiling limit on the transaction amount to be done in cash.

With the surge in liquidity that banks will experience as a result of the clampdown on hard cash, investors expect interest rates to fall, making sources of funds cheaper in the economy. Indeed, a good mechanism to propel investments within the economy.

The Government has also moved the printing of notes from overseas to new plants set up in Mysuru and Hoshanabad which has allowed for heightened security features and safety of movement of notes from the mills to the banking system with clear accountability. Demonetization will eliminate counterfeit notes, but the production of new notes in-house will be a better promise to keep such counterfeits out of our economy for a prolonged period. If proven successful, we can expect withdrawal and replacement of other denominations to increase security in paper money altogether.

If old notes are not converted in time, the RBI can write-off its liability in-part on the foregone currency notes. The government doesn’t have a clear picture on how much will not be converted, but no matter what the amount, the reduction in liability will help the RBI and the government to repay some of its foreign debt which will help clean the balance sheet of the nation and reduce the country risk premium international investors demand. Moreover, initiatives like Make in India, Digital India and Start-up India will receive their push to propel the economy at a faster pace.

Lastly, demonetization will bring about a behavioral change in people with respect to the digital medium for transacting using digital wallets, payment banking and plastic money.



About the Authors:


Anoop Prakash

Sankeerth Bondugula and Anoop Prakash (Members, Finance Club, IIM Shillong)