Demonetization is the removal of legal recognition for legal tender of some denomination. Thus, thereafter, those holding the banknotes no more recognized would have to get them converted into other banknotes which are recognized. In India, ‘demonetization’ usually refer ₹ to the same happening to ₹500 and ₹1000 banknotes, then in circulation, at November 8, 2016. Those holding the notes could exchange them for the newly issue ₹500 and ₹2,000 banknotes at banks.
The government provided multiple rationale for its surprise demonetization. One of them was removing ‘black money’.
As in any other country, many people hide their actual income from the Income Tax Department and thus withhold tax. This money is referred to as ‘black money’. Some fraction of black money is retained in cash for future spending, and the bulk is invested in various assets like real estate, gold, and jewelry. Black money is usually not deposited in banks, in fear of Income Tax audit of bank accounts which would expose unaccounted-for money and lead to action.
However, due to demonetization, the cash portion of black money, primarily in large denominations, would either be extinguished (become valueless) or have to be exchanged for new notes or deposited in banks. However, the government imposed limits on such exchanges – ₹4,000 per ₹ on from 8 to 13 November, was increased to ₹4,500 from 14 to 17 November, and reduced to ₹2,000 from 18 to 25 November. So, the only viable option to retain large sums of money, would be to deposit it in bank. Thus, the unaccounted-for money would become a part of the banking system, making it possible for the Income Tax Department to hunt it down and recover stolen tax money.
The government expected that much of the money supply would neither be exchanged nor deposited and become valueless. However, more than 99% of the money got exchanged or deposited.
So, yes, some black money – nearly ₹10,000 crore did disappear from the system and became valueless. But the government had expected it to be in the range of 3-4 lakh crore. However, some of the ‘stolen’ tax did get recovered from the successfully deposited black.
“Anti-black money measures taken by us during the last four-and-half yea ₹ in the form of black money law, Fugitive Criminal Offende ₹ Act, and demonetisation, have brought undisclosed income of about ₹ 1,30,000 crore to tax, and led to seizure and attachment of assets worth ₹ 50,000 crore,” Goyal said while presenting the interim budget for 2019-20 in the Lok Sabha.
The demonetization also had positive effect on tax collection. The net direct tax collections rose by 18% in 2017-18, to 10.03 lakh crore, in comparison to 2016-17.
So, the effect on tax collection, was definitely positive but probably not as much as the government had hoped. People innovated to get their black money converted to new legal tender without depositing in banks. Poorer people were hired to take black money to the counter, thus circumventing the per ₹on limit. Many people invested in assets like jewellery, and the seller then converted the received black money into new banknotes, allowing the buyer to escape the Income Tax Department.
The second goal of the government was to fight back against counterfeit notes. Counterfeit notes are copies of legal tender, illegally produced, and used as legal tender. Prior to demonetization, it was estimated that ₹400 crore worth of counterfeit currency was in circulation. This is, obviously, a very small percentage. However, such counterfeit currency is also printed by national enemies like terrorists to finance their activities. Upon demonetization, the counterfeit notes of ₹500 and ₹1000 denominations, would become unusable. Moreover, it would not be possible to get them exchanged, or deposited in an account, because bank employees would probably recognize counterfeit notes. Thus, the government hoped to strike a blow against terrorists by disrupting their finance.
Soon after the issuance of the new currency notes, it was reported that the newly issued ₹500 and ₹2000 had been counterfeited too. Meanwhile, detections of counterfeit ₹50 and ₹100 spiked. While 6,453 pieces of fake ₹50 notes were detected in 2015-16, this number jumped to 9,222 in 2016-17 and then increased to a whopping 23,447 in 2017-18. Yet, there was indeed a substantial reduction in the detection of counterfeit notes in 2017-18. So, the government was partially successful in curbing counterfeit notes. However, counterfeit ₹ quickly adapted, and in two yea ₹, the supply of counterfeit notes must have returned to pre-demonetization levels. Moreover, some counterfeit notes were successfully deposited.
Another of the government’s motives behind the demonetization was to jump-start a cashless economy, where transactions are done with electronic and not paper currency. This motive was partially successful, as after the Demonetization many people began to use electronic payment applications like Paytm. People began to use debit cards more frequently, as the value of Point-of-Sale Debit card transactions doubled from expected levels, in January 2018.
As expected, there were negative effects too. The sudden collapse in the money supply adversely hurt many businesses. The effect was clear on GDP. The growth rate was 8.2% in 2016, and fell to 7.2% in 2017. The growth rate did not recover, dropping to 6.1% in 2018 and dropped to 4.2% in 2019. 2020 went totally negative due to coronavirus pandemic. Other facto ₹ might have played a role in the 2017-19 deceleration like the international financial situation.
Ultimately, demonetization was conceived as a measure to combat many problems. It did not totally work out – which is exactly what happens with any complex plan. Nevertheless, it led to tangible benefits as mentioned above. It had costs too – it predictably hurt the economy. Did the costs outweigh the benefits or vice versa? That we can never say.
Aniruddha Aloke,
15 years
Nashik
