The sudden move by Prime Minister Narendra Modi to demonetise Rs 500 and Rs 1,000 currencies is being hailed across the board as it would facilitate crackdown on rampant corruption, counterfeit currency and reduce unaccounted money.
The move is a big blow to black economy and involves cost of around Rs 15,000 crore to replace the existing high value currency (HVC) notes and will lead to inconveniencing the general population.
The sudden and strategic announcement around 8 pm on Tuesday gave almost no time to people hoarding black money to buy other assets. The move will force people to bring their money to the formal economy and the rest - those who cannot - the black component will be put to rest for ever.
The big strike of the Modi government will serve many purposes such as reducing unaccounted money, reducing cash-carry economy and making electronic transactions settlement. The move will strengthen the deposit base of banks substantially as banks are struggling for capital due to high non-performing assets (NPAs).
The deposits of large pools of high-value denominated cash lying at various platforms – offices, houses, businesses etc – will also help banks to lend more. Given withdrawal ceiling for a few weeks, it would increase the demand for statutory liquidity requirements leading to demand for government securities and causing a fall in bond yields. Higher deposit base may result in a decline in interest rates thereby promoting enhan-ced investment and growth in the long-run.
Cash and carry transactions is one of the highest in India and HVC notes facilitate these transactions and help hoard black money, unaccounted transactions, funding terrorism etc. It is almost like running a parallel economy which is difficult to control and where policies are less than effective.
The demonetised notes together accounted for more than 85% of the total value of banknotes in circulation. According to the RBI data, the share of Rs 1,000 and Rs 500 notes in the stock of currency in circulation at the end of financial year 2014-15 was a whopping 39% and 45%, respectively.
Therefore, scrapping these HVCs and forcing people to bring them to the formal banking system is expected to end black money hoarding immediately, and pave the way for formal channels of payments. Hoar-ding and counterfeits in Rs 100 denomination notes would be very inconvenient and costly. Promoting the non-cash payment system in the process will lead to better mo-nitoring, regulating and policy effectiveness.
The move will directly put pressure on to improve the digital payment infrastructure base. As per the RBI data released in March, the debit card usage at ATMs account for 88% of the total volume and around 94% of the total value of debit card transactions, hence indicating low transaction through point of sale (PoS).
India’s average number of card transactions per inhabitant is 6.7 per year, lowest in the world, whereas Australia, Canada and UK have more than 200 transactions each, Brazil 54.8 and China 14.4. The poor acceptance infrastructure in the form of lack of penetration of PoS, skewed facilities towards urban areas, largely discouraging smaller transactions are a major hindrance to the proliferation of plastic money in India.
Economic activity
According to a JM Financial report, Card Penetration in India, the number of PoS devices stands at 1.2 million for more than 14 million estimated merchants, which means that over 90% of the outlets are left without a medium to collect payments electronically.
The Institute for Business in the Global Context (IBGC) has estimated that the residents of Delhi spend six million hours and Rs 9.1 crore to obtain cash in the form of fee and transportation costs. Hyderabad spends 1.7 million hours and Rs 3.2 crore to do the same. The RBI and commercial banks face a grand total of Rs. 21,000 crore in currency operations costs annually. Herein lies the scope for promotion of digital payment system for smooth and efficient functioning.
The move has indeed inconvenienced people. Even though the government has made efforts to ensure that every person in the rural area has a bank account through its Jan Dhan Yojana, many in rural areas don’t have accounts.
There is also a fear of slowdown in economic activity temporarily. The large impact is expected for real estate and housing construction sector as black or unaccounted money has long been suspected of being steered into real estate and construction business inflating prices. Thus, this demonetising HVCs would curb property prices and the real estate sector which is already battling a prolonged demand slowdown. Land deals are also likely to be put on hold for some time.
Since banks keep the real estate property as a guarantee for extending loans, and amid falling prices, the other sectors will also be affected directly or indirectly. Even jewellery market will get affected in short-run as cash based transactions getting tax rebate would slow down. Some of the other sectors which heavily depend on high value cash transactions including unaccounted black money such as in trade, mining, transport, hotels and restaurants and some luxury consumer goods sectors would be affected.
Most of the business in India is through cash transactions with less than 2% business transactions taking place electronically. This move will cause severe cash crunch for both customers and sellers. This could lead to a slow down in business for a few weeks. The small artisans and street vendors who deal only in small cash transactions will have a tough time.
Further, the fast growing e-commerce segment which was made popular due to cash on delivery model may get affected for some time. However, all this inconvenience is short term and in due course the economy will adapt itself to these changes and help curb the growth of the black money in the country.
(Sahoo is Associate Professor, Institute of Economic Growth, Delhi; Bishnoi is Faculty, National Institute of Technology, Kurukhestra, Haryana)
Published 11 November 2016, 19:40 IST