<div>On November 8, with minimal warning, Prime Minister Narendra Modi announced that Rs 500 and Rs 1,000 notes ceased to be legal tender to wage a war against black money. The move has been thought of as facilitating a crackdown on fake currency, corruption and unaccounted black money. Though the long-term effect of this decision may be effective in curbing back money, it is bound to have some social ramifications along with the economic ones.<div><br /></div><div>To understand these ramifications, we must first look at some of the facts related to the use of currency notes in India. According to a report by ‘Cost of Cash in India,' India is one of the most cash intensive economies in the world. The value of currency in circulation (M0) as a percentage of GDP in India is 12.04% which is significantly higher than other large emerging market economies such as Brazil with 3.93%, Mexico with 5.32%, and South Africa 3.72%. On the financial inclusion front, Indians above the age of 15 who have used a bank account and have used non-cash payment as an instrument is less than 35% and 10%, respectively.</div><div><br /></div><div>According to the RBI data, the value of total bank notes for the year ending 2015-16 was worth Rs 16.42 lakh crore out of which the notes of the denomination of Rs 500 and Rs 1000 was a whopping Rs 14.18 lakh crore (86% of total). The share of Rs 500 and Rs 1,000 notes in the stock of circulated currency note stand at staggering 47.8% and 38.6%, respectively. Moreover, the percentage of Fake Indian Currency Notes (FICN) in the Notes in Circulation (NIC) is 0.0007% making it a less significant and irrelevant issue of black money. </div><div><br /></div><div>Possible macroeconomic implications: The decrease in liquidity as a result of the ban will help ease inflation in the economy as consumption will be tilted towards the future. In other words, the decline in purchasing power will reduce the aggregate demand of the economy which will further decrease the overall price level of the economy. It is known that time lags reduce the effectiveness of monetary policy and if the adjustment towards boosting demand is not quick, then this might even precipitate into a recession. </div><div><br /></div><div>In addition, since currency in circulation is a liability for the central bank, the deposits of unaccounted wealth will decrease the RBI’s liabilities. The increase in deposits may help ease the interest rate in future. On the monetary policy side, reduction in back money will improve its transmission mechanism and thus enhance RBI’s credibility in the long-run, which is crucial in curbing the inflationary expectations to achieve the inflation target.</div><div><br /></div><div>However, in the short-run, the RBI’s credibility and independence will be severely affected. On the fiscal side, the unaccounted wealth above the threshold of Rs 2.5 lakh will come under the income tax penalties and if the implementation is effective, then this can result in a windfall gain for the government and can provide a huge boost to fiscal consolidation. </div><div><br /></div><div>How has it fared so far?Demonetisation will be a good push to move towards the more formal economy in the long-run. However, in the short-run, the informal and unorganised sectors will take a massive hit as these are largely dependent on cash-based transactions. The informal sector accounts for about 45% of the GDP and nearly 80% of the total employment. Another sector that will be significantly affected is real estate. The decrease in demand for housing will drive the real estate prices down and this may prevail for a longer period of time. </div><div><br /></div><div>Over the last 18 days, a careful examination of the effectiveness gives us a mixed picture. Inflation rate has dropped to a 14-month low of 4.2%, and the demonetisation is expected to drive it further down. According to the latest RBI reports, only around 38% of the total currency in denominations of Rs 500 and Rs 1,000 have been deposited, and the rest are still with the public. This shows the presence of frictions in the market and the unwillingness of black money hoarders to deposit the unaccounted cash and come into the realm of tax penalties. </div><div><br /></div><div>On the implementation side, the process of injecting new currency and disbursement is not as smooth as it was expected. Throughout the country people are seen standing in long queues to obtain legal tender, and there is a large case of banks and ATMs running out of cash. Demonetisation has severely affected the informal sector where daily wage labourers are unable to find employment. </div><div><br /></div><div>The Way Forward: While Narendra Modi has signalled that this is only one part of a bigger plan, the key issue lies with the implementation of such strikes. The success of the transition lies in the ability of people to withdraw money freely and the banks in disbursing them. The current withdrawal limit of Rs 2,000 and Rs 4,000 from ATMs and banks, respectively, needs to be increased to effectively inject the new currency in the economy. With the future prospects on tackling black money and corruption, there is a dire need for a better and simplified tax regime. The Goods and Services Tax can go a long way in helping this cause.</div><div><br /></div><div>Also, disincentivising the creation of black money and dealing with it will rectify the root cause of black money. Although there have been many attempts in the past, such as the Pradhan Mantri Jan Dhan Yojana to improve and extend financial reach to all sections of the economy, still there is a need for a better implementation of policies of financial inclusiveness in the form of institutional reforms, in order to ensure effective implementation.</div><div><br /></div><div>(Prabheesh is Assistant Professor and Garg is Researcher, Indian Institute of Technology-Hyderabad) </div></div>
<div>On November 8, with minimal warning, Prime Minister Narendra Modi announced that Rs 500 and Rs 1,000 notes ceased to be legal tender to wage a war against black money. The move has been thought of as facilitating a crackdown on fake currency, corruption and unaccounted black money. Though the long-term effect of this decision may be effective in curbing back money, it is bound to have some social ramifications along with the economic ones.<div><br /></div><div>To understand these ramifications, we must first look at some of the facts related to the use of currency notes in India. According to a report by ‘Cost of Cash in India,' India is one of the most cash intensive economies in the world. The value of currency in circulation (M0) as a percentage of GDP in India is 12.04% which is significantly higher than other large emerging market economies such as Brazil with 3.93%, Mexico with 5.32%, and South Africa 3.72%. On the financial inclusion front, Indians above the age of 15 who have used a bank account and have used non-cash payment as an instrument is less than 35% and 10%, respectively.</div><div><br /></div><div>According to the RBI data, the value of total bank notes for the year ending 2015-16 was worth Rs 16.42 lakh crore out of which the notes of the denomination of Rs 500 and Rs 1000 was a whopping Rs 14.18 lakh crore (86% of total). The share of Rs 500 and Rs 1,000 notes in the stock of circulated currency note stand at staggering 47.8% and 38.6%, respectively. Moreover, the percentage of Fake Indian Currency Notes (FICN) in the Notes in Circulation (NIC) is 0.0007% making it a less significant and irrelevant issue of black money. </div><div><br /></div><div>Possible macroeconomic implications: The decrease in liquidity as a result of the ban will help ease inflation in the economy as consumption will be tilted towards the future. In other words, the decline in purchasing power will reduce the aggregate demand of the economy which will further decrease the overall price level of the economy. It is known that time lags reduce the effectiveness of monetary policy and if the adjustment towards boosting demand is not quick, then this might even precipitate into a recession. </div><div><br /></div><div>In addition, since currency in circulation is a liability for the central bank, the deposits of unaccounted wealth will decrease the RBI’s liabilities. The increase in deposits may help ease the interest rate in future. On the monetary policy side, reduction in back money will improve its transmission mechanism and thus enhance RBI’s credibility in the long-run, which is crucial in curbing the inflationary expectations to achieve the inflation target.</div><div><br /></div><div>However, in the short-run, the RBI’s credibility and independence will be severely affected. On the fiscal side, the unaccounted wealth above the threshold of Rs 2.5 lakh will come under the income tax penalties and if the implementation is effective, then this can result in a windfall gain for the government and can provide a huge boost to fiscal consolidation. </div><div><br /></div><div>How has it fared so far?Demonetisation will be a good push to move towards the more formal economy in the long-run. However, in the short-run, the informal and unorganised sectors will take a massive hit as these are largely dependent on cash-based transactions. The informal sector accounts for about 45% of the GDP and nearly 80% of the total employment. Another sector that will be significantly affected is real estate. The decrease in demand for housing will drive the real estate prices down and this may prevail for a longer period of time. </div><div><br /></div><div>Over the last 18 days, a careful examination of the effectiveness gives us a mixed picture. Inflation rate has dropped to a 14-month low of 4.2%, and the demonetisation is expected to drive it further down. According to the latest RBI reports, only around 38% of the total currency in denominations of Rs 500 and Rs 1,000 have been deposited, and the rest are still with the public. This shows the presence of frictions in the market and the unwillingness of black money hoarders to deposit the unaccounted cash and come into the realm of tax penalties. </div><div><br /></div><div>On the implementation side, the process of injecting new currency and disbursement is not as smooth as it was expected. Throughout the country people are seen standing in long queues to obtain legal tender, and there is a large case of banks and ATMs running out of cash. Demonetisation has severely affected the informal sector where daily wage labourers are unable to find employment. </div><div><br /></div><div>The Way Forward: While Narendra Modi has signalled that this is only one part of a bigger plan, the key issue lies with the implementation of such strikes. The success of the transition lies in the ability of people to withdraw money freely and the banks in disbursing them. The current withdrawal limit of Rs 2,000 and Rs 4,000 from ATMs and banks, respectively, needs to be increased to effectively inject the new currency in the economy. With the future prospects on tackling black money and corruption, there is a dire need for a better and simplified tax regime. The Goods and Services Tax can go a long way in helping this cause.</div><div><br /></div><div>Also, disincentivising the creation of black money and dealing with it will rectify the root cause of black money. Although there have been many attempts in the past, such as the Pradhan Mantri Jan Dhan Yojana to improve and extend financial reach to all sections of the economy, still there is a need for a better implementation of policies of financial inclusiveness in the form of institutional reforms, in order to ensure effective implementation.</div><div><br /></div><div>(Prabheesh is Assistant Professor and Garg is Researcher, Indian Institute of Technology-Hyderabad) </div></div>
