Demonetization: Advantages and Disadvantages

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Tough the move by PM Modi to flush out the black money is a welcome measure, the impact it has on the intended result is to be seen and felt over a period of time. A brief list of advantages, disadvantages and what it doesn’t do as it is claimed will do are listed below.

Let’s have a quick look at the big picture of Indian Economy first – Breakup on High Value Notes of total currency in circulation –

Denomination | Currency in circulation (INR  Bn) Mar-16

500 | 7,854

1000 | 6326

% of High Denomination ~ 86%

Source : RBI

The total value of circulation of these high value notes amount to ~14 lakh crores  which accounts to 86% of the total value of money in the system. Please also note that this physical money in circulation is only 10-12 % of the Indian GDP (USD 2.73 Trillion as per IMF, 2015)

ADVANTAGES – Demonetization (++)

1)  Some of the money from 14 lakh Crore won’t come back. Let’s assume if only 12 Crore worth comes  – So the remaining  will no longer be liability of the RBI and the RBI will make a windfall profit. The same would be paid to Govt as a dividend

2)  This money (non tax revenue) can be effectively utilized to boost up Infrastructure Sector as well Re-Capitalisation of PSU Banks

3)  Unaccounted monies held as cash which was not productive will become productive as it enters the legal system. Of the 12 Lakh Crore – Hard cash held as black money will be brought into the system which is traceable and taxable henceforth thereby increasing the government revenue.

4)  To the extent of penalties imposed by the Income Tax department on the illegal conversion of black money into white money, the revenue to the government will increase in the immediate future.

5)  Counterfeit money in circulation which was a ongoing menace all over India will cease to exist with immediate effect.

6)  Funding of terrorist and other illegal activities will be curtailed as they generally are funded by black/counterfeit money.

7)  To the extent the black money held by the political parties is flushed out, the elections in the near future will be more cleaner and more transparent.

8)  With huge cash at the disposal of the banks, the borrowing of money will get cheaper providing impetus to economic growth.

9)  Government can avail finances at lower rates and speed up the infrastructural spending creating huge job opportunities

10)Will be a boost to government’s financial inclusion drive as more people will move under formal Banking Platform

This is probably the best time for India to take such a risk

–         Good monsoon coupled with almost nil current account deficit has put India’s Economy in a rock solid launching platform

–         Crude is not showing any sign of recovery

–         A right launching pad for GST

–         A real big leap towards cashless India

DISADVANTAGES: Demonetization (–)

1)  Black money invested in other forms of investment like in jewellery, real estate, gold, shares, and apartments in the name of fictitious persons, given as loans etc. are absolutely untouched and will become new black money as the assets are sold and will be out of the legal system once again.

2)  A vast amount of money is held at the places of worship in India as they are exempt from accountability and scrutiny. Unscrupulous people known to take advantage of this will again use this route to convert their monies from black to white to black thus avoiding coming into the legal system within a short span.

3)  With 65% of the population in rural areas of India without proper access to banking and internet facilities, the cash crunch will destabilize the rural economies in the short run.

4)  Consumption of goods and services will decline with no black money at disposal leading to deflationary pressure on the economy.

5)  Consequently, production of goods and services will decline impacting the GDP growth in the near future.

6)  Without any further changes or addendum to the current policy, it is only matter of time before the black money is generated in the system again.

7)  India was insulated from the global financial upheavals, specially sub-prime crisis of 2008/2009, due to its robust economy greased by black money. Now it becomes vulnerable to global financial crisis.

8)  The proportionate increase in the tax revenues generated by the black monies coming into the legal system is negated by the loss in the tax revenues due to lower industrial and service activity.

WHAT IT DOES NOT DO: Demonetization (??)

1.   It is a myth that demonetization will eradicate corruption. It has nothing to do with it.

2.   Issue of 2000 rupee notes will facilitate hoarding of new black money generated and not vice versa.

3.   Will not stop new counterfeit money coming into the system in the future.

4.   As black money is generated in the system again, all the illegal activities associated with it will surface again.

5.   Banking Data has shown Deposits surged weeks ahead of demonetization – Rs 3.56 trillion in the fortnight ended September 30 on a sequential basis . It’s a earnest request to GOI to scan all deposits from 15th September 2016 and not only from 09th November 2016 – 30th December 2016. Let the limit under scanner of 2.5 Lakh is doubled to INR 5.0 Lakhs in that case – I am personally convinced all big fishes and hoarders of black money who had the inside news – will be caught immediately. We have to remember 1% of Indian population  hold 58% of the total money in circulation


In Conclusion

In summary, this measure of demonetization is a measure that temporarily brings into the system the unaccounted money and generates additional taxes in the near future. Whether this measure is detrimental or beneficial is based on the amount of black money being brought into the system, not just cash but assets held in various forms. It is to be seen if benefits exceed the hardships that people are currently undergoing. If indeed the measure is selective, it will not serve the intended purpose. Diversified portfolio of black money, unless brought under this scheme, will not yield the intended result as only 20% of the black money is held in the form of cash as per the estimates.

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