According to my reading, I stand for Indian Prime Minister’s currency policy to demonetize the 500- and 1000- rupee notes. After giving a definition of demonetization, I state the goals of the policy. Then, I analyse the pros and cons of the demonetization in India at the time of the announcement in November 2016. Based on the recent news, I look at the short term impacts of the policy. In particular, I explain in what extent the policy has not reached the main initial stated goals. Although the failure of the policy regarding its goals is acknowledged, demonetization has tangible and concrete positive effects in India, which will benefit to the whole country in the long run.
Investopedia defines demonetization as “the act of stripping a currency unit of its status as legal tender”. The Times of India explains that demonetisation is a situation where the Central Bank of the country withdraws the old currency notes of certain denomination as an official mode of payment”.
Content and Goals of the policy
In 2016, the Indian government decided to demonetize the 500- and 1000- rupee notes, the two biggest denominations in its currency system; these notes accounted for 86% of the country’s circulating cash. With little warning, India’s Prime Minister Narendra Modi announced on November 8 that those notes were worthless, effective immediately and gave his country’s 1.3 billion people a 50-day window to deposit or exchange them for newly introduced 2000 rupee and 500 rupee bills. The government’s main goal was to combat India’s corruption and thriving underground economy on several fronts:
- Eliminate black money gotten from money laundering and terrorist-financing activities,
- Eradicate counterfeit currency,
- Fight tax evasion (only 1% of the population pays taxes).
SWOT Analysis
To assess India’s demonetization policy, I use the SWOT analysis (Strengths, Weaknesses, Opportunities, Threats). I first investigate the internal strengths and weaknesses of the policy and then explore the long term opportunities and the threats of the move.
The key strength of Modi’s move was the surprise effect . As only few people are aware of the announcement, it prevents black money holders to plan and build complex financial operations to launder their money. Modi’s policy has five main weaknesses though. First, the move causes extra cost as the Reserve Bank of India (RBI) has to spend 79.65 billion rupees on quickly printing updated replacements for the 500 rupee and 1,000 rupee notes. Second, the move may generate substantial notes shortage in the days following the announcement as everybody can physically not deposit or exchange their notes as the same time. Moreover, ATMs are not calibrated for the new sized bills and half the people in the country would need to open a bank account for the first time if they want to deposit their old notes. Third, the timeline is tight that can lead to some panic. Considering India’s population, it may lead to long lines at banks and ATMs and large queues from forming outside bank branches and automated teller machines. Fourth, the policy might be unfair as it might hurt the weakest sections of India’s society, specifically daily-wage labourers, small traders and businesspersons, farmers, women and senior citizens. Last but not least, the policy might be drastically ineffective as black money holders keep only 6% or less of their wealth as cash, suggesting that targeting this cash would not be a successful strategy.
Regarding the long term effects of the policy, demonetization has attractive opportunities and big threats for India. On the one hand, demonetization might be the perfect opportunity for small and medium businesses to develop and offer innovative digital payment solutions . On the other hand, Modi has to pay attention to some issues as he can be accused of damaging the economy and tarnishing the country’s credibility at home and abroad. On the economical side, the policy could provoke a slowdown in economic growth and a decrease in industrial production. On the political side, Prime Minister and his party BJP can lose popularity, credibility and trust both nationally and internationally if the policy is a failure.
One year after the demonetization, is the policy a success?
Data released by the RBI indicates that demonetization has failed to flush out black money . It said in its annual report on August 30 that 99 percent, or around 15.28 trillion rupees ($238.7 billion), of the demonetized 500- and 1,000-rupee notes were deposited or exchanged for new currency. That figure suggests that most people (including corrupt officials, businessmen and criminals said to have hoarded their illicit wealth in cash) have managed to preserve their fortunes. One of the reason of this failure was that India’s black market rarely stores money in cash, as its players prefer other ways of storing wealth, such as jewelry or property (see weaknesses above). Second, demonetization has failed to eradicate counterfeit currency . Indeed, counterfeits of the new 2,000 rupee notes began emerging almost as soon as the legitimate ones were minted.
On top of that, the policy might be involved in the slowdown of the economy. A Parliamentary panel report in April 2017 stated that rural households and honest taxpayers were the worst hit by demonetisation. It said that it was not just the poor that suffered, but the manufacturing sector was impacted too. According to the panel, demonetisation created significant disruption throughout economy, because it was carried out without prior study or research. By reducing money supply, demonetization has also acted as a temporary drag on India’s gross domestic product: The country’s second quarter GDP growth fell to 5.7 percent, which was below a consensus estimate of 6.6 percent for that quarter.
Secondary benefits
Although India’s demonetization policy failed to purge black money from the market, the move has had “secondary benefits” such as fiscal improvement, economic boost, and political benefit.
First, demonetization has widened the tax base and eased tax collection . Modi’s ministers and government spokespersons say there has been an 18 percent rise in income tax returns over the last year after demonetisation. Moreover, the policy was actually a stark success in its ability to get people to open bank accounts for the first time and to get acquainted with electronic payment systems. The way this was carried out was straightforward: people weren’t really given another choice. Reinforcing Modi’s Digital India strategy, which aims to expand India’s online infrastructure, the country now sits on a treasure trove of data. The government has been gradually making enrolment to its national electronic database ‘Aadhaar’ mandatory for tax returns, opening of bank accounts and any purchases above 50,000 rupees. It is estimated that over 99 percent of Indians aged 18 and above are now enrolled in the scheme. Forecasters even expect the country’s tax base to grow larger and help drive the GDP in the fourth quarter to around 8 percent.
Second, demonetization has facilitated the rise in digital financial services. Traditional payment methods, such as bank transfers and debit cards, have been increasing. Innovative financial instruments have also been booming such as mobile banking and and e-wallets. Paytm, India’s largest digital payments company and backed by Alibaba, Ant Financial, and Softbank, is looking to expand its footprint to include lending services and credit cards for customers. Paytm has already secured a banking license and launched Digital Gold, which allows users to buy, sell. and store the precious metal pegged to real-time market rates. “Fintech companies are joining in and banks are encouraging mobile banking through specially created apps” said Professor Charan Singh, who teaches monetary economics at the Indian Institute of Management Bangalore. “Demonetization should not be viewed in a narrow sense as simply searching for unaccounted money” he added, “it will meet the aspirations of young population, improve India’s rank in Ease of Doing Business and encourage growth.”
Third, Prime Minister Narendra Modi largely benefited from his move on the political level . His party, BJP, saw a resounding electoral win in March, following implementation. “It’s important to remember that the demonetization move was intended more as a political move than as an economic one” noted New York-based South Asia-focused Eurasia Group analyst Sasha Riser-Kositsky. He explained that “the drama of demonetization allowed Prime Minister Narendra Modi to demonstrate in a very visible way his commitment to fighting corruption and black money”. Capital Economics’ Shah added that the scheme appeared to be a political success for the Modi government: “After all, the measures enabled PM Modi to demonstrate in a very visible way his commitment to fighting corruption and black money (even though they proved to be a failure). This helped the ruling BJP to secure major victories in state elections earlier this year”.
Conclusion
Although 2016 India’s demonetization has failed to reach its main stated goal, ie eliminate black money, and hurt the economy in the short run, Prime Minister Narendra Modi’s policy has created the favourable conditions for the further development of a more secure, reliable, buoyant, flourishing and digital economy in India. Above all, Modi has shown his ability to unify the country and gather all citizens, whatever their social, religious or financial status, to a common vision. The remaining questions are: Back in November 2016, did Narendra Modi have other alternatives? Would he have been able to create ingenious and less costly measures or policies to achieve the stated goals of demonetisation and still bring the same ‘secondary benefits’ that are currently happening in India?
Alexandre PERSON
Released on December 8, 2017
Sources:
- https://timesofindia.indiatimes.com/topic/Demonetisation
- http://www.hindustantimes.com/opinion/digitisation-of-india-s-economy-is-the-success-story-of-demonetisation/story-ghQdJ9a9H8fs0i57bHvJ3H.html
- http://www.thehindu.com/todays-paper/tp-business/currency-in-public-hands-surges/article20376142.ece
- http://indianexpress.com/article/india/demonetisation-pm-modi-carried-forward-ambedkars-theory-in-letter-and-spirit-says-devendra-fadnavis-4933442/
- https://www.investopedia.com/terms/d/demonetization.asp
- https://www.investopedia.com/news/india-discontinues-500-and-1000-rupee-currency-notes-hdb-ibn/
- http://www.aljazeera.com/indepth/features/2017/11/demonetisation-modi-cash-gamble-divided-india-171108065749571.html
- http://www.aljazeera.com/indepth/features/2017/11/day-protests-mark-demonetisation-anniversary-171107074631199.html
- http://www.aljazeera.com/programmes/insidestory/2017/11/india-currency-policy-worked-171108185812057.html
- https://economictimes.indiatimes.com/news/economy/policy/demonetisation-economy-shaken-gdp-hurt-trust-in-govt-undermined/articleshow/61182455.cms
- https://www.ft.com/content/7dbe0e14-8d8a-11e7-a352-e46f43c5825d
- https://en.wikipedia.org/wiki/2016_Indian_banknote_demonetisation
- https://www.cnbc.com/2017/09/01/indias-demonetized-currency-back-in-the-system-but-canwe-still-call-it-a-success.html
- https://www.cnbc.com/2017/09/07/demonetization-reserve-bank-of-india-suggests-that-demonetisation-allowed-black-money-to-enter-banking-system.html
- https://www.cnbc.com/2017/06/23/india-digital-payments-giant-paytm-offering-credit-card-and-lending.html
- https://thediplomat.com/2017/09/is-indias-demonetization-a-failure/
- https://www.forbes.com/sites/wadeshepard/2017/07/29/how-india-is-surviving-post-demonetization/#407c84111164
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