On 8 November, 2016, Union government has announced demonetization of Rs 500 and Rs 1000 currency, which has been referred to as a masterstroke by many experts. Demonetisation is an act of stripping a currency unit of its status as a legal tender. In India, as per RBI, 87% of the transactions are cash transactions.

According to the government, the objectives of demonetisation were:

To curb rampant corruption, to unearth black money, to tackle counterfeit currency problem and to attack illicit trade and terrorist activities.

Government wanted to reduce the cash transactions and also control corruption and thereby move towards cashless society and digital India. But the Annual Report presented by RBI tells something else. The RBI Annual Report released on 30 September was much awaited by those who wanted to know the impact of last year’s demonetisation exercise.

The Annual Report by RBI shows that during the year 2016-’17, Rs 41.5 crores worth of fake currency notes in the form of old Rs 500 and Rs 1,000 notes were detected in the banking system. This is well above the Rs 27.4 crores of fake currency detected in these denominations in 2015-’16. It is safe to say that fake currency of Rs 500 and Rs 1,000 denominations was eliminated as those notes can no longer be used anywhere. However, fake currency of new Rs 2,000 and Rs500 notes are already being intercepted, which suggests that the elimination of fake currency is not a lasting benefit and perhaps alternative approaches are required to address this problem.

Impact On Black money:

On black money, the initial narrative by the government was that a large amount of demonetised currency will not find its way back into the system. But, The RBI Annual Report says:

“Subject to future corrections based on verification process when completed, the estimated value of SBNs received as on June 30, 2017 is 15.28 trillion.”

As the estimated value of demonetised notes was Rs 15.44 lakh crore, only about Rs 16,000 crore worth of demonetised notes did not come back. Even this may be an overestimate, as the notes to be received from Nepalese citizens, District Central Cooperative Banks and Financial Institutions are yet to be added to the total value of notes returned. So, this purported benefit did not materialise in any significant way. It cannot be said that significant losses have been inflicted upon those holding black money. From the stated objectives of demonetisation, the only variable that remains in the favour of government claim that it would lead to an increase in tax collection.

Impact on monetary policy:

The RBI formally became an inflation targeting central bank in 2016 but the liquidity surge in the banking system due to demonetisation complicated the conduct of monetary policy. There was a hike in incremental Cash Reserve Ratio – the percentage of cash deposits that banks must keep with the RBI– at 100% on deposits accrued between September 15 and November 11, and the increase in celling on the issuance of securities under Market Stabilisation Bonds.

While the increase in incremental Cash Reserve Ratio dented banks’ earnings as banks do not earn interest on the cash reserve parked with the RBI, the issuance of Market Stabilisation Bonds marked a departure from their traditional role. These bonds are generally issued to mop up the excess supply of rupees arising from the RBI’s intervention to purchase dollars. While the increase in these bonds represents an increase in quasi-fiscal to the government, the repeated auctioning of such bonds tends to push up the yields which may be contrary to the stance of monetary policy. The mopping up of the liquidity eroded the RBI’s earnings. Its expenditure on printing of currency doubled from last year. While its income for the year decreased by 23.46%, its expenditure increased by 106.8% resulting in a sharp decline in the RBI’s surplus.

IMPACT ON TERROR AND CRIMINAL ACTIVITIES

It is difficult to explain how the decision may have affected terror and criminal activities. Those scholar or people commenting that demonetisation has had a negative impact on these activities are mainly relying on anecdotal reports. It is possible that cash-based terror and criminal activities may have been disrupted for some time, as did cash-based legitimate activity, but from the data on terror-related casualties, it is not clear that there has been a significant disruption or not.

What Government claim versus reality?
Government Claim: Demonetisation will result in at least Rs 3 lakh crore not returning in the system (as it may be destroyed) by the tax evaders because they won’t be able to account for it.

Reality: 99.3% of all the old currency has been returned. But report says that Rs 15.44 lakh crore demonetised versuss Rs 15.28 lakh crore returned.

Government Claim:  Demonetisation of Rs 1,000 and Rs 500 notes will end fake currency, and the new Rs 2000 and Rs 500 note will have inimitable exceptional security features.

Reality: The number of fake notes caught has risen by 20% since demonetization, but the total number of counterfeits account for 0.0007% of total currency in circulation. Also, 637 new Rs 2000 notes were found to be fake, breaking the myth around security features.

Government Claim: The demonetisation exercise was always intended to get cash into the banking system. The number of taxpayers and amount of tax collection will rise significantly.

Reality: The number of new tax filers increased by 24%. But this is not the first such instance — there have been years in the past when new tax registrations rose by up to 27%. Total income tax collections rose 20% in the financial year (FY) 2017, and over 16% in FY 2015. Demonetisation hasn’t really been a game-changer.

CONCLUSION

Demonetisation served as a negative shock to the economy, it was not very helpful as per RBI report. Growth in the quarter following demonetisation slowed to 6.1%, and to 5.7% in the next quarter (April-June). Number of small-scale businesses was adversely affected specially in unorganised sector. The lessons are clear: effective monitoring of suspicious transactions and tax reforms are a better alternative for addressing the issues that the policy-makers sought to fix through demonetisation.

Written By:

Ankesh Kumar, Campus Ambassador at Legal Desire