An announcement made by Prime Minister Narendra Modi on 8th November, 2016 came as a big surprise to India. The announcement to ban all 500 rupee and 1000 rupee notes currently in circulation in the economy was made in the favour of breaking the strong grip of corruption on our country. The past few days have seen a huge pool of people’s varied opinions on the issue. However, before taking a stance on the issue, it is important to understand how black money affects our economy.
Black money simply refers to income illegally obtained or not declared for the purpose of taxes. There are a number of ways in which it affects the economy of a country. It leads to a loss of revenue to the government due to tax evasion. This in turn results in poor quality of public goods and infrastructure provided to people since the government doesn’t have enough revenue to spend on it. And ironically, since the government taxes people to earn revenue to finance its expenses, lack of revenue in the government’s hand will naturally lead to an increase in the tax burden on people in any case.
Black money also results in underestimation of per capita and national income since it doesn’t get recorded in the government’s book of accounts. Hence, if all the black money circulating in the economy flows back into the official records, there will be a substantial rise in the real incomes of people and national income of the country. And, lastly black money can also result in distortion in the consumption, as well as production patterns of the country. Since most of the black money is spent on luxury items, production pattern is bound to make a transition from the manufacturing of essential items to non-essential items, leaving the poor with even more little resources. Hence, it become important for the government of any country to take necessary steps in order to curb black money in the economy.
Keeping that in mind, let’s go back to the issue of demonetizing 500 rupee and 1000 rupee notes. Considering the fact, that any policy introduced by a government has its own set of economic implications, this particular policy and the recent developments made within the policy will certainly have its consequences as well. With the old notes becoming invalid and with withdrawal limit being set to 10,000 rupees per day and 20,000 rupees per week, and exchange being limited to 4,000 rupees per day for now, the demand in the economy is bound to decline, and in turn resulting in reduction of prices.
Hence, due to lack of circulation of money in the economy, markets may come to a standstill for a short period of time. Demonetisation of notes is also said to have an adverse impact on real estate since a huge share of black money is parked in the real estate. Due to lack of standardized and transparent mechanisms for property valuations, cash transactions form a major part of the sector which can cause the market to slow down for at least a while and result in housing prices to witness downward pressure.
Apart from that, the policy is said to impact the low income group the most, since they are the ones who don’t have access to banks where they can go and get their money exchanged. And for few of those who do have access to banks owing to the recent schemes introduced by the government such as Jan Dhan Yojana, may not have any sort of identity proof required to exchange or deposit money. This might lead to them not having money to even meet their basic requirements. And, hence this is something that requires immediate attention from the centre.
However, in spite of there being few inevitable negative external factors initially, as discussed above, this scheme seems to have some positive long term implications as well. Firstly, this could lead to an immediate increase in bank deposits if the holders of the old notes decide to deposit their money rather than exchange. This would in turn increase the liquidity in the banks, making the chances of lending out loans to people, for the purpose of investments, higher in the future. This would definitely give a boost to the country’s GDP. Secondly, this policy would encourage and force rural household to create their bank accounts to deposit and exchange their money, indirectly giving a boost to the government’s financial inclusion schemes. For instance, a large amount of cash has started flowing into previously inactive Jan Dhan accounts post demonetization.
Thirdly, since a lot of black money would be eventually brought under legitimate channel, the government’s revenue collection through taxes will certainly increase resulting in better development of the country. Lastly, black money is usually seen to be associated with high inflation, hence, this scheme would certainly bring down inflation but at the cost of short term demand constraint.
The scheme so far has faced mixed reactions. Some have argued that the people should’ve been given at least two to three days’ notice. However, that would’ve defeated the whole purpose of the scheme since then the money could’ve been easily circulated. Another big challenge for the government would be to track the number of foreign accounts, since a huge amount of black money is stored in these foreign banks which would remain untapped without any government intervention.
Criticisms received from other political parties include the scheme acting against the interests of the common man. However, a number of measures have been taken in that regard. People were given the liberty to use the old notes for medical services, international travels, petrol pumps, amongst rest for the 72 hours following the announcement which was then extended to 14th November for people’s convenience. The government also made clear that deposits up to 2.5 lakhs will not be reported to the income tax department and the farmer’s income will be tax free.
The announcement of the policy should actually not be seen as a shock since the government gave people of the country a good chance to disclose their black income under the Income Declaration Scheme which was active till September 30, 2016. Considering the fact that people did not take the scheme as seriously as they should’ve, it became essential for the government to take a big step in order to eliminate black money and corruption from the country.
This move is seen to be in the direction of the scheme ‘Digital India’ and in the favour of making India a cashless economy. It is definitely not going to be a smooth transition. How effective this scheme turns out to be in curbing black money is something that remains to be seen. However, if the government along with the support of people is able to overcome few short term challenges and take effective measure to facilitate this process, there seems to be a high possibility of India becoming corruption free, few years down the line.
By Smera Dania
Dubey, Yogesh. “Dead since birth, Jan Dhan accounts now flush with cash “. The Economic Times, 12th November 2016. Web.
Patnia, Alok. “How will the Rs 500 and Rs 1,000 note ban impact your business?”. Your Story, 10th November 2016. Web.