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How Demonetization will benefit Indian Economy in the Long Run

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Demonetization was introduced with the objective of curbing black money, terror financing and counterfeit currency.

Demonetization was introduced with the objective of curbing black money, terror financing and counterfeit currency. No one knows the exact measure of our black economy but as per certain estimates the black economy is large as 3 times our GDP imposing an immense drain on our resources. All over the world the countries that have experimented with demonetization of high denomination currency have met with varying degrees of success. But in none of the countries a measure of this magnitude had been introduced as was the case with India where almost 85% of currency was rendered illegal with a single stroke. This move came at a time when the government had initiated several measures in the preceding months to curb black money including the Black Money Bill, Real Estate (Regulation and Development) Act, 2016, Income disclosure scheme etc.

Although the move might impact the economy negatively in the very short run owing to liquidity crunch and excessive dependence on cash transactions in real estate, jewellery, retail, logistics, consumer durables, cement and some segments in MSMEs which may get deferred, but in the long run the benefits are going to far exceed the costs.

Firstly, there are significant costs to cash economy and cashless economy would help to eliminate those costs. Hard currency transactions involve the cost of time and shoe-leather cost involved in approaching the bank or ATM to withdraw cash. Also there are significant costs of printing currency, logistics involved in maintaining currency chests that can be avoided with greater use of digital transactions. Moreover cash transactions are anonymous while digital transactions ensure greater accountability and transparency.

Secondly, this move will severely dent terror financing which thrives on counterfeit currency and high denomination notes. Greater transparency in transactions will deter smuggling of arms.

Thirdly, it will boost tax revenues of the government as the black and unaccounted income gets converted to white. It is a shocking fact that in a country with 1.2 billion population, only 24 lakh persons declared their annual income to be above Rs. 10 lakhs. There is serious under-reporting of income to evade taxes causing significant loss to the exchequer.

Fourthly, going cashless will improve financial inclusion in remote areas where bank branches are far and unviable. The move has shifted behaviour of the people to move towards cashless transactions.

Demonetization is also expected to reducing liability of the RBI. It is expected approximately Rs. 5 Lakh Crore may come to the government in the form of extinguished RBI Liability, Taxes and Penalties, an amount that is enough to meet entire Fiscal Deficit for a year. Recent figures released suggest that only Rs. 1 to 2 lakh crore may actually come to the government from the money not drawn back into the system. However the final estimates would only be known after penalties on unaccounted income are realized by the Income tax department.

More importantly, in the long run, policy rates are expected to come down as bank deposits increase and NPAs decline which would further boost overall investment in the economy. Also higher tax revenues arising from better compliance would offer scope to reduce rates over the long term which will boost consumption demand.

Although there are immense opportunities for economy to grow in the long-run from demonetization, few threats remain in the short-run. The liquidity crunch caused by demonetization will negatively impact sectors with high level cash transactions. Also there will be added costs of replacement of currency. Moreover it will be a big challenge to turn the society cashless where more than 50% population is not well versed with card transactions and mobile wallets and do not possess smart phones or internet.

The Government is however making all efforts to ease the liquidity crunch and encouraging cashless transactions. The central government started the “Lucky Grahak Yojana” and “Digi Dhan Vyapar Yojana” to incentivize digital transactions so that the e-payments are adopted by the poor as well. The government also launched the digital payments BHIM app (Bharat Interface for Money)- after Babasaheb Dr Bhimrao Ambedkar, to support Aadhar-based transactions using fingerprint. To make the demonetization move a success, efforts on the digital India campaign also need to be intensified.

Overall demonetization is a progressive step shaped by the right idea, intention and initiative and like any other shock will have negative impact in the short run but will be instrumental in a positive transformation of the economy in the long run.