The good, bad and ugly side of Demonetisation..

Demonetisation(DeMo) has been termed as one of the boldest moves taken by the Government of India since independence. While we have mixed reviews about it, the audacity to term 86% of the currency in the economy as void post Nov 8 midnight, itself showed the strength of a powerful Government. It showed that the Government can take unpopular and bold decisions if required.

Why Demonetisation was needed?

  • To lower the cash circulation in the country which is directly related to corruption in our country..According to the data from Income Tax Department, only 1.4 million people (or 0.1% of the total population) pay 80% of income tax in India. The total personal income tax collections in FY16 was only 2.2.% of GDP.
  • To eliminate fake currency and dodgy funds which have been used by terror groups to fund terrorism in India..         Rs 400 crore worth of such fake currency was in circulation in the country before DeMo.
  • The move is estimated to scoop out black money from the economy.. 
    India’s black money has been estimated to be roughly Rs 30 lakh crore (20% of GDP).

DeMo was a well planned move to a series of actions that the government had taken to curb black money in the last two years..

  1. Supreme Court Monitored Special Investigation Team (SIT) on black money.
  2. Jan Dhan Yojna.
  3. Information Exchange Agreements with Tax Havens, such as Switzerland.
  4. The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 for Foreign Black Money.
  5. Income Disclosure Scheme, 2016.
  6. Benami Transaction (Prohibition) Amendment Bill.

 

The impact of DeMo on key indicators..

  • GDP:  Short Term (Negative) – Consumption and investment demand to see some dent as the cash based economy feels a crunch. Long Term (positive) – Increased direct tax collections to create room for investment spending. The Tax to GDP ratio which is currently at 16.6% will increase in the long run.
  • Inflation: Immediate Impact (Negative): Downward pressure on prices due to lower demand, especially in rural areas and for sectors such as housing, transport and food where share of cash transactions is high.Sharper fall in rural inflation Vs urban is possible. Long Term Impact (Neutral): To have minimal impact in the long run, as demand will bounce back up with increased government spending and positive impact on employment and incomes.
  • Fiscal Deficit: Immediate Impact (Neutral): To take time for tax officials to claim tax on the deposits made by people. The one-time impact on tax collections could be high. Long Term Impact (Positive): Income tax collections expected to see a kick-up as funds earlier unaccounted for enter the banking system and eventually get taxed. About 23% of the economy estimated to be unaccounted for. Additionally this involuntary declaration of income to invite 30 to 120% tax rate, depending on the source of income will be positive.
  • Current account deficit (CAD): Immediate Impact (Positive): Gold demand already dented due to policy restrictions. This step will additionally bring down gold import because demand is mostly driven by cash (about 80%). Long Term Impact (Negative): Pent up demand for gold may lead to higher imports. People might chose to hoard gold instead of cash. This can widen CAD.

 

How demonetisation has stalled the economic growth of India..

  1. Automobile sales have dipped by 18% in December over a year ago, the steepest fall since 2000.
  2. Residential plot sales across top eight cities dropped by 44% in the October-December quarter even as new launches fell by over 60%.
  3. Over 3 lakh MSMEs, reveals 35% job losses and a 50% revenue dip in the 34 days since November 8.
  4. At 422 projects, new investment proposals during the quarter ending December 2016 fell to their lowest levels since June 2004, recording a contraction of 28% YoY.
  5. Projects proposals fell by 42% from the average of INR 2.18tn (since May 2014) to INR 1.27tn.
  6. Quarterly project completion rate fell to its lowest level since September 2008. Only 262 projects were completed in quarter ending December 2016 versus 319 in the previous quarter.
  7. The stock of stalled projects remains almost at an all time high of INR 11.71 tn.

 

‘Demonetisation a great move weakened by bad execution’

The total currency in circulation was Rs 16.42 lakh crore and the value through Rs 500 and Rs 1000 notes is Rs 14.18 lakh crore. If one assumes that 20% of it is black money and therefore, will not come back to the banking system for replacement, it is a gain of Rs 2.84 lakh crore.

The pitfalls..

  • The government and the RBI were not able to communicate properly about the “currency exchange limit“ of Rs 4,000 (increased now to Rs 4,500).
    Since existing bank account holders were allowed to deposit old currency notes without any limit, this restriction was applicable only for the unbanked people and that should have been spelt out clearly.
  • The introduction of Rs 2,000 notes was a bad idea and the people who got Rs 2,000 notes were still not able to use them because change in lower denominations was not available. Instead, RBI should have flooded the banking system with more Rs 100 and that would have calmed the situation faster. The entire delay due to ATM recalibration (i.e.new Rs 2,000 notes are of different size and therefore, ATM can’t dispense them without recalibration) would also have been avoided by this strategy.
  • Several people deposited money into their bank accounts on November 8 itself and thereby escaped income tax scrutiny (i.e. as of now, government has said that any deposit above Rs 2.5 lakh made after November 9 will be reported to the income tax department).To trap them, government should ask banks to report Rs 2.5 lakh plus cash deposit from October 1 itself. By doing government could have also caught several money laundering transactions with backdated receipts.

 

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