After sudden announcement by Prime Minister Narendra Modi on eve of 8th Nov, India is on buzz with benefits of demonetization. While whole nation is thrown into que, majority seems to be supporting the move for eradication of black money from market. From tea vendor to celebrities, suddenly everyone is qualified to air opinion on economic effects of demonetization. So why should I be left out .
With majority of India being illiterate in financial matters, people have developed the perception that black money lies solely in Cash and Properties only. While Cash transaction represents the source of generation of Black Money, the money itself as an asset doesn’t remain too long with individuals in form of cash. They’re either parked into real estate or incorporated into capital corpus for such individuals.
In a country where little documentation more money is focused in market, there remains hardly any sector where black money is not formalized. From share markets to reality sector, black money has found its way everywhere to get formalized. While this action of PM is seen as a major setback for black money, there is hardly any actions being planned on stopping generation of black money itself. What this scheme does instead is to levy one-time interest of 20 – 40% in form of cash discount on the intermediary fund held by individuals before they qualify to be part of new capital corpus. It neither stops black money nor it’s going to affect the rates of generation by itself, unless government is of view that psychological fear alone can stop criminals from committing crime.
Instead unofficial exchange counters were in mood of profiteering high returns by exchanging old notes at discount percentage in line with the cost of conversion of black into white. Part of this problem is that so called high denomination aren’t that high either. ₹500 bill doesn’t even qualify to be called high denomination when it is barely sufficient to pay for one-time dinner of a family. And, it still represents 45% of value of total currency in circulation.
The exact data of currency in circulation is with RBI only and accordingly estimates suggests that 17 lakh cores of currency were on circulation out of which 84% were in now scrapped bills. Let’s look at mathematics involved in it.
With population of India at 126 Crore, assuming 8 members in a family, there would be 15.75 crore families with each family having share of approximately just ₹80,000/- (well below ₹2,50,000 of basic exemption limit for income tax purposes) in liquid cash balance.
Also, with over 31 crore bank accounts (incorporating into calculation only fraction of active Accounts under Jan Dhan Scheme), and only half being utilized to convert old currency notes, they would be able to provide swift transition of black money in scrapped bills into black money in new bills. While definitely not all families will be part of this nexus, with discount rates of 20 – 30%, either knowingly or unknowingly with help of formalized hoarders of currency, majority of this so called pure black money will find its way to new currencies. After all Black Money doesn’t look like black at all. Perhaps, None. That’s why shopkeeper sell their goods to those earning Black Money. If it were distinguished in colors, angry farmers would have stopped feeding Black Money holders, long ago.
While there are lot of inconveniences and sufferings to people, this move is certainly not without benefits that have been weighted by government before being opted.
By this move, government will be able to eliminate existing stocks of fake currency in the market. Also it will significantly bring individuals into the ambit of cashless transactions. Already PayTM, Freecharge and other e-wallet services have reported triple digit percentage rise in both no. of customers and volume of daily transactions. Also, it is good for banking sector which has been crippled due to NPAs.
With this move RBI is expected to profit from reduction of its liabilities upto 20% on account of currencies not returning back to banks for exchange. While this figure can’t be easily estimated due to complexities involved, it is certain that there will be significant gain for RBI to uplift whole banking sector. Instead it’s not just an opportunity but also a challenge – depends on the way government and the market players take it to. The money is coming in the banks for now but may not be there for longer enough. With high deposits of cash balances into banks, interest rates will also be moving down significantly which will boost rates of loan disbursals and increase capital expenditure in the economy.
But, the intention of government wouldn’t have been limited to this one-time stimulus, instead for weighting out short term disruptions and slowed economy, it must have focused on the long term achievements to be made out of it. It is expected that government will be investing heavily on pushing documenting transactions when significant population doesn’t hold even basic standard identity documents and still lack access to formalized banking sector. It still needs to allow easy access to people for investing their savings into liquid markets. The way cash market flourishes due to convenience, it extends delays into movements to and from, formalized capital segments. Due to the basic nature of the cash market, before returning back to formalized segments, it has to undergo compulsory resting period for each such cycle. To out-weight the sufferings of throwing mass into ques and turning country into idle in short-run and deaths of its citizens (more than 70 for which it depends on political affiliations before relating any such incidents to demonetization and its effects while leaving aside unaccounted for those who rarely ever matter for prime time coverage), government needs to make sure it doesn’t go into chasing crime scenes instead of preventing it to happen. In a country which believes in innocence out-weight guilty, government needs to incorporate lessons learned by foreign countries from such moves.