Was Demonetisation A Good Idea? – Explained

| Updated: 09 November, 2021 5:13 pm IST

Many described demonetisation as a ‘surgical strike on corruption’. Others tried to justify it as a soft nudge from Prime minister Modi towards a digital economy vis-a-vis ‘Digital India’.

“To break the grip of corruption and black money, we have decided that the five hundred rupee and thousand rupee currency notes presently in use will no longer be legal tender from midnight tonight, that is November 8, 2016.” These words by the current PM shook the entire nation. In less than an hour, hordes of people started flocking around to dispense with the soon-to-be illegal tender. Early the next morning, lines as long as the naked eye could see were seen outside banks to deposit stacks of notes.

One of the reasons given was to get rid of the high denomination fake currency printed overseas in neighbouring countries such as Pakistan. Though demonetisation temporarily tackled the problem, seizure of fake currency has increased since 2017. As per National Crime Records Bureau data, high quality fake currency seized in 2020 was more than Rs. 92.17 crore, compared to ₹25.39 crore in 2019, ₹17.95 crore in 2018, ₹28.10 crore in 2017 and ₹15.92 crore in 2016, the year of demonetisation.

What is demonetisation?

Demonetisation is an act of stripping a currency of its status as a legal mode of payment.

When is it applied?

Demonetisation is carried out when there is a change of national currency, and the current form of currency needs to be pulled out from circulation, to be replaced by newly produced notes or coins. Sometimes, countries completely replace existing currencies with a new one.

Is it easy to apply the process?

Demonetisation is a drastic intervention because it directly affects the medium of exchange in all economic transactions. It can either help in stabilising existing problems or can cause havoc in an economy. For instance, demonetisation has been used to stabilise the value of the currency as was observed in the case of the coinage act of 1873, which demonetised silver as a legal tender of the United States, in favour of fully adopting the gold standard to manage inflation. But the withdrawal of silver from the economy caused a recession throughout the country. So in 1878, in response to the continued recession and political pressure from silver miners and refiners, the Bland-Allison act remonetised silver as a legal tender.

Similarly, the cash-dependent Indian economy went topsy-turvy when Indian Prime Minister Narendra Modi on November 8, 2016 announced that Rupees 500 and 1000 notes were worthless and that people had until the end of the year to deposit or exchange notes.

This led to long queues outside banks and ATMs. Small businesses and households struggled to find cash and the rupee fell sharply against the dollar.

When does a country resort to demonetisation?

Demonetisation has been used by countries to stabilise their currency and fight inflation. It has been used as a tool to modernise a cash-dependent developing economy with the use of digital currency and combat crime, corruption, counterfeiting of currency and tax evasion.

What are the good aspects of demonetisation?

Demonetisation can help reduce black money. Nearly 9 million new tax payers were reportedly added to the list post demonetisation. The tax returns have reached an all-time high of 25.3%, giving an impetus to many government-funded social and economical development projects.
Helped boost the digital economy. In a country where 86% of people had access to the internet and smartphone penetration was at an all-time high, Indians were stuck with cash for the majority of their transactions. Cash dependent economies looked towards becoming cashless economies through the use of mobile apps and digital wallets.
A shock to the shell companies. After demonetisation, the government of India claims to have shut 3 lakh shell companies that were siphoning off black money.
Boost to financial institutions. Post demonetisation, banks and other financial institutions have reportedly seen a substantial increase in deposits. Nearly 30 crore families had opened a bank account for the first time using the Jan Dhan Scheme and zero balance deposits reduced from 77% to a whopping low of 20%.
Demonetisation moulded our investment habits for good. Post demonetisation, millions of investors, looking for alternative investment choices, led to a massive boom in the popularity of mutual funds and equities. Retail investors are gradually moving away from fixed deposits towards mutual funds. Moreover, life insurance premium collection had gone up to more than 113% post demonetisation.

The dark side of demonetisation

Impact on interest rates and inflation. During demonetisation, there were limits on how much cash can be exchanged but no limits on how much can be deposited in the banks.
Demonetisation severely affected the banking sector: Post demonetisation, the small and medium scale enterprises, small traders, real estates, transport sector and consumer durables were severely impacted because a majority of the transactions in these industries were made in cash.
Adversely impacted GDP growth: The sudden move led the government to suck out 86% of the money in circulation in a few hours. Some eminent economists have even stated that the demonetisation move had severely impacted India’s economic growth.
Impact on the Indian rupee: Due to the sharp decline in consumption post demonetisation, demand for the products in the domestic market fell sharply from a point at 9.2% in January 2016, to a record low of 6.1% in March 2017. GDP had rallied down on a downward spiral since then.
Cash Crunch: Post demonetisation, people found it difficult to get cash in hand for their day to day needs. Rural areas were most impacted where people were not used to using plastic money and digital wallets as most people did not have bank accounts or even a stable internet connection As a result, people lined up in front of banks to get cash for their daily needs.

However, most Indians considered it a service to the nation and patiently supported the move by the government to eliminate black money.