Demonetization of Indian Currency

In the wake and aftermath of demonetisation of current high denomination currency notes by the Central Government of India and confusion that surrounds it, regarded as one of the most landmark economic decisions in the Indian history. A presentation on this subject describing the decision and modus operandi was given by Mr. Gaveen George on 12th December 2016. This presentation was organised by Keli Adelaide - Book Club.
A Populist politician chose to implement chaos in a land not famed for order. In a surprise, TV address Narendra Modi, the Indian prime minister, announced that all 500- and 1,000-rupee notes would be withdrawn immediately from circulation. It was justified as a move designed to fight corruption and target people who have been dodging taxes by holding stockpiles of cash, known in India as “black money”.
While giving the presentation, Gavin gave an elaborate account of the move and reasons behind taking the step plus the hardships common man is facing on the ground.
Gavin spoke about advantages and disadvantages of the move for the Indian economy. Session was highly interactive, attendees shared their views and debated on the current facts vis a vis predictions made before and now by the pro movement economists. Concerns and views of all members revolved around the old saying which is “It is a surgery done without administering the patient the dose of anaesthesia”
The sole purpose of the presentation was to remove doubts and anxiety and create stronger hope on smooth sail in near future from the current turbulent state nation India is in.
Following notes of the presenter gives deeper understanding of this compelling subject called “demonetization” tour highlights on the history of such execution and impact intensity then, brief statistics of different industries economy before and after demonetization, execution process, polarising effects and possible outcomes.

Topic of discussion: Demonetisation
Presented by Gaveen George
0n 12/12/2016

We are exploring two things in this discussion.

• Looking  at demonetisation policy impact in Economic sense.
  
• How the will this policy achieve it stated objectives? 

​Definition of 'Demonetization'
Demonetization is the act of stripping a currency unit of its status as legal tender.It is the process of ceasing to produce and circulate particular forms of currency. Demonization in the strict sense is banning of a particular currency denomination. The opposite is re remonetisation - introduce all-new currency for the value of the dimensioned currency/even with existing currency.  Coins and banknotes are usually defined as legal tender whereas personal cheques, credit cards, and similar non-cash methods of payment are not considered legal tender as debt obligations is not relieved until the payment is tendered. On Nov. 8, Indian Prime Minister Narendra Modi announced that, at the stroke of midnight, some 14 trillion rupees worth of 500- and 1,000-rupee notes – 86 percent of all the currency in circulation -- would no longer be legal tender
What happened in India is not strict demonetisation in the economic sense– it was more of a currency exchange – not a note banth – it note bathaly.
In figurative sense it is – it demonetising of Cash – rather than currency as you have sucked 86 % of the cash out of the economy.
Recent History in world.

• Ghana:In 1982, Ghana rolled out the decision to demonetise their 50 cedi currency notes in order to monitor money laundering and corruption. The change was not welcomed warmly, creating chaos across the country and finally resulted in a move back to physical assets and foreign currency.
• Nigeria: Nigeria’s economy collapsed after the 1984 demonetisation move that did not go as planned. The military government of then President Muhammadu Buhari introduced different coloured notes to invalidate their old currency in order to fight black money.
• Myanmar: Around 80% of Myanmar’s currency was demonetised in 1987 by the military to curb black money, but the move resulted in a lot of protests and the country witnessed several killings.
• Soviet Union:Under the governance of Mikhail Gorbachev in 1991, the then Soviet Union demonetised the higher denominations of ruble bills, the 50s and 100s. The move did not go well and resulted in takeover of Mikhail’s leadership within eight months of the plan.
• North Korea: North Korea faced demonetisation of their currency in 2010, which led to major economy breakdown with people left to starve for basics.
• Zimbabwe :Zimbabwe once had hundred trillion dollar note, which was demonetised and was exchanged in a mocking way dropping trillion dollars to $0.5 dollar.
• Libya :Its central bank started withdrawing old currency in early 2012  in an attempt to restore liquidity after it found that the vast majority of funds are being kept outside banks.

All this demonetization move was to deal with hyperinflation – currency rates and corruption.
There were some instances in Australia, Pakistan, European Union, United States, Iraq – demonetisationwas largely at small scale.
History of demonetization in India

• January 1946- Rs.1,000 and Rs.10,000 banknotes, which were in circulation were demonetized primarily to curb unaccounted money.
• 1978- The higher denomination banknotes in Rs 1,000, Rs 5,000 and Rs 10,000 were reintroduced in the year 1954 and these banknotes were again demonetized in January 1978.
• Denominations of 1, 2, 3, 5, 10, 20 & 25 paise were in circulation till June 30, 2011 but were then withdrawn. While the 50 paise coins are still in circulation. They are called small coins while the other denominations are known as rupee coins.
• So the last time demonetisation was done in India is almost 36 years ago.

1. Nov 8th Policy announcement of Demonetization

On Nov. 8, Indian Prime Minister Narendra Modi announced that, at the stroke of midnight, some 14 trillion rupees worth of 500- and 1,000-rupee notes – 86 percent of all the currency in circulation -- would no longer be legal tender. Modi’s stated goal was to make good on his campaign pledge to fight “black money:” the illicit proceeds -- often held as cash -- of tax evasion, crime, and corruption. He also hoped to render worthless the counterfeit notes reportedly printed by Pakistan to fuel terrorism against India.
Impact of Demonetisation on the economic side following the announcement
Impact of demonetisation is it is simple basically cash crunch – severe liquidity
The impact on India’s growth story was rather immediate.

1. Goldman Sachs slashed its forecast for India’s GDP growth to 6.8% for the current fiscal.
2. Mumbai-based Ambit Capital was even more pessimistic, forecasting that India’s GDP would grow only by a meagre 3.5% in the current fiscal.
3. Deutsche Bank, too, cut its GDP growth forecast for India by 100 basis points to 6.5% in the current fiscal.

Manufacturing
Since storming to power in 2014, Modi has tried hard to revive India’s struggling manufacturing sector, which accounted for about 16% (pdf) of the GDP in 2015.
Modi wants to increase this to about 25% by 2025, but demonetisation may have thrown the sector into a tailspin.
In November, India’s Purchasing Managers’ Index (PMI)—an economic indicator of the manufacturing sector that tracks new orders, inventory levels, production, supplier deliveries, and the employment environment—stood at 52.3. That’s two points lower than the 22-month high of 54.4 recorded in October. A PMI of less than 50 indicates a contraction in the economy.
“PMI data for November showed that the sudden withdrawal of high-value banknotes in India caused problems for manufacturers, as a cash shortage hampered growth of new work, buying activity and production,” said Pollyanna De Lima, an economist at IHS Markit, one of the compilers of the index.
I reiterate this this is because this demonetization was unpresented move – there is no away of an accurate assessment.
A window of opportunity here is cash liquidity can or may attract big business to thus employment – a very small percentage of the job market.
Services & consumption sector
Worse hit sector - The sector comprises areas such as trade, hotels and restaurants, transport, communication, finance, insurance, and real estate, among others, and accounts for 60% of India’s $2 trillion GDP
Asia’s third-largest economy has also been hit by poor consumer spending since demonetisation. Private consumption expenditure contributes to around 60% of India’s GDP.
“Interestingly, the consumer goods sector, which has reported solid growth so far, was the weakest performer this month. This suggests that consumption—the sole growth driver—has been hit rather sharply,” financial times
India’s rural economy—which services 68% of the population and has seen sluggish demand for the past two years—could take months before it sees a recovery. This rural economy was the driver of India’s consumption boom between 2007 and 2012.
“The sluggish rural consumption is staring at a further dip due to their higher dependency on cash transactions,” market research firm Nielsen said in a report on Nov.15 (pdf). “Discretionary spends will see a bigger impact in this geography.
“Mandis” may experience a shortfall of cash for the purchase of daily essentials including fruits and vegetables; leading to further problems for farmers and having a domino effect on their ability to purchase.”
And it could take at least a few months before consumer spending is finally back on track.
But that could also mean that India’s central bank could bring down key lending rates, since inflation has eased. But the recent indication is that RBI has not taken a decision yet: they have advised that they haven’t yet analysed the effect of demonetisation as now.
The agriculture sector
India’s agriculture sector was widely expected to have a robust year. The rainfall was good after two years of drought and the sector was pegged to grow by about 4% in the current fiscal. The agriculture sector constitutes about 15% of India’s GDP but grew by a paltry 0.2% and 1.2% in 2014 and 2015, respectively.
Demonetisation means that the sector could once again take a hit.
Agriculture is a cash-rich sector and most of the payments for the purchase of seeds, fertilizers, and tools, as well as for labourer salaries, are carried out in cash. It also doesn’t help that the sale, transport and distribution of agricultural products take place at mandis which are almost entirely dependent on cash. In addition, the RBI has also banned the exchange of old notes at co-operative banks, which farmers visit more often.
India is currently in the midst of harvesting its Kharif (or monsoon) crops and is soon expected to prepare land for the Rabi crops, which are harvested during spring.
“The agriculture sector will bear the brunt of demonetisation,” Dharmakirti Joshi, chief economist at credit rating agency Crisil said. “Farmers are finding it tough to sell their produce in the APMC (agricultural produce marketing committee) markets. Therefore, despite a good harvest, there is unlikely to be a commensurate improvement in rural demand.”
Sensex and foreign inflows
Meanwhile, investors have also been jittery since the news of demonetisation and that hasn’t helped Modi’s cause.
Since Nov. 08, the Sensex has fallen by around 5% while foreign portfolio investors (FPIs) withdrew some Rs37,300 crore in November, the highest since June 2013.
FPIs had withdrawn Rs12,140 crore in October.
“Foreign investors have pulled out funds from capital markets due to fears of (a) rate hike by the US Federal Reserve in December, uncertainty over US ties with emerging markets post (the) Donald Trump victory, and concerns over the the impact of demonetisation and GST on economic growth & corporate earnings,” the Centre for Monitoring Indian Economy (CMIE), a think tank which tracks business and economic data, said on Dec. 02.
A poll by Reuters on Dec.05 predicted a 25 basis point reduction in repo rates—the rates at which the Reserve Bank of India (RBI) lends to banks. Market was hoping for a rate cut – however RBI – did not do anything – they advised that they haven’t yet studied impact of demonetisation.
Economic time’s recent survey published 05/12/2016 - Real estate - Jobs – ecommerce’s – tourism automobile telecom and metals – All going negatively impacted
Now let us look at the Positives

• Banks stand to gain meaningfully from implementation of demonetisation, but over a period of time. While operating costs could increase in the immediate future, there would be an increase in the low-cost current and savings accounts (CASA), which in turn will rub off favourably on the banks’ funding costs and liquidity.
• Revenue generated from transactions through cashless measures – significant increase.
• If government take a positive call – investing boost in infrastructure could possible boost in the informal sector.
• This could also have the effect of bringing down deposit and lending rates further without the RBI having to cut its repo rate. A rise in deposit base will allow banks to lower the blended cost of funds
• Increased tax compliance. In the immediate run, we are likely to witness larger bank deposits, price corrections and better tax collection possibilities in the economy—all great for Indian bonds.
• Greater financials Inclusion –leading to healthy informal sector

 
All these positive efforts contingent upon how quickly the can restore the sufficient liquidity of cash.
This also depends upon the behaviour of the people – thingscannot go back to 85% cash – cashless economy then becomes political hogwash and  people may withdrew the money again – they continue To transact in cash.

1. A closer look at the policy objectives and of Nov 8 announcement.

On November 8th, government announced the decision to discontinue the legal tender status of Rs. 500 and Rs. 1000 notes. The original objectives were stated as: eliminating fake currency; inflicting losses on those with black money; and disrupting terror and criminal activities.
Later, new objectives were tacked on: enabling growth in bank credit, turning India into a cashless economy.
The principles underpinning the policy formulation – is possibly flawedas eminent economists lot of the people pointed out.
Black money 
Definition of black money - money from illegal and criminal activities / money without paying tax.
Global Stats on Black money
US = 16000 billion dollars
China 14000
Japan 500
India 500
Israel 490
Belgium 439
Percentage of GDP _
India 22 percentage – (Of which 5 five percentage is cash part)
US 8 percentage – (Of which 6 percentage cash component)
China 11 percentage – (of which 7 percentage cash component)
 
A clear distinction tobe made between black money generations Vs back money stock
Our economy is operating insuch a way there seamless interlink between black money and white money
Basic principle of supply and demand – there no significant move till date to address the sectors that generate black money. On top of all of this, this does nothing to control the source of black money. It will not be long before old habits -- under-invoicing, fake purchase orders and bills, reporting of non-existent transactions, and blatant bribery -- generates a new store of black money.
Recent figures – 14.5cros supposed black money, as last 13. 2 per came back to the banking system:
Those who held large quantities of black money seem to have found creative ways to launder it, rather than destroying it to avoid attracting the taxman’s attention, as the government expected. As a result, most of the black money believed to have been in circulation has now flooded into banks, depriving the government of its expected dividend.
Approximately rupees 200 crore of new currency has been impounded through various raids.
Solutions – A well thought through plan and not a knee jerk policy making approach. 

1. Systematic changes – Required
2. Election funding – are out political parties willing to reveals the source of their funding..???
3. Tax reforms – both direct and income tax introductionTransaction taxes
4. Even thinking Abolishing income tax - Only 5 percent of Indian workers’ pay income tax, just 15 percent of the economy is inside the tax net and India’s tax to GDP ratio at 17 percent is 5 points lower than other comparable countries.

Counterfeiting & Terror funding
Data shows only 400 cr is the only counterfeit in India; ArunJailtly the finance Minister told inparliament that only .02% of the GDP is being counter feted.
World number one currency that is being counterfeited in the world is US dollars:
The US has had acute trouble dealing with black money and dirty cash for over a hundred years now. Yet, not once has it declared its currency illegal since it began issuing notes in 1862. That is the strength of its financial system, on which the entire world relies. 
Transition to cashless Economy
Great initiative – India needs tone cashless if it wants to grow & lead the world and if aspireTobetheworlds great power.
Does that situation now require all the poor put under such great distress / gun point to go cashless. Financial inclusion is the greatest thing for inclusive growth.
In India we have 640867 villages.
Only 12500 bank branches – including corporative banks
52000 villages are not electrified – 38 million homes don’t have electricity- which means 36% of our homes are not electrified.
55669 villages don’t have a mobile coverage or phone connection.
Another interesting statistics
Digital India plan proposes to give internet by 2020 – 250,000 villages by implication it means that they only plan for out of 640000 villages only 250000 villages to digitalise.
So arewe really kite flying??
 
Challenges of going cashless
Financial inclusion – the rural continue to experience distress till Govt re monetizes till the previous level.
Lack of enough security system and a unified approach- one thigh can come to those help is the Adar enable payments – and we know how this government was critical of Adhar in the past.
There are lot of payer come into the market –there is lot of work requires Tobe done to have better legislation in place.
Safety and security issues Fire wall –
Digital literacy
What is Govt’s long term Plan????
Many Govt supporters claim that the demonetization policy’s problems are a result of inept implementation. But the truth is that its design was fundamentally flawed. There was no “policy skeleton,” no cost-benefit analysis, and no evidence that alternative policy options were considered. Judging by the blizzard of policy tweaks since the announcement, it seems clear that no impact study was carried out.
My Concluding take –
Things are unfolding day by day …. So far nothing so convincing that is visibleto make any economic sense. My believe demonetisation of this scale should not have happened – even if the govt thought it was an absolute necessity- it should have been preceded by range other measures. To think demonetisation will solve this century old menace of black my and tax criminality is rather naïve. By withdrawing 86 percent of circulating currency when 70 to 80 percent of transactions are cash-based, has the Indian government burned down its economic house in order to eradicate the pest of corruption/Black money?
The jury is out there.