2. What is Demonetization ?
Demonetization of currency means discontinuity of the
particular currency from circulation and replacing it with
a new currency.
3. Global Examples of Demonetization
Nigeria in 1984
Pakistan in 2016
Zimbabwe
5. India Demonetized
At the stroke of the hour on midnight of 9th November
2016, India lost 86% of its monetary base.
In this single move, the RBI has attempted to tackle all the
three issues affecting the economy:
6. Major Reasons for India to
Demonetize
Shadow economy
Counterfeit currency in circulation
Terror financing.
7. Rationales for Demonetization
1. Boost deposit base and savings
The banks' deposit base is expected to receive a fillip of
0.5-1.4% of GDP.
In turn, financing savings can be expected to rise by close
to this proportion due to switch from savings from
unproductive physical assets to financial assets.
8. Rationales for Demonetization
2. Improve monetary transmission and reduce lending rate
A rise in deposit base will allow banks to lower the
blended cost of funds as higher CASA (current accounts,
savings accounts) deposits help to replace the high cost of
borrowing and lower overall cost of funds.
9. Rationales for Demonetization
3. Create room for further monetary accommodation
With improved monetary transmission, economic
efficiency and structural moderation in currency in
circulation, there is likely to be a greater room for the RBI
to ease monetary policy rate further. I am hopeful that
the RBI will ease by another 100 bps in 2017-18 to a repo
rate of 4% by March 2018.
10. Rationales for Demonetization
4. Support government finances
With some part of unaccounted money making way into
the formal channel, the government stands to benefit
from higher income tax collections. This should help
cushion the government's FY17 fiscal deficit target,
especially post the shortfall in anticipated spectrum
revenues.
11. Rationales for Demonetization
5. Positive impacts from a bond market perspective
Improvement in bank deposit base leads to higher SLR
(statutory liquidity ratio) demand.
Anticipation of monetary easing to further support
bonds.
12. Rationales for Demonetization
6. Rise in GDP growth potential
While there are short-term implications for growth in
cash-intensive sectors such as real estate, construction,
and discretionary household consumption in general, I
believe that long-term benefits for GDP growth will
outweigh the short term transitional impact. We are now
surely heading towards a 9% GDP growth by FY2018-19.
14. Steps to Demonetization by RBI
As a first step the central bank had urged people to create
bank accounts under Jan Dhan Yojana. They were asked
to deposit all the money in their Jan Dhan accounts and
do their future transaction through banking methods
only.
The second step that the central bank initiated was a tax
declaration of the income and had given
15. Steps to Demonetization by RBI
October 30, 2016: deadline for this purpose.
Government was able to mop up a huge amount of undeclared
income.
Government gave part of the salary as cash to its employees
This might lead to a further increase in shortage of currency.
There are about four printing presses for currency in India and
depending upon the value and number of pieces of Rs.500 and
Rs.2000 to be printed
Might take a long time taking into account the large scale of
withdrawal of the monetary base.
16.
17. CRR and Demonetization
RBI has asked banks to maintain an incremental cash
reserve ratio of 100% to absorb the excess liquidity.
The cash is now a liability as banks have to pay interest on
savings accounts, but they are not earning interest under
the new 100% reserve requirement rule.
18. CRR and Demonetization
Putting the demonetization deposit as CRR means banks
can’t give any loans out of these temporary deposits.
Building assets or giving loans out of this very short term
money will be disastrous for banks as these deposits
should be given back quickly.
Some banks made wrong announcements about loan
hikes out of the windfall deposit bonanza.
19. Arbitrage and Demonetization
The present decision is to manage the excess liquidity
conditions prevailing in the banking system.
Already, the inter-bank call money market has fallen
below the repo rate.
This may encourage banks to borrow from call money
market and lend it to RBI; which is often called as
arbitrage.
20. Immediate Impact of Cash Crunch
The total transaction
value is more than 7
times the end-of-year
value of assets, and
about 16 times the end-
of-year financial net
worth.
This household needs to
do high frequency cash-
intensive transactions
just to make the timing of
consumption match the
timing of money
availability.
Table: Financial life of a tailor’s household in
eastern Uttar Pradesh.
21. Impact of Demonetization in
Inflation
The demonetization that has been in effect since
November 9 is expected to have a negative impact on
inflation
Activity in the real estate sector, which includes a lot of
cash and undocumented transactions, slowed down
significantly, Metropolitan and Tier 1 cities reported up to
a 30% fall in house prices
Food item inflation, measured by changes in the
Consumer Food Price Index, accounts for 47.3% of the
overall CPI.
22. Post-Implementation Period of
Demonetization
85-86% that has been demonetized is in the process of
getting replaced.
The other thing which has complicated the issue is the
lack of standards in the currency notes.
New currency notes have got new set of standards which
cannot be used in the ATMs without recalibration.
This has further added to the chaos. If the standards
would have been same, the ATMs could have disbursed
the notes without any delay.
23. Post-Implementation Period of
Demonetization
The economy was used to a system by and large where
people do not need to visit their banks for day to day
purposes. Management wise, response system of the
banks has not been satisfactory.
There might be a downturn in the economy because of
the lack of demand and businesses not running as usual.
As far as the black money issue is concerned, this step
only checks the stock of black money and not the flow
which is the root cause.
24. Merits of Demonetization for India
The demonetization policy will help India to become
corruption-free.
Those indulging in taking bribe will refrain from corrupt
practices as it will be hard for them to keep their
unaccounted cash.
This move will help the government to track the black
money.
It will also stop funding to the unlawful activities that are
thriving due to unaccounted cash flow.
25. Merits of Demonetization for India
The ban on high value currency will also curb the menace
of money laundering.
This move will stop the circulation of fake currency Which
are mainly 500 and 1000 notes.
This move has generated interest among those people
who had opened Jan Dhan accounts under the Prime
Minister’s Jan Dhan Yojana. They can now deposit their
cash under this scheme and this money can be used for
the developmental activity of the country.
26. Merits of Demonetization for India
The demonetization policy will force people hiding their
income to pay income tax returns.
This will help the income tax department to track
individuals with high denominations currency.
The ultimate objective is to make India a cashless society.
All the monetary transaction has to be through the
banking methods and individuals have to be accountable
for each penny they possess.
27. Demerits of Demonetization for India
The announcement of the demonization of the currency
has caused huge inconvenience to the people.
They are running to the banks to exchange, deposit or
withdraw notes.
It has deeply affected business. Due to the cash crunch,
the entire economy has been made to come to a
standstill.
28. Demerits of Demonetization for India
Many poor daily wage workers are left with no jobs and
their daily income has stopped because employers are
unable to pay their daily wage.
The government is finding it hard to implement this
policy.
It has to bear the cost of printing of the new currency
notes. It is also finding it difficult to put new currency into
circulation.
29. Criticism
The 2000 rupees note is a burden on the people as no
one likes to do transaction with such high value currency.
Some critics think it will only help people to use black
money more easily in future.