Introduction to Demonetization in India

On November 8, 2016, Indian Prime Minister Narendra Modi announced the demonetization of Rs. 500 and Rs. 1000 notes, two major denominations that accounted for approximately 86% of the currency in circulation. This sudden and unannounced move had far-reaching implications for the Indian economy, affecting a vast array of sectors and millions of citizens.

Objectives and Intended Impacts of Demonetization

The primary objectives of demonetization were twofold:

To curb black money (wealth amassed through tax evasion) and eliminate counterfeit currency To push people towards digital financial transactions, thus promoting financial inclusion

According to proponents, demonetization was meant to disrupt and expose illicit financial flows, and to compel informal sector workers to bring their cash transactions to the formal banking system. However, the implementation and outcomes did not fully align with these expectations.

Impact on the Indian Economy

Black Money and Tax Evasion

The term black money refers to wealth generated from illegal activities such as tax evasion. While demonetization aimed to curb black money, it may not have achieved its goals effectively. According to the Reserve Bank of India (RBI), 99.35% of the junked Rs 500 and Rs 1000 notes had been deposited by August 30, 2018. This suggests that either the hoarders managed to legitimize their black money or did not hold them in the form of cash. Therefore, demonetization did not deliver on its primary objective of eliminating black money.

Terror Funding and Counterfeit Currency

Furthermore, terrorist organizations were known to use fake currency for funding. Demonetization could have theoretically disrupted this practice by increasing the difficulty of using counterfeit notes. The Income Tax department seized Rs. 474.37 crore during the demonetization period. Although there is no clear evidence linking this amount to terror funding, the cash reserves of several terrorist groups were certainly hit.

Regarding counterfeit currency, the number of counterfeit notes detected by the RBI increased in the year of demonetization due to banks screening all deposited notes. However, it is difficult to estimate the extent of counterfeit currency in circulation. In 2018-19, the RBI detected 3.17 lakh counterfeit notes, indicating that demonetization did reduce the proliferation of counterfeit currency to some extent.

Impact on MSMEs

Medium, Small, and Micro Enterprises (MSMEs) faced significant challenges post-demonetization. The informal sector, which comprises a large portion of MSMEs, was particularly affected. The move towards digital transactions presented an opportunity, but many micro industries and workers were unprepared. Many returned to their villages, and the growth rate of these companies plummeted.

Income Tax Payments and Digitalization

The introduction of demonetization significantly increased the number of income tax payers. According to government data, 9.1 million new taxpayers were added post-demonetization, raising the total number of returns to 58,713,458 in 2018-19. The number of filers increased by 10.1 million, reflecting a 80% rise over the typical yearly addition.

While demonetization boosted digital transactions, many argue that the goal of digitalization was an unexpected bonus. The volume of digital payments has grown significantly, with a 55.1% annual growth rate between 2015-16 and 2019-20. This growth has been further accelerated by the COVID-19 pandemic, which has shifted consumer behavior towards contactless transactions.

Conclusion

Overall, demonetization was a bold and disruptive decision that disregarded the advice of the RBI Governor, Raghuram Rajan. While it did not deliver on its primary objectives of eliminating black money and counterfeit currency, it did pave the way for a more digitalized and cashless economy. As the Indian economy continues to evolve, the long-term effects of demonetization will be felt for years to come.