A promoting terrorist activities. The increasing incidence

A Year After Demonetization – To a
Cashless Economy

Neha Mangla

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Abstract: Money is the backbone of all the
capitalist economies of the world. It has eased on the exchange process in the
economies by making sale independent of purchase. Money is also a universally
accepted medium for exchange and also acts as a store of value that can be used
at any point of time. However, for any economy to function efficiently the
right amount of money circulation is required. The Indian economy has been
seeing a major increase in the generation of black money over the years. Also a
lot of fake currency is in circulation in the economy that is being used for
illegal and malpractice especially for promoting terrorist activities. The
increasing incidence of counterfeit currency and the growing parallel economy
makes the monetary policy ineffective and hence increases economic instability.

India
is a cash based economy with majority of the transactions taking place in the
form of cash. With the aim of curbing the menace of black economy, removing the
illegal money from the financial system and transforming India to a digital
economy, Prime Minister, Narendra Modi,on 8th November 2017,
declared that the two highest denomination currency notes in circulation i.e.
500 and 1000 rupee notes will no longer be legal tender and the same were
demonetized with effect from midnight of 8th November.  The big economic decision was taken primarily
to rid the economy of fake currency and to counter the tax evaders who had
illegitimately acquired wealth in the form of high denomination currency notes.
The move was also aimed at moving India from a cash based economy to a cashless
one by promoting more digital payment options.

This
paper is based on secondary research to understand and evaluate the impact of
the demonetization on transitioning India to a cashless economy.

 

1.     Introduction

At present, India is on
paper currency standard. The Reserve Bank of India is responsible for issuing
and circulating of money in the economy under the minimum reserve method.

As per RBI’s annual report,
at end-March 2016, banknotes worth Rupees 16,415 billion were in circulation in
the economy. Of these, 500 and 1000 rupee notes accounted for 86.4 percent of
the total value. As per the report, the proportion of counterfeit notes was
highest for higher denomination notes of 500 and 1000 rupees.

The fake notes are used
for financing illegal activities in the economy, especially terrorist
activities that are posing a major threat to not only the social and political
environment but also the economic growth of the Indian economy.

Also, as per various
studies, it has been estimated that the size of black economy in India is quite
large and is increasing. India’s parallel or black economy is estimated to be
around 25 percent of India’s GDP and Cash Black economy around 10 percent of
GDP. This size of the parallel economy breaks down the entire economic activity
in the economy by failing economic policies and also by reducing the tax base
and hence government revenues.

Das
& Aggarwal (2010) in their article ‘Cashless Payment System in India-

A
Roadmap’ have discussed the disadvantages of a cash based economy that India
currently is. They have cited, high cash management costs, lack of accountability
and possibility of frauds as some of the disadvantages of cash based economies.
Accordingly, demonetization as an economic move aimed to help move India to a
digital platform and promote cashless transaction options, like debit and
credit cards and other digitized payment platforms.

 

Through this article we
will try to analyze the impact of this major economic move on the economic and
financial aspects of the Indian Economy during the one year period post
demonetization was announced.

2.     Literature
Review

Alvares, Cliford (2009)
reported the problems pertinent to the fake currency in India. It is explained
in the report that many fake notes are going undetected and the battle against
the fake note is harder.

Das & Aggarwal (2010)
analyzed the cash transaction system in India and suggested that India should
move on to being a cashless economy as the high cash dependency in the economy
meant huge currency management costs for the government. Moreover moving to a
less-cash economy would ensure, better tax compliance, encourage financial
inclusion and integrate the parallel economy to the main economy.

2.1 How has
Demonetization affected the Indian Economy so far?

The key rationale behind
the big economic move was to curb the unmanageable and unaccountable black
money that was circulating in the economy and was being used for many illegal
and unproductive activities. However, almost 10 months after the demonetization
exercise, the Reserve Bank of India in it’s annual report stated that a total of 15.28 trillion rupees ($239 billion) worth
of cancelled high-value notes were deposited or exchanged for new money in the
10 months since the strategy was implemented. This accounted to 99% of the
total value of the demonetized currency. This figure suggests that almost all
of the people with illicit cash were able to save their fortunes and
demonetization was unable to get the unaccounted cash out of the system.
Despite this failure, the government is probing suspicious bank account
deposits and investigating many accounts to catch the guilty. The results are
yet to be seen.

In value terms, the share
of 500 and above banknotes, which had together accounted for 86.4 per cent of
the total value of banknotes in circulation at end-March 2016, stood at 73.4
per cent at end-March 2017, RBI report said

The demonetization
exercise may not as yet have been able to pump out black money from the system
but it came in as a major economic shock for the Indian economy and affected
almost all the aspects of economic activity. There was a slowdown in the growth
rate of GDP because of both a decrease in the consumption expenditure and
investment expenditure. Consumption expenditure decreased because of the cash
crunch in the economy and investments decreased because of uncertainties and
limited consumption demand. However, a year after demonetization we do see that
the economy has started settling back and accepting the big move. There has
been a revival in the economic activity in the economy helping a revival in the
growth rate of GDP.

Fig.
1

 

Source: http://www.moneycontrol.com/news/business/economy/live-gdp-growth-arun-jaitley-gst-demonetisation-2451001.html
: http://www.moneycontrol.com/news/business/economy/live-gdp-growth-arun-jaitley-gst-demonetisation-2451001.html
http://www.moneycontrol.com/news/business/economy/live-gdp-growth-arun-jaitley-gst-demonetisation-2451001.html
http://www.moneycontrol.com/news/business/economy/live-gdp-growth-arun-jaitley-gst-demonetisation-2451001.html
 

 

As suggested by the data,
post demonetization was announced in Q3FY17, the GDP growth rates slipped
during the last quarter of the financial year 2016-2017 and the first quarter
of financial year 2017 – 2018. However, there has been a reversal in trend and
the GDP growth started showing an uptrend in the second quarter of 2017-2018.  

2.2 Cashless Payment
System

With the evolution of the
banking system, it became a safe, easy and income generating place for keeping
and storing money. Also, the banking system helped in making money transfers
and exchanges easier by using different payment instruments. Till sometime back
cheques were the most common used instrument for cashless transfers through
banks.  

However, with so many
innovations happening every day in the field of information technology to make
customers life easy, there have been many developments in the different kinds
of cashless payment systems available today. Various types of payment options
exist today that meet the different requirements of users and help them in
transacting with ease and convenience. These days apart from cheques, we have net
banking facility, plastic money options like debit & credit cards,
e-wallets & mobile wallets like Paytm & Mobikwik, prepaid payment instruments
like gift cards & vouchers, and the recently launched Unified Payment
Interface (UPI) that help users to transact without cash. The use of such
systems help in promoting a less-cash dependence amongst people.

3.     Findings:
Role of Demonetization in helping India transition to a cashless economy

Apart from taking care of
counterfeit currency and the growing black economy, one of the aims of
demonetization was also cited as to help transition India from a current cash
based economy to a less-cash economy. So it was said that once all the cash
currency in circulation was siphoned back to the banking system through
demonetization, it will lay the foundations for transitioning to a digital
economy.

As cited by Das & Aggarwal
(2010), 95% of the retail sales in India is dependent on cash. High pricing of
debit cards acts has a disincentive for small and medium merchants to shift to
card based payment systems. The high cash dependence in turn results in high
pressures for currency management, tax leakages and limited financial inclusion.

However, the biggest
problem related to the demonetization exercise in India was to suddenly remove
86% currency in circulation without any provision for supplying new notes
adequately. In one go people in India were left without any means to transact
economically, to meet even their daily needs, given the heavy reliance on cash
as the medium of exchange. Even small businesses were trapped as their payments
were delayed and so they did not have money to finance further supplies.

The extent of the
dependence of the economy on cash was evident from the fact that India is the
only country where Uber (worldwide cab facility provider) accepted cash as a
payment option.  Also, for around 70% of
the online shoppers in India, “Cash on Delivery” was the preferred choice.

Thus with demonetization,
the people of India were left in the middle of the sea with their basic means
of surviving snatched and no alternative provisions made. At first sight it
seems that it was a major implementation glitch of the entire exercise, but,
deeper insights provide that this surprise was to push millions of cash dependent
people to the country’s digital framework and take the first step to ‘Digital
India’.

Fig.
1

 

As envisioned, removing
notes from circulation acted as a catalyst for mobile money and other forms of
electronic financial transactions. There was a rise in the use of debit and
credit cards, and new users added to the digital payment category. The first few
weeks after demonetization saw 300 percent increase in the use of digital
payment options. The growth has continued as reported by MG Arun, India Today (4th
November, 2017), ‘Demonetisation shook
the economy. Did it break it, or leave it healthier?’ (accessed on 20th
January, 2018). There was a 80 percent increase in the point of sale
devices over the 9 month period post demonetization from November 2016 to
August 2017. Paytm registered a three times increase in new users with 14
million new accounts in November alone.

However, the initial
surge in the use of digital payment options has started witnessing a decline as
the economy is getting remonetized and the currency in circulation is back to
its initial levels.  The card
transactions, though still higher than the pre-demonetization period, have
started showing a dip in both volume and value terms after the initial peak
reached just after demonetization was announced.  

Source: MG Arun, India
Today (4th November, 2017), ‘Demonetisation
shook the economy. Did it break it, or leave it healthier?’, http://indiatoday.intoday.in/story/demonitisation-note-ban-bjp-modi-economy-arun-jaitley-gdp/1/1080524.html  (accessed on 20th
January, 2018)

4.    
Conclusions

Across the world cashless
payment systems are growing day by day facilitating economic transactions by
providing users ease and convenience. Also, a less-cash society results in more
monitored financial economy with less tax avoidance, less illegal money and
helps in financial inclusion of everyone contributing to the growth of the
economy. Less-cash dependency is what is needed for India as well to make the
economic and financial system more effective and economy corruption free.
Demonetization has helped in giving the first big push for digital transactions.
However, to ensure the continued growth and promotion of cashless transactions
the government needs to provide appropriate incentives to promote such
transactions and charge cash transactions to discourage them.    

References