Prime Minister of India Narendra Modi on November 8th announced demonetization of Rs. 1,000 and Rs. 500 notes on with effect from midnight, making these notes invalid in a major assault on black money, fake currency and corruption.
By making the present Rs500 and Rs1,000 currency notes illegal from Nov. 09 onwards, the government has effectively forced the entire country to go to the banks (or post offices) and have their cash (in those denominations) added to their accounts.The surprise step appears designed to hit the finances of Islamist militants who target India and are suspected of using fake 500 rupee notes to fund operations.
Some officials and experts said Tuesday’s move was the biggest in decades aimed at fighting graft.
RBI data shows that in 2015-16, almost 6.5 lakh counterfeit notes were detected in commercial banks of which almost 4 lakh were in the Rs 500 and Rs 1,000 category. It is in this context that the government wants to re-monetise the Rs 500 note while de-monetizing the Rs 1,000 note. But the number of Rs 100 counterfeit currency were also close to 2 lakh this year.
The impacts of the Demonetization
- Immediate Impact: Heavy Deflation, Initially there will be heavy deflation as people who have earned money through illegal means such as smuggling, corruption would be afraid to declare the money as they might be prosecuted by Govt/Income Tax Dept on the legitimacy of their income.This will reduce the total currency circulation in the economy – leading to deflation. Deflation increases the value of money that we have because the total money supply goes down but the commodities and things available in the market have not gone down.
- Gold prices, stocks & commodities will drop. Which will lead to Inflation (eventually). There will be a lot of people who have a lot of cash, legally earned, which they will deposit it in the bank.Now the bank with more deposits can do more lending.Credit (loans) will become easier and interest rates may come down. More loans given out increases broad money supply and creates inflation. But this will happen slowly, not over-night.
- Deflation and Inflation will balance out each other in the future.
- It will help the government to fight Black money, corruption, terrorism and counterfeit currency with one single decision.
- Arms smuggling, espionage and terrorist related activities will be choked due to lack of funding.
- Card transactions will slowly replace the cash transactions in daily activities. It will be easy for the Government to track the money being exchanged as exchange can only be done by producing a valid government identity cards.
- Will help institutionalize the real estate sector bringing more transparency in the Indian real estate industry.
- Housing prices could witness downward pressure, helping revive demand in the sluggish housing segment. It Is estimated to help the common man by putting an end to the artificial increase in Real Estate, Higher Education and Healthcare transactions bringing them within the reach of the common man.
With the good always comes the bad. This declaration comes with its fair share of drawbacks:
- Inconvenience to common people who will start running to the nearby bank to exchange the 500 and 1000 currency notes.
- Costly Affair: A spectacular Rs.6.666 trillion had to be printed using Rs.100 notes, it would cost RBI about Rs.11,900 crore, which is more than a four-fold increase. This is without taking into consideration the increased costs of operating ATMs (since they would need to be refilled more often), and of handling money in general.
- This move deeply impacts the working sections of society: drivers, maids, cooks, electricians, plumbers. Anybody who provides services in the informal sector and depends on monthly or bi-monthly cash payments.
- How is the Govt going to handle situations in which a common man discovers his note is fake.
- It will be a long time before rural India moves to completely cashless transactions. In the short-term, people in rural India who have a significant amount of Rs 500 and Rs 1000 notes, but no official form of identification will have a tough time in exchanging their note.
- The big fish will be left out whose black money is in the form of foreign currency, gold and stashed away in tax havens.
Let’s hope the new law helps restore order in India.