Dissecting the demon of demonetisation

Demonetisation is believed to kill the black money market but encouraging banking is also a potential solution to prevent the flow of black money. We deep-dive into whether the socio-economic culture of India was conducive to implementing this scheme here which could have had a positive outcome elsewhere.

Status quo
Investopedia.com states that demonetisation is "the act of stripping a currency unit of its status as legal tender." On November 8, 2016, the government of India announced that the existing high value currencies of Rs. 500 and 1000 would be invalid post midnight. A week later, on November 16, 2016, firstpost.com reported of more than 30 deaths related to demonetisation followed by the alleged loss to the small businesses in the wake of cash crisis triggered by demonetisation. From demonetisation, related deaths to speculations about its failure, the policy has been in light for various reasons.

Did demonetisation succeed in curbing black money in India?
Black money has always been a concern for the Indian economy. Its detrimental effect was felt and analysed as early as mid 1940s. The governments in the past too have demonetised high value currencies. "The first instance was in 1946 and the second in 1978 when an ordinance was promulgated to phase out notes with denomination of Rs. 1,000, Rs. 5,000 and Rs. 10,000 (Geeta Rani, 2016)."

The dichotomy
Four decades later, there are people who are confident about the scheme and claim a 'positive impact' in the coming time. "By adopting the cashless means certainly there will be a check on black money." (Geeta Rani, 2016). Others believe that "demonetization is a progressive shift to a cashless economy with a greater focus on electronic transactions" (Manpreet Kaur, 2017) subsequently beneficial for the economy.

However, critics argue that in a country like India where the majority of the population lives in rural areas and where "70 to 80 percent of transactions are cash based; the Indian government has burned down its economic house in order to eradicate the pest of corruption." (M. Angel Jasmine Shirley, 2017).

Versus opinion
India is not the first country to replace the high value currencies.

1. United States - In 1969, US demonetised the high value currencies above 100 dollars for prevention of black money. (Tyagi and Narula, 2017). The move was successful because the high value currencies were pulled out from the economy, destroyed and never came back in contrast to India where they were reintroduced. The development of an effective banking system ensured the long term success of the policy. (mostlyeconomics.com)

2. Venezuela - In 2016, Venezuela withdrew its high value 100 Bolivar notes, again to fight black money. (Counterview.org) As they ran into cash crisis like India, the Venezuelan government had to postpone the project until having devised a proper implementation strategy.

3. Zimbabwe - In 2015, the government of Zimbabwe decided to replace its own dollar with US dollar. The decision had an unintended result on the economic growth. The growth rate plummeted because the exports were unable to compete in the market.(qz.com)

4. Philippines - Demonetisation was announced around the end of 2014 before its implementation in January 2015 (cnnphilippines.com).Fighting counterfeit currency was the reason for the decision. There are two major differences between India and the Philippines' approach in implementing the policy. Philippines granted a one-year period for the exchange of old currencies unlike India where few weeks were given and since people had enough time to replace the cash, it ensured a smooth transition. Second, unlike India where the currencies are replaced with new ones, Philippines decided to withdraw small currencies for good.

When and how can demonetization work?
1. Identifying the sources of black money generation

2. Internet literacy and black money

3. Banking, Black money and Demonetisation

Identifying the sources of black money generation
While demonetisation has presented its own challenges, the efforts have been towards inventing instant solutions rather than attacking the root cause – black money. The approach taken by Subash Sonawane (Inevitability of Black Money, 2013) helps in understanding black money in India subsequently developing a better strategy to curb it.

Sonawane focuses on two specific areas which need an immediate attention. He considers elections and real estate transactions as two largest sectors which facilitate the generation of black money.

For elections, he suggests that the political parties should not be given donation by corporate companies because they influence policy making process and even a legal reciprocity would generate black money. Involvement of black money in elections has been a concern for the election commission of India.

Internet literacy and black money
One thing that is common between all those countries where demonetisation has worked is the usage of internet banking. For example in Sweden around 83% transactions were done through net banking in 2016.(statista.com) A cash less transaction system is difficult if the people are uninformed about it. Internet plays a crucial role here. While 460 million internet users looks like a huge number, it's relatively low considering the total population of India which is more than 1.3 billion. Also, there is a huge divide between the rural and urban users. Only 20% of the population in the rural areas use internet compared to 60% urban population. (Economic Times, 20 February, 2018). Notwithstanding, in the remote areas of the country where electricity is still a far-fetched dream, usage of computers could be bedevilled by the lack of infrastructure.

Banking, Black money and Demonetisation
An ordinary fruit vendor in India opens his roadside shop in the morning and returns home with his/her earnings in the evening. In a span of 10 years he/she saves an amount, which may not be the result of a dodgy transaction, but will be categorised as black money for want of education, for want of a formal banking account, etc. In the wake of current scheme those who suffered the most were what I would call the 'piggy bankers'. For three reasons, banks have never attracted the lower middle class which is the biggest economic category in the country.

1- Trust deficit with banks because of the hidden charges.

2- Lack of infrastructure especially in the rural areas

3- Banks are distrusted due to their invasive and lucent nature.

While banking has its undeniable benefits and should be promoted at all levels, banking as a habit will take time to develop unless people are taken into confidence.

Two cents' worth
Since black money is not confined to cash alone with substitutes like investing in real estate, jewellery and shell companies, demonetisation in isolation might not address this issue. India even today lives in its villages, hence, a cashless transaction on the lines of western countries like US or UK is difficult. In the countries where it worked, they had a proper banking system which would provide people an alternative source of payment method rather than heavily relying on cash. Drawing lessons from different countries, India needs to work on the implementation of the scheme. While people should be imparted basic training to use internet in the rural areas, fostering belief in the banking system is imperative. A trust in the system will encourage people to deposit in banks rather than stashing cash at home.