custom writing uk

Demonetisation: The real need and compulsions

Government took a major initiative to cling the economic system through demonetization. It created huge  economic disruption with 85% currency reverting back to the banks. According to government, the 4 major objectives behind this demonetisation is to curb

  1. Corruption
  2. Counterfeiting
  3. Terrorist activities
  4. Black money

My article tries to analyse the compulsions which forced government to withdraw over 80% of the currency from a country that is highly cash dependent.

The facts that motivated demonetization can be summarised under following heads

  1. High Currency/ GDP ratio
  2. High cash dependent economy
  3. Dominance of high denomination currency
  4. Mismatch between present PCI and high value currency notes
  5. Soil Rate of low denomination currency notes is much higher than that of high denomination currency notes.

Dimensions of currency

Before going into the details of real motive behind demonetization, we must try to understand the dimensions of currency.

Cash can be understood in terms of two dimensions:

  1. In terms of function, cash can be used as
  • Medium of exchange i.e. transaction, or
  • A store of value
  1. In terms of nature, it may be
  • Legal, or
  • Illegal

So, we may find legal or illegal transaction as well legal or illegal store of value

Illegal transaction leads to the growth and progress of corruption, counterfeiting and terrorist financing.

Illegal store of value results in the generation of black money.

Now we can analyse government’s compulsion of demonetization one by one.

Currency/ GDP ratio (C/GDP)

First we should know the different cases of C/GDP ratios and then we will try to correlate them with Indian conditions.

Two conditions may occur: one when the ratio increases and second, when the ratio may decline.

  • Increasing ratio may be either due to increase in currency circulation in the market, or decline in GDP
  • Decreasing ratio may be either due to decrease in currency circulation in the market, or increase in GDP

However, these two cases may lead to different possibilities under increasing or decreasing C/ GDP. First ratio increase may be when

  1. Currency circulation in the market increases with GDP declining or remaining constant. Under this situation high C/ GDP ratio indicates the generation of black money.
  2. Currency circulation increases with corresponding increase in GDP. This has lesser potential for black money generation.
  3. GDP decreases with money supply either constant or increasing. This also indicates the generation of black money.

Secondly, ratio decrease may be when

  1. Currency in the market decreases and GDP either remain constant or increases. This is a difficult condition to assume.
  2. GDP increases and currency supply increases with lesser intensity. This has lesser potential for black money generation.

So, we may conclude that the chances of black money generation arise when there is mismatch between money in circulation and the GDP growth.

Indian scenario and C/GDP Ratio

  • Just after independence C/GDP Ratio was high at 12%
  • It declined to 9% in 1967-68
  • There after the ratio seems to have responded to the growth
  • It began its upward trend in late 1970s when growth increased
  • It further accelerated during growth boom of 2000s
  • It declined in late 2000s and early 2010s during the period of high inflation
  • It rebounded to 12% after 2014-15 when inflation declined.

NOTE: With such high C/GDP ratio in India, there is maximum possibility of black money generation.

High cash dependent economy

Indian economy is highly cash dependent economy but it does not reflect in GDP growth.

So, we may conclude that some of the cash holding were not used for legitimate transactions but for other activities like corruption.

According to Transparency International, there is direct relationship between cash in circulation and the level of corruption.

Dominance of high denomination currency

India’s high level of currency circulation is dominated by high denomination currency notes. (over 80% in 500 and 1000 currency notes)

High value currency notes are mostly used for store value rather than for transaction.

These stored high value notes are used more for other activities, rather than facilitation of economic transactions.

Mismatch between present PCI and high value currency notes

High level currency notes do not match with the current level of PCI.

The higher the note is relative to income, less likely it is to be used purely for transaction purposes.

In India, it is still high, though in the last few decades after 2000s, it has fallen. So, we may say that high denomination note have become increasingly useful for transaction in recent past.

Soil Rate (SR)

Soil rate is the rate at which notes are considered to be too damaged to use and have been returned to the central bank.

In India, SR of low denomination currency notes (SR-HCN) is 33%, while that of 500 notes is 22% and 1000 notes is 11%.

If different currency notes are equally transacted, then there SRs must be the same. Since SRs of high denomination notes (SR-HCN) are less, it indicates towards the generation of non-transacted black money.

However, this assumption need not be correct, as higher denomination notes are less frequently used as compared to low denomination notes and so SR-LCN  is higher than SR-HCN.

Conclusion

A country with such large cash circulation that does not translate into economic growth must have other utilities in the form of corruption and black money. So, this condition was the real hindrance against inclusive growth and social justice, which are the core of our constitutional and political thought. 

Therefore, according to me the core objective of demonetisation can be summed up as

  1. To curb corruption
  2. To limit counterfeiting
  3. To restrict terrorist activities
  4. To remove black money from the system
  5. To encourage inclusive growth
  6. To achieve social justice
  7. To reduce rural- urban divide
  8. To promote sustainable development 
Please follow and like us:
100
error: Content is protected !!