[Editorial Analysis] The debacle of demonetisation

Mains Paper 3: Economy
Prelims level: Demonetisation
Mains level: Post demonetisation issues and developments


• On November 8, 2016, the Prime Minister announced that from midnight, ₹500 and ₹1,000 notes would no longer be legal tender. The total value of the currency affected by this move was 85% hence referred to as demonetisation. A former U.S. Secretary of the Treasury has commented that this was by far the “most sweeping change in currency policy that has occurred anywhere in the world in decades”.

Aim of the move:

• Black Money argument: The original argument given for demonetisation was that it would extinguish unaccounted or ‘black’ money. The presumption underlying this was that with unaccounted income inevitably held as cash, owners of these hoards would be hesitant to turn them in to banks as they would have to explain the source.

• Retort: it was pointed out that unaccounted income is very likely to have been converted into real assets or transferred overseas, the government shifted the narrative. Further, the RBI’s Annual Report of 2019 settled the issue conclusively when it reported that approximately 99% of the affected money supply was deposited into accounts with commercial banks.

• ‘Less Cash’ Argument: Government explained that the move was meant to get the economy to run on ‘less cash’.

• Retort: the ratio of currency with the public to national income has, at 11.5%, remarkably remained the same from 2015-16 onwards. Money seems to remain a chosen medium of exchange for Indians, even if purchases are increasingly being made online. This is because expenditure in India is largely done using savings in Cash, even when using e-commerce.

• Further, if main reason was less cash then, demonetization should have been done patiently after providing comprehensive financial inclusion through taxation policy and other incentives.

• ‘Increasing direct tax’ Argument: it strongly asserted that the move would incentivise direct tax payment and this would raise the government’s revenues sufficiently to allow for greater public investment and the provision of more public services.

• Retort: The ratio of direct tax collections to the national income rose marginally in 2016-17, but higher rates had been achieved earlier. It continued to rise marginally for two more years, but this cannot confidently be attributed to demonetisation alone. The Goods and Services Tax introduced in 2017 may have nudged potential income tax assesses to comply with the law due to the surveillance that came into force.

• We can see in the Finance Ministry’s latest ‘Budget at a Glance’ that the trend of a rising direct tax to national income ratio came to an end in 2019-20, and is now lower than it was at the beginning of the decade.

Problems created by Demonetization:

• Reversing growth acceleration:

• In 2016-17, India’s economy did register a slight increase in the rate of growth as the growth of the agricultural sector registered a positive swing of over 7%, due to good monsoon.

• But in the other sectors of the economy, production could have been held back by the cash crunch engineered by demonetisation, thus slowing expansion.

• Nevertheless, growth of the overall economy did not slow in 2016-17 as much of the services sector held out. However, annual growth has been slowing continuously ever since.

• Imposing hardship:

• Numbers cannot, however, capture the hardship and insecurity that were so casually imposed on the population by the move. The country was thrown into utter chaos with people trying to change their hard-earned small cash savings in banks that were utterly unprepared for the task.
• The supply chain for farm produce was severely disrupted but a history of informal credit meant that it did not die out entirely. Indeed, India was bailed out by the traditional practices of its business communities, even as the government was ostensibly goading it into modernity.


• The Economic survey of 2016-17 had itself pointed out that Demonetisation was potentially a shock in three ways:

• an aggregate demand shock, because it reduces the supply of money and affects private wealth

• an aggregate supply shock to the extent that cash is a necessary input for economic activity

• an uncertainty shock because economic agents face imponderables related to the impact and duration of the liquidity shock.


Prelims Questions:

Q.1) With reference to the India and France relations, consider the following statements:

1. France recently reiterated its commitment to fully support Prime Minister of India’s vision of Atmanirbhar Bharat and defence industrialisation, joint research and technology development in India.

2. Both the countries agreed for closer partnership between the two countries, including in the UN Security Council and other UN forums.

Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Answer: C

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