1. Demonitising Rs 500, Rs 1,000 notes: Ban to boost demand, say experts

Demonitising Rs 500, Rs 1,000 notes: Ban to boost demand, say experts

Most experts have stood by the government’s decision to demonetise R500 and R1,000 notes, saying the measure would gradually integrate the black economy with the formal one...

By: | New Delhi | Updated: November 10, 2016 8:12 AM
Finance minister Arun Jaitley on Wednesday said the move would not just nudge but push the economy in the direction of becoming a cashless economy.

Most experts have stood by the government’s decision to demonetise R500 and R1,000 notes, saying the measure would gradually integrate the black economy with the formal one, boost tax receipts and savings, curb inflation, buttress banks’ ability to support the economy and give a push to aggregate demand in the medium term.

Finance minister Arun Jaitley on Wednesday said the move would not just nudge but push the economy in the direction of becoming a cashless economy. Stating that the clampdown on black money would enhance the credibility of the country’s financial system and the economy, he said: “It pays to be honest. And the not-so-honest are being left to worry.” The minister warned that people exchanging huge amounts of old notes would have to explain the source of money as they won’t enjoy immunity from tax.

The Reserve Bank of India (RBI) would issue new R500 and R2,000 notes to replace the scrapped ones fully in about two-three weeks.

Analysts said given the over 14 lakh crore that was in circulation until Tuesday as the two high denomination notes, even by a conservative estimate, at least a 10th of of these would return to the banks in the form of disclosures. It could be legitimate to expect that such disclosures would give a giant push to tax collection. Under the recent Income Disclosure Scheme, R65,000 crore of unaccounted money was unearthed and 45% of this would reach the exchequer through FY18.

Though the withdrawal of R500 and R1,000 notes could be disruptive of some economic activities in the short term and have a sobering effect on certain consumption, it could help increase the aggregate demand in the medium term as enhanced bank credit could catalyse investments.

“We do not see any major impact on general consumption as most consumers in India use small denomination notes for small-value items and transactions and they can anyway exchange their current high-denomination notes with new ones at their banks,” wrote Kotak Institutional Equities.

The firm, however, added: “We see a modest negative impact on consumption of high-value items as entities and individuals with large amounts of undisclosed cash (and income) focus on managing their finances rather than on spending in the short term.”

Deloitte lead economist Anis Chakravarty said there would be a disruption in the current liquidity situation as households could be affected by the note exchange terms laid by the government. “It is estimated that there will be a negative GDP impact in the current quarter as consumption gets a shock in the immediate term,” he said. The real estate sector is likely to see a significant negative impact in the medium to long term particularly in the repurchase market, Chakravarty added.

On reports that cash-rich people are buying gold to evade scrutiny, Jaitley said government agencies and RBI were keeping a close watch on such transactions and ultimately the cash receiver would have to account for the source. To a criticism that why the government is introducing R2,000 notes, he said, in fact, the RBI had proposed introducing R5,000 and R10,000 notes, but the government decided against it.

Former finance minister P Chidambaram criticised the government’s move, saying that a similar step to stamp out high value notes in 1978 by the Janata government failed to achieve its objectives. “Ultimately, only the old notes that are not legally exchanged for new notes will be actually demonetised. How much will that be, by value, is uncertain and unknown. This will be the real test of the success of demonetisation,” Chidambaram said.

Estimating that the introduction of a new series of notes to cost between R15,000-R20,000 crore, the ex-minister said the economic gains of demonetisation should be at least equal to that amount.

Rating agency Crisil said the government move would have a transitory impact on GDP growth in the short term, but will spell significant structural benefits over the long term. “In 2007, the World Bank estimated the size of India’s shadow economy at 23.2% of GDP. Assuming this ratio still holds, that’s about $479 billion unaccounted for. Much of that money should get mainstreamed because of the demonetisation move,” it said.

Notes allowed for some essential payments

Even though the government discontinued the legal tender of R500, R1,000 notes, it has allowed use of these for some essential payments such as paying hospital bills. This list was expanded on Wednesday to include payments such as those for Metro rail, pharmacies and LPG cylinders, among others.

To deal with the rush to exchange notes, banks will remain open on coming Saturday and Sunday while 1,55,000 network strong post offices and bank correspondents have been roped in in rural areas to help people deposit and withdraw cash.

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