Here’s what the impact will be of Rs 500, Rs 1,000 note ban

By: |
November 10, 2016 6:20 AM

A massive change in informal cash-carry system to formal financing

Notes of denomination of R500 and R1,000 account for more than 85 % of the total value of banknotes in circulation. (Reuters)Notes of denomination of R500 and R1,000 account for more than 85 % of the total value of banknotes in circulation. (Reuters)

The Modi government came to power with a promise to bring back black money and end corruption. Towards this end, in the last two years, it has taken a few major steps. First, it set up an SIT on black money. In Budget 2016-17, it unveiled a new scheme under which those with undisclosed income and assets located in India could come clean by paying a tax of 45%. As an outcome, the tax department reported recovery of R65,250 crore from 64,275 declarations. But the way forward is to move from an economy predominantly dependent on cash to electronic transfers, which needs universal banking accessibility and facility. Therefore, the government launched the PMJDY. Nearly 220 million accounts were opened as of April 20, 2016, with total deposits amounting to a little over R36,700 crore. Further, the government approved guidelines for promotion of payments through cards and digital means in February 2016. The latest bold decision, to demonetise R500 and R1,000 currency notes, is nothing short of a surgical strike on the black economy that would give a massive push to the formal economy. However, the success of this big step depends on how effectively government counters the inconvenience that would be faced by people and groups that solely depend on cash-and-carry economy.

Notes of denomination of R500 and R1,000 account for more than 85 % of the total value of banknotes in circulation. According to RBI data, their share in the stock of currency in circulation at the end of financial year 2014-15 was a whopping 39% and 45%, respectively. Scrapping these is expected to end black money hoarding immediately, as this will reduce high-value cash transactions in the parallel economy and pave the way for formal channels of payments.

Hoarding and counterfeits in R100 denomination notes would be very inconvenient and costly. Promoting the non-cash payment system in the process will lead to better monitoring, regulating and policy effectiveness. As a result it may enable government machinery to widen the tax base, help cleanse electoral politics, control hawala transactions, etc. As Peter Sands, British banker states, “Criminals move more than $2 trillion (£1.4 trillion) around the world each year, corrupt payments amount to $1 trillion and tax evasion robs countries of up to 70% of their tax income”. Since most of these transactions take place in high value currency notes, the move is the boldest step to curb financial crimes.

A massive change, from the informal cash-carry system to formal financing payment system, will give an impetus to the payment and settlement system in India. Though paper-based transactions continued to show a declining trend over the years, it still accounted for 25.4% of the total transactions during 2014-15.

RTGS and NEFT volumes increased almost threefold between 2013 and 2016 reflecting greater adoption of the system by all segments of users. Similarly, the volume of mobile banking transactions has increased nearly seven-fold. Card transactions have also grown significantly at both ATMs as well as at the Point-of-Sale (PoS) with the growth in debit card usage at PoS picking up significantly. It clearly indicates that banks are widely adopting the non-cash payment mode for catering to the objective of faster transaction, improving efficiencies and tackling growing burdens due to relating all the government welfare services (subsidies to the LPG holders, payments to MNREGA, etc.) through bank accounts. Improved efficiency may have implications for reducing interest rate margin by offering reasonable returns to the depositors and soft loans to the investment activities. Moreover, the cut in interest rate measures by central bank can be passed on effectively.

Non-cash payment users in India are only an estimated 10-15 % of the population, compared to 40% of people in countries like Brazil and China. Meanwhile, as of 2014, India’s ratio of currency in circulation outside of banks to GDP was 11.1%, higher than other emerging economies like Russia, Mexico, and Brazil. It puts forth ample scope for strengthening the base of untapped non-cash user market. Increasing the horizon of non-cash users along with convenient, reliable, secure, and affordable payment systems will have implications for access to other financial services such as loans and insurance to the unbanked particularly in the wake of financial inclusion initiative. However, the possible challenge is to strengthen the digital infrastructure of banks along with safe transactions with vendors, failing which threat of cyber related theft may increase.

The concern comes from rise in printing, replacement and maintenance cost of fresh money equivalent to the high value denominated bank notes. However, the substitution with notes of R2000 denomination may address the supposed increase in cost problem. Higher visits to ATMs for depositing and withdrawal will lead to higher transaction costs for the bank as well common people. There are also concerns of deflationary impact as many productive sectors like real estate, trade constructions, transports, etc., use black money or high value denominated currency notes in huge amount for day to day business. There is apprehension that with this move the people involved in the black economy may try to convert their holding into real estate, but already stringent transparency rules in the land or property dealings will curb those practices. Overall, the move by PM Modi to demonetise is being hailed across the board as it would facilitate a crack down on rampant corruption and counterfeit currency. The move is a big blow to the black economy of India.

Pravakar Sahoo is associate professor, Institute of Economic Growth, while Ashwani Bishnoi is assistant professor, NIT, Kurukshetra. Views are personal


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