By Deepthi Mary Mathew* | Written on 10 November 2016
The Prime Minister announcing the withdrawal of the legal tender status of Rs 500 and Rs 1000 notes was conceived as a surgical strike on black money. At the same time, the demonetisation of currency is intended to push the economy towards a less cash society. In a less cash society, the menace of black money can be controlled to a large extent. The notion of demonetisation of currency is not novel. Mario Draghi, the President of European Central Bank, proposed the idea of scrapping €500 notes early this year. The move was mainly to curb funding for terrorism and to lift the economy from deflation. Kenneth Rogoff, in his latest book, The Curse of Cash, also proposed the idea of moving towards a less cash society. He recommended the phasing out of $100 bills, followed by $50 and $20. According to Rogoff, move towards less cash society can help boost economic growth by shoving the economy to negative interest rate territory. Negative interest rate regime discourages savings, inducing the people to spend more, which can add up to the GDP of a country.
Demonetisation is among the various steps taken by the Central Government for fulfilling one of the key promises made during the 2014 Lok Sabha election campaign – fight against black money. The first step in this battle was the introduction of Income Declaration Scheme (IDS), which came into force on June 1, 2016. IDS should be considered successful, as the Government was able to gather around Rs 65,000 crore from this exercise[i]. Even though the Prime Minister had warned of stern action against those who did not come clean with IDS, the demonetisation of higher denomination notes came as a surprise.
A Cash Intensive Economy: The Indian Case
As on March 2016, there were around 25 million credit card holders and around 662 million debit card holders[ii] in the country. Yet, in India, 95 per cent of transactions are still made in cash[iii], which shows there is a huge potential being untapped. India spends a whopping Rs 21,000 crore[iv] a year for maintaining physical cash and is one of the most cash intensive economies in the world. Cash-to-GDP ratio of India stands at 12 per cent, whereas it is only around four per cent for developing countries such as Mexico and Brazil[v]. The above statistics depict the urgency to move towards a less cash society. That the Government is encouraging the use of plastic money is evident from its decision to bear the transaction cost for all payments made through credit cards/debit cards/net banking. In August 2016, the Finance Ministry constituted a high-level committee headed by former Finance Secretary Ratan P Watal for suggesting measures to encourage card payments through various incentives such as tax rebates and cash back schemes[vi]. Another big step in this regard was the introduction of Unified Payment Interface (UPI) by the Reserve Bank of India (RBI) in August 2016. Thus, various measures adopted by the Government and the RBI over the last two years indicate that both the entities are encouraging the move towards a less cash society. By limiting money circulation in the economy, interest rates will come down, which will fuel the country’s economic growth.
Why Rs 500 and Rs 1000 notes?
Now, what needs to be analysed is why the Government and the RBI targeted Rs 500 and Rs 1000 notes? As on March 2016, Rs 16.42 lakh crore worth of bank notes were in circulation, of which Rs 14.18 lakh crore were Rs 500 and Rs 1000 notes[vii]. This means that of the total 9026 crore bank notes, around 2200 crore are in the denominations of Rs 500 and Rs 1000, which amounts to around 25 per cent of the total number of notes in circulation. During 2011–16, the circulation of currency (of all denominations) increased by around 40 per cent. In the same period, the circulation of Rs 500 and Rs 1000 notes also increased by 76 per cent and 109 per cent, respectively. It clearly shows that there is an excessive usage of high denomination currency in the economy.
A large share of counterfeit and unaccounted money is stored in currency of higher denominations. This is mainly because the cost of printing currency of higher denominations is cheaper than that of lower denominations. For example, it costs Rs 3.17 for printing a thousand-rupee note, whereas it costs Rs 1.79 for printing a hundred-rupee note. In absolute terms, it costs more to print a thousand-rupee note. But, when the cost is taken as the percentage of its face value, it costs much less to print currency of higher denominations. The cost of printing a ten-rupee note is around 10 per cent the value of the note, whereas it costs only 0.317 per cent of the value of the note for printing a thousand-rupee note. This is an incentive for counterfeit/black money holders to have their wealth in currency of higher denominations. Thus, targeting currency of higher denominations should be considered a welcome sign in the battle against counterfeit and black money.
Several critics have pointed out that the demonetisation of Rs 500 and Rs 1000 notes will have repercussions in the economy. According to them, this drastic step taken by the Government can negatively affect businesses in the country, which will be reflected in the GDP in the coming quarters. This will only be a short-term phenomenon. In the long run, benefits accruing from this act will outweigh the cost borne by the economy. Another serious concern is the surge in gold prices, as the demand for bullion has increased over the last two days. The increase in demand for bullion is linked with the speculation that black money holders are trying to convert their wealth into gold. Since the demonetisation came as a surprise, it has given little time for black money holders to act. Hence, the positive impact will be much greater.
In India, only 35 per cent of the population have accounts with formal banking institutions and despite high mobile penetration, only two per cent are engaged in mobile banking[viii]. The demonetisation of higher denomination notes should be considered as a constructive step by the Government to push the country towards a less cash society. This can also act as an impetus for various Government initiatives such as financial inclusion and Digital India.
*Deepthi Mary Mathew, Research Associate, CPPR- Centre for Comparative Studies. The views expressed by the author is personal and does not represent that of CPPR.
This article was first published in The Dialogue: Demonetisation A Positive Step towards a Less Cash Society
[iv]Institute for Business in the Global Context (2015) : The Cost of Cash in India http://fletcher.tufts.edu/~/media/Fletcher/Microsites/Cost%20of%20Cash/COC-India-lowres.pdf
[vi]Government of India (2016): http://finmin.nic.in/the_ministry/dept_eco_affairs/currency_coinage/Constitution_Committee_digitalpayments.pdf
[vii]RBI Annual Report 2015-16
[viii]Institute for Business in the Global Context (2015) : The Cost of Cash in India http://fletcher.tufts.edu/~/media/Fletcher/Microsites/Cost%20of%20Cash/COC-India-lowres.pdf
MA Economics from University of Kerala, Trivandrum, Kerala