“A recent move of the Central Government exercising its powers
u/s 26(2) of the Reserve Bank of India Act, 1934, to withdraw the legal tender
character of existing bank notes in denominations of ₹ 500 and ₹ 1000 issued by
Reserve Bank of India (RBI) is unprecedented. The demonetization of ₹ 500 and ₹
1000 banknotes was a policy enacted by the Government of India on 8th November,
2016. All ₹ 500 and ₹ 1000 banknotes of the Mahatma Gandhi Series ceased to be
legal tender in India from 9th November, 2016”
What is Currency Demonetization? It is a radical financial
step in which a currency unit's status as a legal tender is declared invalid.
This move is usually executed when old currencies have to be replaced by new
one's or whenever there is a change of national currency.
In a historical move that may record strength in the fight
against corruption, black money, money laundering, terrorism and financing of
terrorists as well as counterfeit notes, the Government of India decided that
500 and 1000 notes will no longer be legal tender from midnight, 8th November,
2016.
The Government of India has taken this step of demonetization
of ₹ 500 and ₹ 1000 banknotes with the intention to curb financing of terrorism
through the proceeds of Fake Indian Currency Notes (FICN) and use of such funds
for subversive activities such as espionage, smuggling of arms, drugs and other
contrabands into India, and for eliminating unaccounted Money which casts a
long shadow of parallel economy on our real economy, effect has taken place
from the expiry of the 8th November, 2016.
The banknote denominations of ₹ 100, ₹ 50, ₹ 20, ₹ 10 and ₹ 5
of the Mahatma Gandhi Series continued to remain as legal tender and were
unaffected by the policy.
History and Background:
Erstwhile Government had taken similar measures in the past
for demonetization of currency. In January 1946, currency notes of 1000 and
10,000 rupees were withdrawn and new notes of 1000, 5000 and 10,000 rupees were
introduced in 1954. The Janata Party coalition government had again demonetised
notes of 1000, 5000 and 10,000 rupees on 16 January 1978 to curb counterfeit
money and black money.
On 28th October, 2016 the total currency in circulation in
India was Rs. 17.77 Lakh crore (US$ 260 billion). In terms of value, the annual
report of Reserve Bank of India (RBI) of 31st March, 2016 stated that total
bank notes in circulation valued to Rs. 16.42 lakh crore (US$ 240 billion) of
which nearly 86% (around ₹ 14.18 lakh crore (US$ 210 billion)) was ₹ 500 and ₹
1000 banknotes. In terms of volume, the report stated that 24% (around 2203
crore) of the total 9026.6 crore banknotes were in circulation.
After the official announcement by Prime Minister Modi, the
Governor of the Reserve Bank of India, Urjit Patel, and Economic Affairs secretary,
Shaktikanta Das explained in a press conference that while the supply of notes
of all denominations had increased by 40% between 2011 and 2016, the ₹500 and
₹1000 banknotes increased by 76% and 109% respectively in this period owing to
forgery. This forged cash was then used to fund terrorist activities against
India. As a result the decision to eliminate the notes had been taken.
Brief Overview of
the Demonetization Scheme:
The Reserve Bank of India laid down a detailed procedure for
the exchange of the demonetized banknotes with new ₹ 500 and ₹ 2000 banknotes
of the Mahatma Gandhi New Series and ₹ 100 banknotes of the preceding Mahatma
Gandhi Series. On 13th November, the Ministry of Finance reviewed the
procedure, following are some of the key points-
Citizens will have until 30 December 2016 to tender their old
banknotes at any office of the RBI or any bank branch and credit the value into
their respective bank accounts.
Cash withdrawals from bank accounts were restricted to
₹10,000 per day and ₹20,000 per week per account from 10 to 13 November 2016.
This limit was increased to ₹24,000 per week from 14 November.
For immediate cash needs, the old banknotes of value up to
₹4,000 per person could be exchanged for the new ₹500 and ₹2000 banknotes as
well as ₹100 banknotes over the counter of bank branches by filling up a
requisition form along with a valid ID proof. This limit was increased to
₹4,500 from 14 November 2016 onwards.
Initially, all ATMs were dispensing banknotes of only ₹50 and
₹100 denominations and cash withdrawals from ATMs were restricted to ₹2000 per
day. From 14 November, onwards, ATMs recalibrated to dispense new ₹500 and
₹2000 notes will allow a maximum withdrawal of ₹2,500 per day, while other ATMs
dispensing banknotes of only ₹50 and ₹100 denominations will allow a maximum
withdrawal of ₹2,000 per day.
However, exceptions were given to petrol, CNG and gas
stations, government hospitals, railway and airline booking counters,
state-government recognised dairies and ration stores, and crematoriums to
accept the old ₹500 and ₹1000 banknotes until 11 November 2016, which was later
extended to 14 November 2016 and once again to 24 November 2016. International
airports were also instructed to facilitate an exchange of notes amounting to a
total value of ₹5000 for foreign tourists and out-bound passengers.
Long-term benefits:
Apart from disrupting daily lives of the common citizen,
there are even bigger implications for the economy as a whole. India has a
vibrant and thriving parallel economy that survives purely on cash. There are
no reliable estimates of the size of this parallel economy, but the sheer
number of ₹ 500 and ₹ 1,000 notes is indication enough of its importance.
Politics and various elections are known to run on cash. Same
is the case with sectors such as real estate. The rural areas in particular
which do not have formal sources of banking, also deal largely in cash.
Unorganised labour, including in urban households, such as domestic workers and
drivers, are paid in cash, and mostly in these denominations. Unavailability of
cash for this set of people will create a sudden disruptive effect on
consumption, production and economy utility will severely slow down.
It is too early to even imagine the impact on all sections of
society and parts of the economy, particularly if we factor in savings by
housewives, for example. It is not known how money saved out of income that has
been paid tax on will be distinguished from unaccounted or "black
money".
The advantages of this move, though, will be felt only in the
long-term. While formal modes of payments such as debit and credit cards,
net-banking and digital wallets should get a boost, this will take a long time to
be felt simply because the penetration of these products is still low among the
middle classes and the poor, for whom cash is still the predominant mode of
transaction.
The government’s move is bold in its intent and massive in
its measure. While the intent is clear, the implementation and impact is yet to
be seen. One thing is sure though – the Indian economy just had a massive
disruption overnight.
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