On 8th November 2016, the Government of India took the bold step of demonetising all 500 and 1000 banknotes, ceasing the usage of all these banknotes as a form of legal tender in India. In an effort to stop the counterfeiting of current banknotes used to fund terrorism, and to control the black money in the country, the Indian Prime Minister Mr Narendra Modi made a live address to the nation declaring the usage of 500 and 1000 banknotes invalid, and announcing the issue of new 500 and 2000 banknotes, in a bid to reduce corruption, terrorism, and drug smuggling.
In the ensuing days, a lot has been written for and against this move. Although in general, the move to demonetise and thereby hinder black money was appreciated by the masses, the manner in which it was carried out, and the hardships caused to the common man has been criticised. It is important to understand the economics behind this historical move before forming any further opinion.
Demonetisation is a radical monetary step to invalidate a currency unit’s status as a legal tender. Such a monumental step is usually taken when there may be a need to change national currency, for example when the European Monetary Union nations decided to adopt Euro as their currency. In India’s case, this is a move to curb corruption and control counterfeiting by reducing the amount of cash available in the system.
There is no transparency or accountability for a significant amount of cash flowing through the Indian economy, with the money never entering the tax system of the county, hurting the Indian economy, and making the honest, working class Indian suffer. Due to large amounts of unaccounted money in the economy, the government is unable to collect enough tax revenues, prompting increasing of taxes, further impacting honest tax paying citizens. Rampant corruption exists because of a cash economy, as it allows the money to be unaccountable. Demonetisation may not completely weed out corruption, but it will enable the system to capture the flow of money.
This historical move is likely to have a significant impact because of being unanticipated, thereby not giving people any time to find means to park their black money. A cashless economy can help curb inflated prices, recapitalise banks, reduce interest rates thereby increasing capital inflow to the economy. Such monumental changes cause their share of inconveniences but recalibrating an entire nation’s economy is no small feat. Currently, only 2.6% of the Indian population pays taxes! The rest either don’t make enough money or siphon it off and bypass taxes. Accountability of the cash flow will help the system identify and keep track of the Indian currency, and control tax evasion. As Prime Minister Modi promised, it is a big leap towards building the “India of our dreams”.
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