In one of the historical reforms of the economy of India, Rs 500 and Rs 1,000 notes were banned effective Tuesday midnight. This was one of the boldest movements by the Government of India announced over a 40-minute speech. This scheme has received mixed reactions till now. The majority of industry and commoners alike reacted to this decision with overwhelming support. Whereas some sections are of the opinion that it is a draconian scheme causing hardships to people. It has also been argued that it would’ve been better if two to three days’ notice had been given. That would, in fact, have defeated the entire purpose of the scheme because by then the money would have been circulated. Overall, this scheme is going to impact the businesses, the aam admi, and financial institutions – all at some level or the other.
Heavy adverse impact on the following sectors:
- Black money hoarders: The driving force behind this historical decision was to eradicate black money. A recent study had pegged India’s black market economy at over Rs 30 lakh crore or about 20 percent of total GDP. This is even bigger than the GDP of countries like Thailand and Argentina. With this move in play, black money holders are left with just two options – either route this money through banks, declaring it to be their income or burn the stashed pile. In case they opt for the first option, they will have to declare it as income. Consequently, the question arises that how did they earn that income? Their files would be subjected to scrutiny and a minimum tax of 60 percent (30 percent general tax rate with 100 percent penalty) would be payable on the declared amount if it is found to be undisclosed previous income. Even if they show this as income in the normal course of business, they will have to pay taxes on it as per current rate.
- Fake note circuits: A report by Washington-based think-tank Global Financial Integrity estimated that India lost $344 billion in illicit fund outflows between 2002 and 2011. PM Narendra Modi also said militants operating against India were using fake notes of Rs 500, worth about $7.50 at current exchange rates. “Terrorism is a frightening thing … But have you ever thought about how these terrorists get their money? Enemies from across the border have run their operations using fake currency notes. This has been going on for years,” Modi said. (Source: Media Reports). Hence, withdrawing the entire series of these high-value notes and introducing new notes definitely tantamount to a surgical strike on these groups.
- Rural economy: A very strong criticism of the scheme that came across is the possible draconian impact it can have on the rural economy. India reportedly has somewhere around 10 lakh bank branches all over India. However, there are 6.8 lakh villages alone and most of these villages are without a bank. Rural economy mostly thrives on currency transactions. Most of the population does not even have the slightest idea of banking. This is likely to come across as a huge shocker for such sections. Jan Dhan scheme, UPI/digital payment stack, and payment banks are still in the nascent stage. It will be a long time before rural India moves to completely cashless transactions. In the short term, people in rural India who have a significant amount of Rs 500 and Rs 1000 notes, but no official form of identification, will have a tough time in exchanging their notes.
- Domestic/household sector: The logic behind this demonetisation is to curb the use of these high-value notes in the black money market. However, earlier demonetisation only impacted the super rich, big black marketers,and smugglers/hawala operators as only they kept high denomination notes. Now, almost everyone has Rs 500/1,000 notes. How do you expect people running grocery shops, chaiwallas, and maids to leave their businesses and stand in a queue to deposit these notes in the bank?
- Tax havens and foreign accounts still untapped: The big fish will be left out whose black money is in the form of foreign currency, gold, and stashed away in tax havens. The scheme is not affecting the huge volumes of black money parked in Swiss/ Panama Banks, offshore accounts, gold, and property, etc. How the government plans to nab these offenders is yet to be seen.
- Illegal election funds of political parties: We all know how much black money is used by political parties. It will be a very tough task to use trucks of money at least for the upcoming five state elections.
Favourable impact for the following:
- Bank deposits will spike: Banks are expected to witness a surge in deposits. Especially, from people and businesses who have a lot of legally earned money (for cash-based businesses). Additionally, as per the new scheme, up to Rs 4,000 will be immediately exchanged by banks and the balance amount would be credited to the account holder. This will increase bank’s deposits by a huge margin. This, in turn, will increase the lending activities.
- Deflation in the economy is expected: The combined of the above impacts would lead to a wider impact on the economy, namely deflation. The coming six to seven months are expected to witness a considerable level of deflation. Sectors like real estate, construction material, unorganised trade and services will see significant pain in the near term.
- Impact on jewellery and real estate business: The decision of the government was widely welcomed by the jewellery industry all over the country. The general opinion being gold demand will rise as people will have more faith in the gold than the currency notes. It will indeed create destabilisation for a little while, but overall it is expected to benefit the industry. Unorganised builders and secondary (resale) property market would be adversely impacted following the government’s decision, according to real estate developers and consultants. Housing prices could witness downward pressure, helping revive demand in the sluggish housing segment.
- Mixed impact on the rural sector: Despite the strong criticism that the rural economy is likely to face the brunt of this scheme, the possible positive effects cannot be negated. Most of rural transactions take place in currency notes and undocumented lending and borrowings. Since the Rs 500 note is no more legal tender, rich landlords,and rural politicians have to rush to banks in the city.
- On the way to cashless economy: With the new limits on ATM withdrawals being restricted to Rs 2,000 per day, withdrawals from bank accounts limited to Rs 10,000 a day and Rs 20,000 a week, it will drive the card payments across the country (in simpler words card transactions will slowly replace the cash transactions in daily activities).
Practical difficulties that people will face:
- The owners of the consumer perishable stock like vegetable vendors, local grocers, milk and fruit sellers will face huge trouble. Do they let their stocks rot and refuse to accept the Rs 500 note?
- Medical care is also likely to suffer. As per the scheme, government hospitals would accept these notes. However, many of these government hospitals ask you to buy medicines from outside. How are those transactions to be settled? Also, over 80 percent of healthcare is through private hospitals and nursing homes. How do they provide for critical care and surgeries?
- How do tourists handle their transactions? Do tourists need to queue up outside banks, changing Rs 4,000 at a time whenever the banks get new currency stocks and open again?
- Not more than 10 percent of Indian population know ‘how to operate an ATM’. Thus,there will be huge queues in the banks and people (including daily wage workers) will have to apply leave to stand in those long queues.
- In the case of businesses following mercantile basis of accounting as well, there will be some practical difficulties. For example, instances where credit sales have been made and debtors are due for payment in these two days. The payments will get delayed and will add to the liquidity crunch.
- There will be some genuine cases like the father withdrawing huge amount (say 10 lakh) of money for his daughter’s wedding in next one to two days.
Some tips to avoid hasty mistakes:
- Do not rush. It is a very wrong notion that you do not have time. You have time until December 30, 2016, to exchange your notes and deposit your sums. In fact, even after December 30, 2016, these old notes can be exchanged from the RBI offices till March 31, 2017. The government will come up with further notifications and clarifications for easing problems. So, it would be advisable to wait for some time, say eight to 10 days before hurrying with the deposit and exchange.
- The department will keep track of every individual, their PAN card detail, and tally it with tax filing done during the end of the year. Submit proper and genuine documents.
- A lot of people are also accepting and depositing the cash balances of their friends and relatives blindly in their own account without proper documents. This can lead you invariably towards scrutiny on source of generating cash without proper KYC and correct source.
- Keep in mind that the Income Tax department will be constantly on check for transactions of cash exchanges beyond Rs 2.5 lakh or deposit in savings account beyond this limit. Hence, keep a note of your existing account balance ceiling before depositing them into your account.
- ATMs will not accept cash deposits. Hence, deposit the amounts in your respective bank branches.
Author: Alok Patnia
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