November 13, 2016
The recent move by the government to demonetize Rs. 500 and Rs. 1,000 notes would have a far-reaching impact as it would deal a death blow to black money and the parallel economy. It is estimated that around a fifth of India’s GDP, that is around $450 billion, is in black, unaccounted money. “While some of it is stored in cash, the black money is used to acquire assets such as real estate and jewellery. This negatively affects law-abiding citizens,” said Chandrajit Banerjee, Director General, CII in a press release.
“After a short period of some pain when the economy adjusts to the sudden withdrawal of cash, CII expects a much stronger economy. India’s cash dependence is extremely high with a currency-GDP ratio of around 12 per cent compared to 4-5 per cent in other developing countries. High level of cash usage tends to slow down the flow of money through the economy. As we transition to a greater usage of fintech for payments, spending will rise leading to additional economic growth. This is an economic masterstroke by the Prime Minister and must be allowed time to play out. Lower cash use will have a dampening impact on inflation and this will be a further positive for India’s macro-fundamentals,” he said
“The Reserve Bank will now have more room to cut interest rates as inflation subsides. Already, the bond market has reacted to the news with a reduction in the bond yields,” Banerjee observed. “As the old currency notes will be deposited with banks, more households will find it imperative to open bank accounts and make use of card payments,” he said.
“Currency in the form of Rs. 1,000 and Rs. 500 notes amounted to Rs. 14.2 lakh crores as of March 2016, or about 85 per cent of the total currency in circulation. If this is converted to current and savings deposits, there will be an increase in banks’ liquidity. This is also a great opportunity to transition to a “plastic economy,” where there is a prevalence of debit and credit cards for transactions,” the CII release said.
“The biggest gain from this move will be greater formalization of the economy. Currently, the costs of informality are evident in low tax base which impacts government revenues, lack of economic control through monetary instruments, and lower economies of scale. India’s tax base is low and its tax to GDP ratio needs to increase from the current level of 16.6 per cent, which is much lower compared to about 21 per cent in other emerging economies. Less than 30 million Indians filed personal income tax with more than half of these paying no tax,” said the CII Director General.
The demonetization of high denomination notes is ultimately a strong message that goes out to all those who used cash for illicit activities. A big blow has been dealt to those who engaged in corruption and took cash bribes. The message will have far-reaching implications for those who indulge in such illicit activities. This would greatly curb such transactions and will be a body blow to corruption, racketeering, human trafficking, gambling, and other such activities which vitiate the entire security system of the country, the CII release further said.