Welfare analysis assists the economists to evaluate different policies that are implemented in the state or country and what kind of social benefit will be there for the people, where the policy is being implemented. This is a cost-benefit analysis of DEMONETIZATION as a part of welfare analysis by taking into account a few indicators of welfare.
Demonetization is termed as the act of stripping off the legal tender status of currency units. It happens when there is a change in any national currency. It involves the withdrawal of the current forms of money from being circulated usually replaced with new notes or coins. Pulling down the legal tender status of a unit of currency is a very drastic interference in an economy since it directly affects the day-to-day business. It can either bring stability to the existing problems or may cause chaos in an economy if it goes wrong.
Historical Background of Demonetization:
Demonetization in India had taken place in three phases till now, in the years 1946, 1978, and 2016.
Let’s have a look at all three events.
Demonetization of 1946
The first-ever demonetization event happened in 1946. The denominations of INR 1000 and INR 10000 were drawn out from circulation at that time. There was a visibly lower impact of this demonetization as the higher denomination currencies were not available to the common people. So overall it did not have a deep impact on the country as well. However, in 1954, these notes were again introduced with an additional denomination of INR 5000.
Demonetization of 1978
In 1978, the Prime Minister Morarji Desai made an announcement through radio that a second demonetization will take place. During the second demonetization, the denominations of INR 1000, INR 5000, and INR 10000 were taken out of the circulation. Again, this also did not have a deep impact as these currency denominations were not very common in the hands of common people.
Demonetization of 2016
On the 8th of November 2016, the current Indian Prime Minister Narendra Modi announced the latest demonetization. During this demonetization, the notes that were taken out of circulation were the denominations of both INR 500 and INR 1000. He also introduced the new currency of denominations INR 500 and INR 2000 after demonetization.
Objectives of Demonetization
- To obstruct the circulation of black money in the money market
- To reduce the interest rates of the prevalent banking system
- To help in the creation of a cashless economy
- To help in formalizing the informal Indian Economy
- To remove the counterfeit notes from the market
- To help in reducing anti-social activities and their finances
This concludes the concept of demonetization which helps in stabilizing the economy and curbing the spread of black money in the market.
Indicators of Welfare:
- Count in the Number of Criminal Activities:
The groups conducting criminal activities like terrorism, their supply of money effectively becomes worthless, as the currency is no longer the legal tender. According to the National Crime Records Bureau, initially, there was a decrease in the activities and attacks by Maoist and Naxalite radical groups, which was attributed to a lack of finance following the demonetization only for these activities to return within a few months. This was attributed to the fact that criminals may keep their assets in other forms apart from cash in hand, such as gold or real estate. Nevertheless, there was a decrease in the terror activities in Jammu and Kashmir.
- Count in the Number of Tax Evasion in India:
Demonetization of currency can also prevent tax evasion, as the tax evaders must then:
- Either trade-off their existing currency or
- Risk their income becoming worthless
The government can catch or hold those, who have evaded taxes and then extract taxes from their unreported earnings through the currency exchange process.
The income tax department noticed that despite the obvious attempts at money laundering after demonetization:
- Taxpayers were reporting higher incomes
- The number of taxpayers had increased and
- Revenues had begun to grow at a faster rate
As per GoI, it was consumption that was adversely affected first when a liquidity shortage struck.
Consumption→ Production → Employment → Growth
Thus, demonetization had a chain reaction on the entire economy through consumption.
GDP of India growth was lowered by at least two percentage points due to demonetization. India’s GDP grew 6.8% in the December quarter of 2016, lower than 7.6% in the trailing three months. In the subsequent quarter, it declined to up to 6.1%. Severe unemployment was also accompanied by the contraction of GDP in which 1.5 million people had consequently lost their jobs.
- Digital Payments:
Demonetization had further pushed towards a cashless economy, as the government can slow the circulation of physical currency and move towards more digital options being the protagonist for the establishment of cashless India.
- Black money/ underworld economy:
The major chunk of black money is in the form of physical assets like gold, land, and buildings but only a minute portion of black money is stored in the form of cash or the liquid asset. Hence the amount of black money countered by demonetization depends upon the amount of black money held in the form of cash and it will be much smaller than expected.
- Amount of counterfeit currency:
According to The Economic Times, the number of counterfeit currency reports (CCRs) grew drastically from more than 4.10 lakhs in 2015 to 2016 to more than 7.33 lakhs from 2016 to 2017. In addition, the number of suspicious transaction reports (STRs) received in 2016-17 was 4,73,006. The figure was much greater than four times as compared to 2015-16. All of these must be imputed to the demonetization exercise. It inevitably increased the number of CCRs and STRs. Thus, demonetization aggravated the shadow economy rather than reducing the counterfeit currency.
- Overall Cost of Demonetization:
Overall economic cost = Explicit cost + Implicit cost
The printing of new banknotes and the minting of coins, as well as the discontinuation of existing currency, come with their costs. As per the estimates by the Centre for Monitoring Indian Economy (CMIE), the cost of demonetization during the 50-day window till December 30, 2016 (the deadline for converting all your old banknotes into new ones) would be approximately INR 1.28 lakh crores.
As per the statistics, out of this INR 1284 billion, enterprise accounted for about half of this cost i.e. INR 615 billion.
Former Reserve Bank of India’s governor Raghuram Rajan had said in one of his interviews that demonetization had come at a huge cost for the Indian economy and it had a chilling impact on the Indian economy. Also, the household sector had to pay its costs by standing in the long queue and sacrificing their working hours. They lost the salary that they could have earned per hour while exchanging the currency notes. Apart from that while standing in long queues, people were injured severely and about 100 people died according to the reports. Their earnings were affected drastically leading to a lower Net Emotional Index (NEI). Thus, the household sector had to pay their costs in the form of their lives, injuries, time, efforts, and salaries. Also, apart from affecting the base of the economy, demonetization was at the cost of unemployment of more than 50 lakh people in 2016.
According to me, demonetization can be termed a national disaster. It failed to fulfill its objectives and came out as a huge cost to the Indian economy with an expenditure of INR 1.28 lakh crores. Government expenditure is always done for the betterment of its citizens but demonetization has proved to be a curse to our economy. It failed to expose the shadow economy and counterfeit currency. Unfortunately, the initiative didn’t overcome the costs. However, demonetization formed the footsteps of CASHLESS INDIA but the negative impacts have very well outweighed the positive impacts. Since the costs are greater than the benefits, demonetization is “A Successful Failure” as per the cost-benefit analysis.