X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Demonetisation - Long-Term Effects, Part I - Outside View by Nitin Gregory
  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Demonetisation - Long-Term Effects, Part I
Dec 2, 2016

A medium of exchange.

That's the generally accepted definition of money. The simplicity of it belies the importance of 'hard' cash in a transaction-based economy. Developed economies like Sweden have abandoned paper money. Meanwhile, India's economy is still 95% cash. And any changes to the nation's money will affect a large majority.

It is three weeks since the announcement of 'demonetisation'. Reaction has been mixed. The execution has been questioned. But things seem to be getting back to normal. We all hope that the coming weeks will see some pressure come out of the system.

History

Many nations have employed 'demonetisation' before - including India...twice!

The previous episodes had some similarities. They were also aimed at 'black money', veiled in secrecy, and resulted in long queues.

The differences, though, are more interesting.

For one, unlike current RBI governor, Urijit Patel, the RBI governors who presided over past demonitisations were not impressed. Governor IG Patel, during the 1978 demonetisation, said 'such an exercise seldom produces striking results'.

Another big difference this time is the impact on the common man. Removing the Rs 1000 note in 1978 would be like removing an Rs 10,000 note today (assuming 6% inflation). Very few individuals were using such high-value notes in 1978.

Balance of benefits

Demonitisations has costs and benefits. The costs are fairly obvious today. Demonetising 86% of the cash in a cash-dominated economy means a disruption to daily transactions. And the pain is worse in the rural economy. For example, how will daily wage labourers be paid? There is also the cost of printing new notes and administering the transition period.

Black money is gone?

'Black money' is money acquired illegally or that has evaded tax. Demonitisation is tipped to attack the 'black money' hoarders (similar to the two previous moves). However, an analysis of IT raids from 2012 shows that only 6% of 'black income' is stored in cash.

In other words, the primary storage mechanism for black income is not cash - it's real estate, stocks, and gold. Even in the 1946 demonetisation, only 6% of the currency value in issue did not make it back into the banking system. The government then was expecting a large chunk of the currency not to be deposited back into the system (illegal income that is not declared). However, it turned out only 6% of the value was not deposited back in the system.

A noted economics professor has estimated the amount of black cash (black money sitting as cash) in the system to be three lakh crore, which is roughly 18% of the cash in issue but only 3% of the 'black income' generated in India every year. This means that every year even more black income is generated. The estimated amount that can be netted is only 3% of the yearly generation!

Okay, well, let's assume the move creates a 'reset' and the existing black money is rendered useless. The question remains - what will curb the future creation of illicit income?

Counterfeit countered?

Another stated reason for demonitisation is to clamp down on fake notes. A 2015 study by the Indian Statistical Institute (ISI) estimates that only 400 crore of fake money is in circulation - far too little to warrant demonitisation. And even if the move does suck out the fake notes, what will prevent the creation of new fakes?

The other ancillary benefits stated like a push towards a digital economy remind me of Marion Antoinette - 'no cash? Let them have digital wallets'. An estimated $700 Million people live on less than $3 per day - Is a 'digital wallet' or a new e-payment app really their first priority? Is this the key obstacle towards growth and increased purchasing power? The key drivers for fast growing economies are mentioned here.

However, the centerpiece will remain the black economy. This leads us to believe there will be further measures to tackle the source of the 'black money'.

Demonitisation sends a strong signal to the economy that there is political will to tackle 'black money'. But to truly stamp out the problem, the government will have to take action on the sources of illicit income, not just the cash component.

More in this later...

This column is authored by Nitin Gregory. Nitin, who graduated from IIM-Calcutta, is currently pursuing a finance role with an automotive major. He has a deep interest in Macroeconomics and pens a blog at Gregonomics.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "Demonetisation - Long-Term Effects, Part I". Click here!

  

More Views on News

How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

Jun 10, 2017

Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

You've Heard of Timeless Books... Ever Heard of Timeless Stocks? (The 5 Minute Wrapup)

Aug 19, 2017

Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.

Why NOW Is the WORST Time for Index Investing (The 5 Minute Wrapup)

Aug 18, 2017

Buying the index now will hardly help make money in stocks even in ten years.

Trump Takes a Beating (Vivek Kaul's Diary)

Aug 18, 2017

Donald J Trump, a wrasslin' fan, took a 'Holy Sh*t!' blow on Tuesday.

How To Read Your Mutual Fund Account Statement Correctly (Outside View)

Aug 17, 2017

PersonalFN simplifies the mutual fund account statement for you.

More Views on News

Most Popular

A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

Aug 10, 2017

Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

The Most Profitable Investment in the History of the World(Vivek Kaul's Diary)

Aug 8, 2017

'Yes, it looks like a bubble. And, yes, it's like buying a lottery ticket. But there's something happening that has never happened before. It's an evolutionary leap in money itself.'

Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

Aug 8, 2017

Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

Signs of Life in the India VIX(Daily Profit Hunter)

Aug 12, 2017

The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

Bitcoin Continues Stellar Rise(Chart Of The Day)

Aug 10, 2017

Bitcoin hits an all-time high, is there more upside left?

More

Become A Smarter Investor In
Just 5 Minutes

Multibagger Stocks Guide 2017
Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Aug 21, 2017 11:49 AM

MARKET STATS