The Modi government’s decision on November 8 to strip currency notes with denominations of Rs 500 and Rs 1,000 of their status as legal tender has been hailed as a major attack on black money. It will certainly flush out a good chunk of black money hoarded in currency notes of such denominations.
The government estimates that about Rs 17 lakh crore is circulating in currency notes with such denominations. If the parallel economy is as large as 20 per cent of India’s gross domestic product (GDP), an estimated Rs 3.4 lakh crore of black money would be residing in those high-denomination currency notes and some of it at least could now surface in the open after payment of taxes at a penal rate.
Some of this amount (a little over two per cent of GDP) may also get trashed by those who might be afraid to make declarations for fear of prosecution for not having declared their unaccounted wealth earlier in spite of the government giving them an opportunity to come clean through the Income Disclosure Scheme, 2016, which ended less than two months ago. Depending on how people behave, the government’s tax revenues and the size of the Indian economy would be impacted, though it would not be significant.
Three important factors, however, should be kept in mind while assessing the government move. One, withdrawing the status of a legal tender for these currency notes would not necessarily curb fresh generation of black money. It would only tackle what was hoarded by people as unaccounted income.
Black money generation will not be eliminated completely unless the government takes effective measures against several other sources of black money such as real estate and elections. There are also no adequate incentives for people to switch over to plastic or electronic money. On the contrary, using credit cards can often force a buyer to pay an extra fee over and above the market price of a product or service. The government would do well to create incentives for people to use more plastic money or electronic wallets.
Two, the gains achieved by the manner of stripping these currency notes of their legal status tender are debatable. What would have the government lost if, for instance, a one-month deadline was set for allowing the use of the old high-denomination notes for public utility and emergency services instead of just three days or six days as has been done now? The chaos and long queues that one sees outside banks and post offices across the country and the huge disruption caused to retail trade in many markets could have been avoided. The small trader, the maid servant, the vegetable vendor and the slum dweller would not have had to face the kind of stress and tension that he or she is now going through. The economically well-off sections of society in any case have options of using credit cards and electronic wallets to meet their immediate expenditure needs. Clearly, the inadequacy of bank branches and post offices in dealing with the rush was not correctly assessed before implementing the decision.
Yes, a longer deadline could have given some leeway to those using such currency notes for terrorist activities. But then, there could have been other methods to tackle the terror-money menace and that could have been debated. But surely this aspect of causing inconvenience to a large section of small traders and poor people could have been avoided by setting a longer deadline.The goal of unearthing black money, seemingly the primary target of the entire drive, would still have been achieved.
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Three, it is important to note that the government chose to use Section 26 (2) of the RBI Act to declare these currency notes invalid through a notification. In 1978, the Morarji Desai government issued an ordinance to demonetise currency notes with denominations of Rs 1,000, Rs 5,000 and Rs 10,000 on January 16. This ordinance became a law by March 1978. That is also why Yashwant Sinha, while reintroducing currency notes of Rs 1,000 denomination two decades later in December 1998, had to amend the High Denomination Bank Notes (Demonetisation) Act, 1978.
Why the Desai government chose not to use the RBI Act’s provision to strip those currencies of their legal tender status is not known. Perhaps his government believed that such a big decision needed to be taken by changing the law, which would also make reintroduction of the notes declared invalid more difficult requiring Parliament to make an amendment. That is exactly what happened in 1998.
In contrast, the Modi government has chosen the RBI Act, under whose provision a decision to strip a currency of its legal tender status can be taken after being advised accordingly by the Central Board of the central bank. The big message of what happened on November 8 is that demonetisation can take place by a notification and not necessarily by a change in law, as was practised by the Desai government in 1978 and followed by Sinha in 1998.
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