 "Currency notes being carried from a bank chest amid tight security")
The Confederation of Indian Industry (CII) on Sunday said the demonetization move of the government will strike a blow to the illegal economy and would have a dampening impact on inflation, giving room to the Reserve Bank of India (RBI) to cut the policy rates.
Describing the step as an economic masterstroke by Prime Minister Narendra Modi, the chamber said it must be allowed time to play out as it would result in greater use of plastic money, more increase in liquidity in the banking system and reduction in liability of RBI to the public. In a statement, it said after a "short" period of some pain when the economy adjusts to the withdrawal of old Rs 500, 1000 currency notes, much stronger economy is expected to emerge.
The prevalence of cash use has made India prone to high inflation as corruption and excessive cash use tends to erode the purchasing power of money, the chamber said.
Lower cash use will have a dampening impact on inflation and this will be a further positive for India’s macro-fundamentals.
“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” CII director general Chandrajit Banerjee said.
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RBI had cut the policy rate by 25 basis points in October, and is scheduled to meet for a policy review in December.
The chamber said while it is not possible to have a firm estimate of unaccounted wealth, it is widely estimated at around a fifth of India’s GDP or around $450 billion, CII said.
While some of this may be stored in cash, some may be in assets such as real estate and jewellery, it said adding this negatively affects the business environment, especially for those who comply with the law of the land and follow ethical practices.
"India’s cash-dependence is extremely high with a currency-GDP ratio of around 12% compared to 4-5% 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," Banerjee said.
The CII said the move will be positive for banks whose deposit mobilisation will be strengthened.
The old currency notes will be deposited with banks and more households will find it imperative to open bank accounts and make use of card payments. Currency in the form of Rs 1000 and Rs 500 notes amounted to Rs 14.2 lakh crore as of March 2016, or about 85 per cent of 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, CII said.
CII has stated that in all likelihood, a fair proportion of the Rs 14 lakh crore in high-denomination currency will not return to the banking system, for fear of accounts being scrutinised. If one assumes that about 20 per cent of the cash does not return to the system, this would amount to about Rs 3 lakh crore or $42 billion. This is a reduction in the RBI’s liability to the public, allowing it to print a similar amount of fresh money or transfer the gain to the government.
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CII has stated that in all likelihood, a fair proportion of the Rs 14 lakh crore in high-denomination currency will not return to the banking system, for fear of accounts being scrutinised. If one assumes that about 20 per cent of the cash does not return to the system, this would amount to about Rs 3 lakh crore or $42 billion. This is a reduction in the RBI’s liability to the public, allowing it to print a similar amount of fresh money or transfer the gain to the government.
READ OUR FULL COVERAGE
