Demonetization is a process in which a particular currency note or coin is withdrawn from circulation and is no longer considered as a legal tender. It involves replacing the old currency with new currency in order to curb illegal activities such as black money, corruption, and terrorism financing.
In India, demonetization was announced on November 8, 2016, by the Prime Minister Narendra Modi. The government withdrew the circulation of Rs. 500 and Rs. 1,000 notes as legal tenders in order to tackle the problem of black money and fake currency in the economy.
The objective of demonetization was to reduce the amount of black money held in the form of cash and to promote a cashless economy. The government believed that the move would help in curbing the menace of black money, corruption, terrorism financing, and counterfeit currency.
The process of demonetization involved the withdrawal of old currency notes of Rs. 500 and Rs. 1,000 from circulation and the issuance of new notes of Rs. 500 and Rs. 2,000. The old notes were to be deposited in banks or exchanged for new notes at designated bank branches.
Demonetization implications on Economic Development
- Short-term economic disruption: Demonetization led to a temporary shortage of cash in the economy, which disrupted economic activity, especially in the informal sector. The cash crunch led to a decline in consumer spending, which in turn led to a decline in production and employment in several sectors.
- Impact on the informal sector: The informal sector, which heavily relies on cash transactions, was hit the hardest by demonetization. Small businesses, daily wage workers, and farmers who were dependent on cash transactions faced the most difficulties in the aftermath of demonetization.
- Negative impact on GDP: The Indian economy witnessed a decline in GDP growth rate in the year following demonetization. The GDP growth rate declined from 7.9% in the third quarter of 2016-17 to 5.7% in the first quarter of 2017-18.
- Impact on employment: Demonetization had a negative impact on employment in the informal sector. Small businesses and daily wage workers faced difficulties in paying wages, which led to job losses.
- Boost to digital transactions: Demonetization gave a boost to digital transactions in India. The government promoted digital payments as an alternative to cash transactions, which led to an increase in the use of digital payment platforms such as PHONPE and UPI
- Reduction in black money: The government’s main objective behind demonetization was to curb the circulation of black money. While the long-term impact of demonetization on black money is debatable, it did lead to a short-term reduction in black money circulation.
- Increase in tax compliance: Demonetization led to an increase in tax compliance in India. The government used the opportunity to promote tax compliance and launched several schemes to encourage people to declare their unaccounted income.