Decoding

Demonetization
 Demonetization: What is it ?

• Demonetization is the act of stripping a currency unit of its

status as legal tender.

• Section 26(2) of the Reserve Bank of India Act, 1934 empowers

the Union Government on the recommendation of Central
Board to declare that “any notes issue by the Reserve Bank will
no longer be legal tender.”

• The Madras, Karnataka & Bombay High Courts dismissed the

PILs filed and observed that demonetization was good for India.
History of Demonetization
Demonetization in India

• On January 12, 1946, the Government demonetized Rs. 500, Rs.

1,000 & Rs. 10,000 currency notes in order to curb black money.

– People were given only 10 days for exchange. This was later
extended by 17 days where people had to give explanations on why
they could not exchange their currency in first ten days;

– The outcome was almost a failure as most of the notes were

exchanged and hardly anything got demonetized;

– out of a total issue of Rs. 143.97 crores of the high denomination

notes, notes of the value of Rs. 134.9 crores were exchanged. Thus,
notes worth only Rs. 9.07 crores were probably ‘demonetized’.
• On January 16, 1978, the Government decided to demonetize Rs.
1,000, Rs. 5,000 & Rs. 10,000 currency notes. The purpose of this
move, as mentioned by the then Finance Minister H.M. Patel
was to control illegal transactions.

– This time public was given even lesser time of 3 days to exchange
Rs 1,000, Rs 5,000 and Rs 10,000 notes;

– The effectiveness of this move was similar to previous

demonetization. However, this time the total currency actually
rose! Leave conversion or demonetization, this was accumulation;

– The major cause of the failure was that the public at large were
already aware of the Government’s move in advance.
Demonetization outside India

• In 1982, Ghana demonetized their 50 cedis note to tackle tax

evasion and empty excess liquidity.

• In 1984, Nigeria introduced new currency and banned the old

notes.

• The Soviet Union Government ordered to withdrew large-ruble

bills from circulation in 1991, to take over the black market.

• Australia in 1996, became the first country to release polymer

(plastic) notes to stop widespread counterfeiting.
• In North Korea, demonetization happened in 2010. Kim-Jong II
introduced a reform that knocked off two zeros from the face
value of the old currency in order to banish black market.

• Zimbabwe demonetized its dollar from 15th June 2015. This was
a case of ‘hyperinflation’, where inflation rose to 231 million
percent which caused Zimbabwe dollar to collapse in value.

• From December 2016, Pakistan will phase out the old notes as
it will bring in new designs.

• Philippines demonetized their currency recently. The reason is

to get rid of counterfeit currencies.

• The United States of America never demonetize its old bills.

There is even a law in the USA prohibiting demonetization.
Purpose of Demonetization
General Purpose:
• After most of the wars, old currencies were demonetized and
new currencies were introduced;

• Hyperinflation is another reason where lot of countries had to

demonetize their old currencies. (In last 25 years, there have
been more than 20 countries which had demonized their
currency due to hyperinflation!);

• Shifting to a new currency is also a reason for demonetization;

• Fight against black money & counterfeit currency are usual

causes for demonetization.
Specific Purpose:

• Any government has a specific intent to demonetize its

currency.

• The purpose determines how demonetization should be

implemented.

• The intent of ongoing demonetization move in India is to

eradicate existing black money & counterfeit currency.
Effects of Demonetization
Intended Effects

• Eradication of black money

• End of counterfeit currency menace

• Reduction in terrorism

• Streamlining of unorganised sectors

• A move towards becoming a cashless economy

• Increment in Government revenues

Unintended Effects
• Short term turbulence in the economy due to cash crunch

• Subdued economic activity due to financial instability

• Smurfing transactions

• Negative impact on unorganised micro finance sector (Nidhis,

Chit Funds, Hundis etc.)

• Reduction in purchasing power

• Remote & rural localities to be in distressed state

Impact on Economy
Short term Impact
• Inconvenience to people;
• Since 86% of the circulating currency has to be converted, the
entire economy will function at a lower capacity during the
transition period;
• The purchasing power of people will reduce to the extent they
held unaccounted money;
• Sectors driven by cash like real estate & infrastructure will take a
sudden hit;
• A fall in GDP growth rate of next quarter is expected due to fall
in aggregate demand;
• Increase in tax litigations pertaining to current financial year.
Long Term Impact
• Reduction in tax evasion will lead to higher tax revenues & will
ultimately benefit the citizens in the form of better
infrastructure & other facilities by the Government;
• Sustained level of low inflation
• Reduction in deposit & loan interest rates;
• Increase in disposable income will lead to increase in the
aggregate demand of the economy & ultimately the GDP;
• Artificially inflated prices of real estate & other commodities
will come back to their fair value;
• Financial inclusion in rural areas will improve standard of
living;
• Ease of doing business.
Gainers & Losers
Gaining Sectors

• Banking

• Finance

• E-commerce

• Auto (in long term)

• Realty & Infrastructure (in long term)

• Consumer Discretionary (in medium to long term)

Losing Sectors

• Realty & Infrastructure (in short & medium term)

• Auto (in short term)

• Micro-finance

• Consumer Discretionary (in short term)

• Unorganised / cash driven market in every sector

 Anticipated Steps
• Action against smurfing transactions;

• Steps to curb benami properties;

• Action against illegally hoarded gold;

• Reduction in Income Tax due to widened tax base;

• Introduction of the Banking Transaction Tax (BTT).

 Tax implications
What is unaccounted money / black money ?
-Cash can become only legal when it is accounted and anything
expect this is black money.

PAN NORMS
• When cash deposit > Rs. 50,000 in a day
Or, > Rs. 2,50,000 in 50 days, PAN is compulsory.
• If KYC is not updated, cash > Rs. 50,000 cannot be deposited.

200% penalty is a misleading information

 Deposit Limits
• No limit
• Banks to report
– Savings account > Rs. 2,50,000
– Current account > Rs. 12,50,000
Of all accounts.
• Deposit only if you can explain
• Any cash out of LIC surrendered or gold loan availed –
no need to worry, source of cash can be easily
explained.
 Cash Deposit
• Housewives
– No fixed amount
– Amount saved > reasonable amount from household
expense, scrutiny might happen.
• Freelancers
– To be reasonable
• Salaried employees
– Should not be more than the cash withdrawn.
• Businessmen
– Cash in hand as per books.
 Important provisions
• Sec 270A
– Penalty of 100%-300% of tax can be imposed.
• Sec 69A
– Unexplained money
– Sec 115BB applies – no deduction of expenses or losses,
higher marginal rate of tax – 33.6% (inc surcharge and cess)
• Penalty only if income stated in ITR < income
assessed by Assessing officer
• Prosecution under Sec 276C
– Imprisonment between 3months to 7 years.
 Probable new income disclosure
scheme (IDS II)

50% tax + 25% 4 year lock in period without

interest

OR

60% tax
Conclusion
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