Demonetisation has been typically looked at from a political stance, rather than through the prism of economics. Second, it has not always been seen as preparatory to the GST. The real test will lie in the LS verdict

This writer saw a glimpse or two of demonetisation way back in early 1946 as a nine-year-old. We had moved to Calcutta (now Kolkata) less than two years before that. One evening, my father came home and promptly showed my mother two large currency notes with a portrait of King George VI, the like of which the writer had never seen before. Each was worth a thousand rupees. My father explained how he was offered five such notes at Rs 600 each only and he declined, thinking it was illegal. Eventually, his office colleague thrust two of them into his jacket’s pocket. He brought that home. The next day, he was meant to go to the bank which would give him new Rs 1,000 notes in exchange. My father went on to explain that during World War II, which had ended in August 1945, many a trader had profiteered by selling war materials for American as well as British troops, who had been deployed on the Burma (now Myanmar) front. The suppliers made money but did not always pay taxes. The British Indian Government, therefore, decided to demonetise the thousand rupee note. Since then, this writer has not been unfamiliar with the process.

The year 1946 is too long ago but in 1978/79, too, the Janata Party Government of Morarji Desai had demonetised high-value notes. But the measure was so half-hearted that most people cannot remember it. Even this writer cannot recollect the details. In contrast, the Modi Government’s action has had an enormous impact; though it took time for many people to comprehend what exactly were the implications. But most, who had stocks of untaxed cash, lost their money. Those, who could not find a way out, deposited it in the bank on the fair assumption that they would sort it out with the Income Tax officer at the time of assessment, with or without penalty. A Kolkata person, who reportedly had Rs 7,000 crore, could have done the same unless his cash was gained not only from an untaxed source but also from a dubious earning like smuggling.

This writer discovered how unusual the move was on the evening when Prime Minister Narendra Modi announced his step with regard to the demonetisation of Rs 500 and Rs 1,000 notes. The writer and one of the most informed veteran journalists were dining at a club when the announcement was made. But that gentleman needed to be explained the implications.

Those, who had bundles and bundles of unaccounted notes of the two denominations, lost heavily that night. One person was rumoured to have become poorer by Rs 7,000 crore in one stroke. Many small holders managed to change their notes at a discount of between 20 and 50 per cent with the help of brokers, who had connections with willing bank managers. This was one of the several mismanagements reported against the Government. Another was the delay at many banks of new supply of currency. The rest was the loss of money by the middle class to upper class holders. Some felt gravely upset and sinned against for being suddenly deprived of their hard earned money. They were right, except that they overlooked that they had not paid income tax on the money they lost.

The first reaction this writer heard of was from three of his acquaintances — a teacher, a technocrat and a businessman. Each one of them stood to lose up to Rs 50 lakh, which were lying in the house or a safe deposit locker. They all swore against the Government. On the other hand, the average lower middle class and poorer people were vicariously happy that the rich people have been hit for their ill-gotten wealth. Until then, their impression was that only the poor get punished while the rich get away with the help of their influence and wealth.

The real stunning effect was that a great deal of informal (euphemism for black) money ceased to be legal tender. Most of it went into the banks. In the process for a few days to a couple of months, parts of over 85 percent of the currency notes, Rs 500 and Rs 1,000, became non-legal tender. Immediately, there was a liquidity crunch also because of the delay in supply of new notes. Except for Rs 2,000 notes, others were not printed for reasons of secrecy. How much of the secrecy was for a dramatic effect and how much was to prevent transfer of cash by the big holders were a matter of conjecture. But one thing was certain that demonetisation was a stinging message against black money as never before in India. It was also a warning that more steps were coming. Sure enough the Goods and Services Tax (GST) was on the anvil.

For those not emotionally involved, could understand that a digital, or just a modern economy could not exist on two parallel money streets — one white and bankable and the other black and not bankable. One which proposes to be taxable and the other which evades tax from start to finish. The latter would continually undercut the former because it would always be cheaper. Those opposed to demonetisation keep calling the latter informal instead of black. Even well-known economists and scholars talk in these terms — possibly they are being considerate to a great portion of yesteryear traders in our country.

This writer’s personal experience is interesting. My company manufactures toothbrushes, whose sales shot up by over 50 per cent on the morrow of demonetisation and more so after the introduction of GST. The explanation was that his competition in the cheaper varieties was taking no notice of taxation; with the changes, several of the competitors stopped manufacturing. There is no doubt that the so-called informal sector has been stunned. Liquidity had shrunk  while new currency notes were being printed. Once they came into full flow, there was no such problem. The only difference was that black money has to be spent; whereas money in the bank is usually spent with care and caution. The reported reduced consumer demand is due to the comparative reduction in superfluous spending.

There are several other countries, which have demonetised their currency, including the UK and Australia, so has Pakistan. Zimbabwe had done something unique — it abolished its own currency and replaced it with the US dollar. Yet other countries are North Korea, Myanmar, Nigeria and Ghana. By and large, they have not benefited, not because of demonetisation per se, but due to the lack of any improvement in financial management. Whenever the Government faced a shortage of funds, its banks resorted to printing notes to meet its expenditure.

Regrettably, demonetisation in India has been looked at politically rather than with the help of economic logic. Second, it has not always been seen as preparatory to the GST, which makes trading with black money almost impossible. Moreover, paying GST means also exposing one’s turnover to the income tax authorities. For those, who were used to tax-free trading, these measures are doubly painful. Its  impact on the general elections remains to be seen.

(The writer is a well-known columnist and an author)

Writer: Prafull Goradia

Courtesy: The Pioneer

Demonetisation has been typically looked at from a political stance, rather than through the prism of economics. Second, it has not always been seen as preparatory to the GST. The real test will lie in the LS verdict

This writer saw a glimpse or two of demonetisation way back in early 1946 as a nine-year-old. We had moved to Calcutta (now Kolkata) less than two years before that. One evening, my father came home and promptly showed my mother two large currency notes with a portrait of King George VI, the like of which the writer had never seen before. Each was worth a thousand rupees. My father explained how he was offered five such notes at Rs 600 each only and he declined, thinking it was illegal. Eventually, his office colleague thrust two of them into his jacket’s pocket. He brought that home. The next day, he was meant to go to the bank which would give him new Rs 1,000 notes in exchange. My father went on to explain that during World War II, which had ended in August 1945, many a trader had profiteered by selling war materials for American as well as British troops, who had been deployed on the Burma (now Myanmar) front. The suppliers made money but did not always pay taxes. The British Indian Government, therefore, decided to demonetise the thousand rupee note. Since then, this writer has not been unfamiliar with the process.

The year 1946 is too long ago but in 1978/79, too, the Janata Party Government of Morarji Desai had demonetised high-value notes. But the measure was so half-hearted that most people cannot remember it. Even this writer cannot recollect the details. In contrast, the Modi Government’s action has had an enormous impact; though it took time for many people to comprehend what exactly were the implications. But most, who had stocks of untaxed cash, lost their money. Those, who could not find a way out, deposited it in the bank on the fair assumption that they would sort it out with the Income Tax officer at the time of assessment, with or without penalty. A Kolkata person, who reportedly had Rs 7,000 crore, could have done the same unless his cash was gained not only from an untaxed source but also from a dubious earning like smuggling.

This writer discovered how unusual the move was on the evening when Prime Minister Narendra Modi announced his step with regard to the demonetisation of Rs 500 and Rs 1,000 notes. The writer and one of the most informed veteran journalists were dining at a club when the announcement was made. But that gentleman needed to be explained the implications.

Those, who had bundles and bundles of unaccounted notes of the two denominations, lost heavily that night. One person was rumoured to have become poorer by Rs 7,000 crore in one stroke. Many small holders managed to change their notes at a discount of between 20 and 50 per cent with the help of brokers, who had connections with willing bank managers. This was one of the several mismanagements reported against the Government. Another was the delay at many banks of new supply of currency. The rest was the loss of money by the middle class to upper class holders. Some felt gravely upset and sinned against for being suddenly deprived of their hard earned money. They were right, except that they overlooked that they had not paid income tax on the money they lost.

The first reaction this writer heard of was from three of his acquaintances — a teacher, a technocrat and a businessman. Each one of them stood to lose up to Rs 50 lakh, which were lying in the house or a safe deposit locker. They all swore against the Government. On the other hand, the average lower middle class and poorer people were vicariously happy that the rich people have been hit for their ill-gotten wealth. Until then, their impression was that only the poor get punished while the rich get away with the help of their influence and wealth.

The real stunning effect was that a great deal of informal (euphemism for black) money ceased to be legal tender. Most of it went into the banks. In the process for a few days to a couple of months, parts of over 85 percent of the currency notes, Rs 500 and Rs 1,000, became non-legal tender. Immediately, there was a liquidity crunch also because of the delay in supply of new notes. Except for Rs 2,000 notes, others were not printed for reasons of secrecy. How much of the secrecy was for a dramatic effect and how much was to prevent transfer of cash by the big holders were a matter of conjecture. But one thing was certain that demonetisation was a stinging message against black money as never before in India. It was also a warning that more steps were coming. Sure enough the Goods and Services Tax (GST) was on the anvil.

For those not emotionally involved, could understand that a digital, or just a modern economy could not exist on two parallel money streets — one white and bankable and the other black and not bankable. One which proposes to be taxable and the other which evades tax from start to finish. The latter would continually undercut the former because it would always be cheaper. Those opposed to demonetisation keep calling the latter informal instead of black. Even well-known economists and scholars talk in these terms — possibly they are being considerate to a great portion of yesteryear traders in our country.

This writer’s personal experience is interesting. My company manufactures toothbrushes, whose sales shot up by over 50 per cent on the morrow of demonetisation and more so after the introduction of GST. The explanation was that his competition in the cheaper varieties was taking no notice of taxation; with the changes, several of the competitors stopped manufacturing. There is no doubt that the so-called informal sector has been stunned. Liquidity had shrunk  while new currency notes were being printed. Once they came into full flow, there was no such problem. The only difference was that black money has to be spent; whereas money in the bank is usually spent with care and caution. The reported reduced consumer demand is due to the comparative reduction in superfluous spending.

There are several other countries, which have demonetised their currency, including the UK and Australia, so has Pakistan. Zimbabwe had done something unique — it abolished its own currency and replaced it with the US dollar. Yet other countries are North Korea, Myanmar, Nigeria and Ghana. By and large, they have not benefited, not because of demonetisation per se, but due to the lack of any improvement in financial management. Whenever the Government faced a shortage of funds, its banks resorted to printing notes to meet its expenditure.

Regrettably, demonetisation in India has been looked at politically rather than with the help of economic logic. Second, it has not always been seen as preparatory to the GST, which makes trading with black money almost impossible. Moreover, paying GST means also exposing one’s turnover to the income tax authorities. For those, who were used to tax-free trading, these measures are doubly painful. Its  impact on the general elections remains to be seen.

(The writer is a well-known columnist and an author)

Writer: Prafull Goradia

Courtesy: The Pioneer