FRIDAY, March 29, 2024
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Flaws of demonetisation: Lessons from India’s journey 

Flaws of demonetisation: Lessons from India’s journey 

The path towards a cashless society leads through a minefield 

A wise man learns by the mistakes of others,” goes the old saying.  Many countries may go for demonetisation in the near future after looking at the success of India in curbing counterfeit and so-called black (untaxable) money. Demonetisation will create a “cash crunch”, slowing down demand in the short term. But, as Prime Minister Narendra Modi says, it’s a “cleaning” process for the economy.
It’s too early to assess the impact of the world’s largest financial experiment. But obvious loopholes in the implementation of Indian demonetisation offer a guide for countries set to follow the same path. The key takeaway from India’s experience is that if the exchange and deposit of demonetised currency is not planned and monitored properly, the whole exercise will be futile.

Shock, awe – and failure?
On November 8, Modi announced that, from midnight, 500- and 1,000-rupee notes would no longer be legal tender, at a stroke removing 86 per cent of all currency in circulation.
The notes were to be replaced with new bills and digital transaction methods, though Modi has been discussing going even further by moving India to an entirely cashless society. 
The cash crunch has brought dire predictions for the economy, most recently from former prime minister Manmohan Singh: “The GDP of the country will decline by about 2 per cent by what has been done. And this is an underestimate and not an overestimate.”  
But ordinary Indians have reacted with stoicism, seemingly willing to heed Modi’s call to be patient for 50 days.
Demonetisation must be planned in secret and declared suddenly, so as to give black-money hoarders no time to act. Replacement banknotes must be designed with anti-counterfeiting measures, and methods of cashless transaction made available and promoted.
India’s preparation included promoting financial inclusion for all households under the Pradhan Mantri Jan-Dhan Yojana scheme. Debit cards were distributed and Internet banking, mobile wallets, and a unified payment interface were promoted. An income-declaration scheme was also launched to encourage tax defaulters to get back on the books. Other financial sector reforms included the Benami Transactions (Prohibition) Bill, which prohibits paying for and owning property in another person’s name. 
Despite this, critics claim there was no “policy skeleton” and no cost-benefit analysis, which has resulted in India’s previously booming economy grinding to a halt. Figures for sales, traders’ incomes, production, and employment are all down since demonetisation was launched. The poor have been hit particularly hard since without credit cards they are dependent on cash, which accounts for more than 90 per cent of financial transactions in India.   
Under demonetisation, the old banknotes could be either exchanged or deposited up until December 31. 

Loopholes and big fish 
Rules on exchange and deposit changed several times as the government sought to close loopholes that allowed money launderers to slip through the net. The many big fish that did manage to escape offer a cautionary tale for other economies considering demonetisation. 
One lesson was that multiple deposits options should not be given to an individual or entity. Government can still take a liberal approach by allowing an account holder to deposit limited amounts for a second or third time within the deadline. But withdrawal has to be strictly monitored and limited per week. Furthermore, the government must require depositors to first report to tax authorities about their demonetised cash deposits. Banks can also directly give such details to the income tax department. Secondly, currency exchange is a method in which all money goes unaccounted, hence a limit on this is a must. The state should allow only one type of personal identification as proof to facilitate exchange. The identification number is fed into the software that limits the number of times the individual in question can exchange cash. Ink marks of the types used during elections can also be useful here. 

Look before you leap
Thirdly, black-money hoarders evaded deposit limits by using proxies and multiple smaller accounts, often opened specially for the purpose.Therefore, all new accounts opened during demonetisation must be thoroughly monitored and new-customer rules followed. Lower-income groups could be deterred from allowing their names to be used to open accounts with the threat of losing their social security benefits. 
Countries now mulling demonetisation must consider several factors before going ahead. These are: the level of literacy, extent of mobile and Internet penetration, availability of new financial transaction and banking technologies, political strength of the government, extent of coverage of national identity or tax identification number, size of population and penetration of financial system in the country. 

Dr Shreekant Sharma is a member of the National Institute for Micro, Small and Medium Enterprises, Hyderabad, India.

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