Thursday, November 10, 2016
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The withdrawal of relatively lower denomination notes in 2016 has widened the net, which was also essential considering the huge amount of black money circulating. Source: Pixabay

The demonetisations done in 1946 and 1978 are in no match to the current action which will have greater ramifications

Cash notes worth over Rs 14 lakh crore have been junked by the government via its order on November 9 to curb black money. Pegged at over Rs 30 lakh crore, black money in India is estimated to be 20 per cent of the GDP. While most are optimistic about this move, many have also questioned if it will be worth the inconvenience people have been put to. Thankfully, we can always look back at history to know if we have done better than before.

This is the third time India has gone through demonetisation of modern currency. In 1946, the British government demonetised hundred rupee currency and in 1978, currency notes of Rs 1,000. Rs 5,000 and Rs 10,000 were demonetised.

We stumbled upon a paper by Kishore C. Samal, published in Journal of Indian School of Political Economy in 1992, which details the various steps India has taken to chase black money. Here are few excerpts:

Demonetisation: 1946

Hundred rupee currency notes were demonetised by the government in 1946. A time limit was fixed for exchange of demonetised notes by genuine holders at the Reserve Bank of India or its agencies on the basis of their declarations. These declarations and explanations regarding the source of earnings and others were investigated carefully.

The exchange was not permitted if the explanation of the source of income was not satisfactory. But this caused great difficulties to the people. It did not also produce impressive results. At that time, total notes of the value of Rs 1235.93 crore were in circulation of which hundred rupee currency notes of the value of Rs 143.97 crore were demonetised. In fact, only Rs 89 crore worth of hundred rupee currency notes were immobilised. 

Total notes of the value of Rs 1235.93 crore were in circulation of which hundred rupee currency notes of the value of Rs 143.97 crore were demonetised. In fact, only Rs 89 crore worth of hundred rupee currency notes were immobilised. 

Demonetisation: 1978

On the night of January 16, 1978, government withdrew from circulation currency notes of denomination of Rs 1,000 and above. Banks were asked immediately to prepare statements of all currency notes of Rs 1,000, Rs 5,000 and Rs 10,000 in their possession. Persons holding such notes could exchange them before January 19, 1978, at the designated branches of the Reserve Bank of India and other Public Sector banks provided they disclosed the source, the time and the manner of acquisition along with a proper attestation of identity. 

If for some reason an individual could not apply for exchange of high denomination notes by January 19, 1978, he could do so by January 24, 1978, to the Reserve Bank of India, together with a satisfactory explanation of the reasons for not applying with the earlier time limit.

Demonetisation in 1978 was better implemented than in 1946. The value of these high denomination notes in circulation on January 17, 1978 was estimated at about Rs 180 crore. Of these, notes worth Rs 20 crore were immobilised. But most holders of high denomination notes did not turn up at bank branches to exchange them. They sold them to others who could present them at the bank with less suspicion. At estimated Rs 20 crore worth of high denomination notes were so exchanged at discount for small denomination notes.

The element of intended surprise and secrecy was also not well maintained and thousand rupee notes were already out of circulation one week before the demonetisation. Reportedly large amounts of high denomination notes were sent to the Gulf countries especially to Dubai and Kuwait a few days before the Ordinance was announced. In due course, they were presented at the Reserve Bank of India though official channels of the middle east-based foreign banks that had connection with such operations.

The element of intended surprise and secrecy was not maintained and thousand rupee notes were already out of circulation one week before the demonetisation. Reportedly large amounts of high denomination notes were sent to the Gulf countries

Despite these limitations, demonetisation served some useful though limited purpose.  First it brought out into open cash circulating in the illegal informal economy. Second, the step gave an effective blow to the political use of unaccounted money at that time. Third, the declaration made during the exchange of demonetized notes gave tax officials clue for further investigation. But frequent demonetisation of currency notes does not help; people with black money in high denomination notes convert them in time into smaller denomination notes.

Demonetisation: 2016

The current withdrawal of Rs 500 and Rs 1,000 notes is different in several respects to previous actions. In both earlier demonetisations, very high currency notes were targeted. The value of Rs 100 in 1946 would be equal to Rs 8,000 of today. In 1978 as well, only notes equal to and above Rs 1,000 were put out of circulation. Rs 1,000 of 1978 would be equal to more than Rs 12,500 of today. Both the earlier demonetisations, thus, effectively targeted only the big fish.

The withdrawal of relatively lower denomination notes in 2016 has widened the net, which was also essential considering the huge amount of black money circulating. This move, though, has also inconvenienced the honest citizens temporarily. Thankfully, the prevalence of electronic money now has saved us from the worse.

The move also came as a surprise as compared to 1978 when the notes had gone out of circulation a week before the decision was announced. This time, the scrutiny of those depositing the money will be more effective as PAN numbers have made it possible to track the flow of money through unknown sources.

This time, the scrutiny of those depositing the money will be more effective as PAN numbers have made it possible to track the flow of money through unknown sources

Possibly, the current demonetisation will also be of great help in tackling the menace of counterfeit currency, funding to terrorism, narcotics trade and exaggerations in the real estate market.  The demonetisation in 1978 too helped curb use of black money in electoral politics, which might be the case this time around as well. With several states going to polls next year, we can expect cleaner political campaigns.

Though there are reports of people buying gold with black money or exchanging the notes at loss in informal markets, the long term impact will be beneficial to the economy.

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