What is Demonetisation? Objective, Advantages & Disadvantages

Demonetisation means the withdrawal of certain currency notes by the government and making them invalid for transactions. In 2016, the Indian government demonetised ₹500 and ₹1,000 currency notes, which was a highly visible move in the Indian economy. The government initiated this action to fight black money, counterfeit currency, and corruption. As well as to promote a digital economy. This article discusses the objectives, benefits, disadvantages, and long-term consequences of demonetisation and its impact on the Indian economy.

What is Demonetisation?

Demonetisation is the act of invalidating a specific type of currency note or coin. The government usually announces that it will no longer accept certain currency denominations for transactions. The government might then issue new currency notes or reintroduce existing notes in smaller denominations.

In India, demonetisation took place on November 8, 2016, when the Prime Minister of India, Narendra Modi, announced the withdrawal of ₹500 and ₹1,000 notes. These notes represented a large portion of the cash in circulation, and their sudden removal had a significant impact on the economy. The objective was to curb black money, counterfeit currency, and tax evasion.

Objective of Demonetisation

The primary objective of demonetisation is to address issues such as black money, counterfeit currency, and corruption. Let’s break down these objectives in more detail:

Curbing Black Money

Black money refers to income that people do not declare to the government and often hide from tax authorities. The government greatly reduced the amount of unaccounted money deposited or exchanged in the banking system by demonetising large-denomination currency notes and keeping it in cash, away from the formal banking system.

• Increase in tax collection: With the cash coming into the formal banking system, the government could greatly reduce tax evasion by encouraging more people to pay taxes, resulting in increased revenue collection.
• Transparency: The move aimed to create a more transparent financial system by bringing more transactions into the formal economy.

Tackling Counterfeit Currency

Another goal of demonetisation was to reduce the circulation of counterfeit currency. Fake notes often circulate in the economy, undermining the value of genuine currency. The demonetisation process forced people to exchange their old notes, allowing the authorities to identify and destroy fake currency.

• Increase in trust: People would have more trust in the currency system when the government took steps to reduce counterfeit money.
• Improve security: New currency notes with advanced security features were introduced, making it more difficult for counterfeiters to produce fake notes.

Reducing Corruption

Demonetisation aimed to reduce corruption by making it difficult to use large amounts of cash for illegal transactions. Public officials, politicians, and businesspersons who engaged in corrupt practices often hoarded cash to avoid tax payments. By invalidating these notes, the government greatly reduced the chances of catching those who were involved in such activities.

• Encourage digital transactions: The government also encouraged a shift towards a more digital and transparent economy, making it easier to track and monitor payments.
• Build a cleaner economy: The aim was to create a cleaner, more honest economy with reduced scope for corrupt activities.

Advantages of Demonetisation

Demonetisation aimed to tackle key financial issues by reducing black money, promoting digital payments, curbing counterfeit currency, and boosting bank deposits. Here are some of the advantages:

1. Reduction in Black Money One of the key goals of demonetisation was to reduce black money. While it may not have entirely eradicated black money, it significantly reduced the amount of unaccounted wealth held in cash.
2. Enhanced Digital Transactions Post-demonetisation, there was a surge in digital payments. People were encouraged to use banking services, debit cards, mobile wallets, and other forms of online payments. This helped to increase financial inclusion and move towards a cashless society.
3. Crackdown on Counterfeit Currency The demonetisation process helped the government identify and destroy counterfeit currency, which had been circulating in large volumes. The new currency notes were equipped with enhanced security features to make counterfeiting more difficult.
4. Increased Bank Deposits As a result of demonetisation, many individuals who were hoarding cash deposited their money into the banking system. This increased bank deposits, improving the liquidity of the banking system.

Disadvantages of Demonetisation

Demonetisation brought several disadvantages, causing short-term economic disruption, impacting small businesses, leading to job losses, and having a limited effect on curbing black money.

1. Short-Term Economic Disruption In the short term, demonetisation caused significant disruption in the economy. Businesses that relied heavily on cash transactions were hit hard, particularly in sectors such as retail, agriculture, and construction. People faced difficulties in accessing money, and there was a temporary slowdown in economic activities.
2. Impact on Small Businesses Small businesses, which often rely on cash transactions, were significantly impacted. Many of them were unable to adapt quickly to digital payment methods or accept bank transfers, leading to losses and closures in some cases.
3. Job Losses The informal sector, which primarily operates in cash, faced job losses due to demonetisation. Small traders, daily wage workers, and farmers were among the worst affected, as they had limited access to banking services and faced difficulties in getting paid.
4. Limited Effect on Black Money While demonetisation succeeded in bringing some black money into the formal banking system, it did not eliminate the problem. Many individuals found ways to convert or launder their illicit wealth, and the overall effect on black money was more limited than initially expected.

Conclusion

In conclusion, what is demonetisation is not just a financial process but a transformative event that can have wide-ranging implications for an economy. While demonetization in India aimed to reduce black money, counterfeit currency, and corruption, it also caused short-term economic disruptions. The benefits of demonetization are still under debate, but it definitely brought about significant changes in the way people transact and manage their finances. Lessons learned from demonetisation can, therefore, provide valuable insights to governments that continue to grapple with the challenges of corruption and black money.

What is Demonetisation FAQs

What is demonetisation in India?

Demonetisation in India refers to the government’s decision in 2016 to invalidate ₹500 and ₹1,000 currency notes.

What is the purpose of demonetisation?

The primary purpose of demonetisation is to reduce black money, counterfeit currency, and corruption. Promoting a shift to digital transactions and increasing tax compliance.

What were the effects of demonetisation on small businesses?

Demonetisation severely affected small businesses because they heavily relied on cash transactions. Many businesses suffered losses and had to either shut down or switch to digital payment methods.

Did demonetisation reduce black money?

Demonetisation helped bring some black money into the formal banking system, but it did not completely eradicate black money. Many individuals found ways to convert or launder illicit funds.

What are the disadvantages of demonetisation?

The main disadvantages of demonetisation include short-term economic disruptions, job losses, and limited effect on eradicating black money.