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Demonetization, the Cash Shortage and the Black Money

Ashok K. Lahiri

NIPFP Working paper No. 184, 2016

Demonetisation of INR 500 and INR 1,000 notes in India on November 8, 2016 is different from many other countries’ scrapping of high value notes in two respects– the withdrawal of their legal tender status and continuation with INR 1,000 and INR 2,000 notes. It has resulted in a cash shortage. Non-cash medium of payments may be encouraged by this shortage, but, with supplies only from the domestic currency presses, the shortage is unlikely to disappear by the end of 2016. Import of currency printed abroad may provide a solution for ending it sooner. The impact of the shortage, if it continues, will be fully felt in the last quarter of 2016-17. Its growth impact in 2016-17 is 0.7-1.3 per cent depending on how much shortage continues and for how long. The big painful jolt of demonetisation creates the right psychological milieu for the war against black money to start. Only Time will tell whether steps such as the Income Declaration Scheme (IDS) in the Budget for 2016-17, the August 2016 amendment of the Benami Transactions (Prohibition) Act of 1988, and the Taxation Laws (Second Amendment) in November 2016, are parts of a concerted plan for tackling black money, and this time is different from 1946 and 1978. With the strides made in digitisation of tax returns and bank records together with PAN, Aadhar and KYC regulations, compared to 6 per cent in 1946 and 11 percent in 1978, at least 15 per cent or INR 2.2 trillion of the demonetised notes not exchanged into deposits or cash will provide a preliminary positive feedback on the success of the current demonetisation.
Courtesy: NIPFP
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