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“ANALYTICAL STUDY OF EFFECT OF DEMONETIZATION ON BANKING SYSTEM OF INDIA”
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“ANALYTICAL STUDY OF
EFFECT OF DEMONETIZATION ON BANKING SYSTEM OF INDIA”
AUTHORED BY- SHAIKH KARISHMA HAMID
CLASS- LLM II ROLL NO.2
PROGRESSIVE EDUCATION SOCIETY’S
MODERN LAW COLLEGE
ABSTRACT
On
8th November 2016, The Government of India has demonetized the currency of
Rs.500 and Rs.1000, sought to
discourse corruption, counterfeit currency, black money and terror financing. The total value of demonetized currency was Rs. 15.4 trillion, which constituted around 86.9% of total currency in
circulation. The study states that demonetization influenced various economic sectors
differently. The highly impacted period due to demonetization was experienced especially during November and December 2016. This impact was moderated prominently
in the month of January 2017 and
immoderate to a longer extent by mid of February 2017. As an impact of demonetization on Indian banks, there is a positive
change in the financial statements of scheduled commercial banks. The quantum of amount
deposited in the banks has raised and created surplus liquidity conditions. A significant increase in total number
of accounts opened under the scheme of Pradhan
Mantri Jan Dhan Yojana and the amount
deposits in these accounts have also increased. A significant impact of demonetization has also been monitored
in the use of electronic banking transactions.
This study is descriptive in nature and the data has been taken for the period
of pre- demonetization and post-demonetization.
INTRODUCTION
Demonetization refers
to stripping of currency from circulation where the old currency is replaced with new currency.
The concept of demonetization is not new in modern
era as Indian government had demonetized bank notes twice that is
in 1946 and 1978 respectively with a motive to combat tax evasion through black money. In 1946, Rs.1000 and Rs.10,000
notes were demonetized whereas in the second
instance that is in 1978, the government withdrew
Rs.10,000, Rs. 5000 and Rs. 1000 notes. On 8th November,2016 demonetization was announced by the Prime
minister Mr. Narender Modi to strip of Rs.500 and Rs.1000 notes from circulation which forms 86% of the cash currency in the market with the objective
to eradicate corruption, black money, terrorism, and counterfeit notes and to make India a Cashless economy as it
makes the spending convenient and increases
the transparency of transactions. The sudden implementation of demonetization
had an impact on the various sectors
of Indian economy including banks as banks forms the core sector of Indian economy, banks played a major
role to in the implementation of demonetization. The present study aims to showcase the effect of demonetization on bank and its operations.[2]
Cash
is the preferred mode of transaction in India and only less than half the
population uses banking
system for monetary transactions. Indians are a resilient lot. By nature, we Indians,
maybe have it in our blood to bounce back from shocks-natural and man-made and get on with things.
On 9th of November, when the
citizens of India- were told that the 500 and 1000 INR currency notes in their pockets
will no longer continue
to be legal tender,
the entire country
was in stun. The next few days that followed were long
queues outside ATM’s (banks were suddenly the most ‘in demand’ commodity); wage earners requested their bosses for short leave
to tend to the same. With demonetization effort 86% of India’s
currency was nullified that aimed to wash the stock of ‘black market's cash supply’ and counterfeit notes out of the economy and convert it into the licit, banked,
and taxable, part of the economy.
CAUSES BEHIND
DEMONETIZATION
1. Black Money: One major cause behind implementing
demonetization is to eliminate or reduce
huge sum of black money hoarded by people, mainly, owners of big business houses, politicians, and bureaucrats.
2. Fake Currency: Another reason of introducing this
policy is that it helps in flushing out fake
currency notes which circulates in market.
3. Corruption: GOI adopted
this policy to break the tentacles of corruption. High denomination
currency notes are vulnerable to be used for unfair purposes. It is easier to bribe someone in high denomination-high
valued currency notes. With demonetization, high
denomination currency notes are declared worthless which make it difficult for corrupt people to
practice corrupt exercises.
4. Digitization: For making India a cashless economy
and to promote digitization, demonetization is adopted. It was assumed
that chances of tax evasion
and corruption will plummet
or reduce as the transactions will be online, recorded and monitored.
5. Terror Funding: Black money is used for
terror funding and other anti-social activities. Therefore, with a view to reduce such activities, the bold step
of demonetisation has been taken by the government.
IMPACTS ON INDIAN ECONOMY
1. Economic slowdown: With demonetization,
consumption demand slacked which further resulted
in decrease in production. As cash in hand decreased, consumption was affected adversely. Consequently, post-demonetization there was a sudden drop-in
GDP growth rate in the following quarters.
Before
demonetization, in second quarter of FY 2016-17, GDP growth rate was 8.87% at 2011-12 prices. But, just after
demonetization, it reduced to 7.55% in third quarter of FY 2016-17. Furthermore, growth
rate of GDP was 7.04% in fourth
quarter of FY 2016-17 and in first quarter of FY 2017-18,
it was just 5.99%.
Growth
rate of GDP showed an erratic pattern after implementation of demonetization. Automobile and real estate
sector are among the badly hit
sectors due to demonetization as demand
for automobiles and properties have reduced. In December 2016, immediately after demonetization, a fall of one-fourth
was noticed in sales of two-wheeler industry.
Moreover, the leading industries dealing in car manufacturing also witnessed
a reduction of 4% in its sales.
2. Scarcity of Cash: Demonetization creates
sudden and short-term shortage of cash. This
results in decrease
in economic activities. This also put many challenges in front of people
as Indians prefer
to hold cash for transaction purposes. Even their simple daily
chores were badly affected as some people had no
cash even to buy their daily pre-requisites. Some even had to take off from their jobs just to stand in queues to
exchange their old currency notes. Consequently,
the daily wage earners were greatly affected. Also, demonetization was announced when the Indian wedding
season was at its peak. Therefore, people faced many difficulties because
of shortage of cash. It even led to some extreme consequences/outcomes as there was news of
people dying because of shock when they had no money to marry their children or fatigue due to standing
in queue for a long period
and working for long hours in banks.
3. Effect on Black Money: On
November 8, 2016,
while introducing demonetization, Prime Minister
Narendra Modi says, “Our generation did not get the opportunity of fighting for the freedom of our nation but today we
have the historic opportunity to weed out the
menace of corruption and black money to secure the future of our
nation.” The main objective of
demonetization was to wipe out the black money from the economy as black money hoarded by people became
a worthless piece
of paper after it. Those who wanted
to replace the old currency
notes with the new ones now will have to show where that money came
from does. But demonetization does not seem to be that effective in removing
black money as it was expected
because black money hoarders did not hoard money in form of cash rather, they preserved their money in
form of physical assets like gold, buildings,
properties etc. Also, according to RBI Report for 2017-18, 99% of old
banned bank notes of Rs.500 and Rs.1000
was returned to the RBI. This surely showed that this demonetization did not prove effective in reducing black money.
4. Impact on counterfeit (fake) currency: Counterfeit
currency is also known as fake currency.
One of the objectives of demonetization was to kick out fake currency from circulation as it is used for funding
terrorism which cripples down an economy. With
demonetization, counterfeit currency is eliminated automatically as this
currency can’t be used for transactions.
5. Digitization: Demonetization promotes Digital
India program. It helped in promoting e- commerce
and e-payment methods. As cash in hand reduced, people suffered problems to meet their daily basic transactions.
This shortage of cash led to automatic inclination of people to the digital modes of payment. People had to pay for
their transactions via e- wallets and plastic cards.
6. Effect on cash hoarding: With implementation of demonetization, cash hoarding reduced
at first, as people had to deposit
their old Rs.500
and Rs.1000 notes in the bank. But, as per the
Indian habits of hoarding money for transaction and precautionary motives, cash hoarding started rising not long
after when new currency notes became available in appropriate amount. It implies that cash hoarding
decreased drastically just after demonetization, but within a short period, it again started increasing as before.
7. Impact on Employment: Employment is also affected by demonetization. The Centre for Monitoring
Indian Economy (CMIE) has estimated that over 1.5 million jobs were lost after demonetization. In the manufacturing
sector, medium and large-scale
industries reported job-loss of 5%
and revenue loss of 20%. In the informal sector, many daily workers were rendered jobless due to paucity of cash in the system.
For example, thousands
of people lost their
jobs in tea gardens of West Bengal
and Assam. 90% of bangle factories of Firozabad, UP had to shut down because
of cash crunch. However, e-commerce and digital
payment platforms
witnessed unexpected boost.
Example can be given of Razorpay which witnessed 150% hike in the morning after the demonetization was announced, which by
afternoon, shot up to 200%. Also, Paytm received more than 25,000 signups.
Hence, it can be concluded that
demonetization had mixed effects on employment. On one side, it adversely influenced daily wage-earners,
MSMEs, contract workers while on the other side, e-commerce
and digital payment platforms
experienced hike in its users.
IMPACTS ON INDIAN BANKING
SECTOR
1. Effect on Banking Operations: After demonetization,
people rushed to banks to deposit or
exchange their old Rs.500 and Rs.1000 notes. Main operation banks performed at
that time was to replace old notes
with the new ones. As demonetization was a secretly taken step by government, there was no prior information to the banks.
This increased complexity for the banks to perform their daily banking operations. Also, at that time most people came to bank to deposit or exchange their old currency notes.
2. Effect on deposits
with banks: With demonetization, in 2016-17
it was seen that percentage share of savings deposits in
total deposits suddenly increased and that of term deposits decreased. In last 16 years, term deposits were
witnessed to be least at 19.1% at this
time. Also, percentage share of savings deposits was 66.2% which was also
highest among past 16 financial
years.
3. Cost of Replacement: Reprinting of new notes incurred
cost of printing. Also, there were only three centres where printing of new notes was done. So, there was two-way
transportation cost to supply new notes all over India and to bring back
old notes. There was also cost of replenishment of ATMs
with new currency notes.
4. Workload on Bank Employees: Demonetization
was a sudden announcement for all people.
So, banks were also not ready to cope with the situation.
Immediately after demonetization,
people rushed to the banks to exchange their old currency notes. There were huge queues in the banks which
increased the workload on bank employees. Also, people were worried about their money, so they were full of
questions and always found to be querying bank employees
about it.[3]
PROBLEMS/ISSUES DUE TO DEMONETIZATION
The
most serious issue is that the massive decline of the cash economy has had a
tremendous impact on the access to essential commodities since trucks
and other goods vehicles have stopped because of insufficient money to buy
diesel and the fact that employers have been forced to retrench labour because of cash. The informal economy - the largest
employer of labour
and a very large producer
of goods, usually cheaper than those in urban markets - has been very badly
hit. Most economists, in India and
abroad, believe that our GDP growth will fall to at least 5.6%, if not 4.6%. The rupee, which is Rs 68.12 to
$1, will fall to Rs 110 to $1. About $5 billion have already left India. Such a major crisis is called recession.
§ Formation of long winding queues in front of each bank as well as ATMs from morning to evening.
§ A considerable hue and cry from the public for getting their money exchanged.
§ Little violation
at some places by public.
§ A few deaths were accounted resulted
from stress of not getting
money, ultimately due to demonetization of currency.
§ Bank employees
must work for longer hours.
§ People are unable to withdraw huge amount for the big occasions at their home.
§ Swipe machines
found to be not working properly at many places whatever may be the issue (i.e.,
personally observed in trade
fair).
§ Illiterate or less
educated people are not so much aware about the cashless transactions.
§ Lack of ATM’s especially in rural areas creates
big problem.
§ In present
time, there are still villages/areas which are unbanked
even today resulting
their routine work disturbed as they must go to nearby villages
or cities to get exchange
their notes.
§ Most of the cashless transactions are connected through internet which demand
proper network that is
still inadequate in some
parts of India.
§ Many illegal agents (Dalals) are emerged who are indulged in exchange of notes with a huge commission resulting in moral degradation.
§ As some newspapers as well as news channels
reported that back door policy on its way at some places
in some banks with the involvement of some bank officials.
§ Even some
bank employees are found to be guilt indulging in conversion of ‘black money’
to ‘white money’.
§ Less educated
or illiterate people may have to face security issues
in case of providing information relevant to their financial instruments to get transactions done through others.
RECENT JUDGMENT
Recently,
the Supreme Court
has passed a verdict on the Demonetisation
of currency notes of Rs 500 and Rs
1,000 in a majority 4-1 by a five-judge Constitution Bench.[4]
What are the Rulings of the Verdict?
1.
Majority
Ruling:
§ The
majority held that Centre’s notification dated November 8, 2016, is valid and satisfies
the test of proportionality.
§ The RBI and
the Centre had been in consultation with each other for six months prior to the November 8 notification issued
under Section 26(2) of the RBI
(Reserve Bank Of India) Act, 1934.
§ The
statutory procedure under Section 26(2) of the RBI Act was not violated merely because the Centre had taken the
initiative to “advice” the Central Board to consider recommending demonetisation.
§ The
government was empowered under the provision to demonetise “all series” of banknotes.
§ On hasty
decision, the court said such measures undisputedly are required to be taken with utmost confidentiality and speed. If the news of such a measure is
leaked out, it is difficult to imagine
how disastrous the consequences would be.
§ Demonetisation was done for the “proper
purposes” of eliminating fake currency, black money, and terror financing.
2. Minority
Ruling:
§ The
government could have issued a notification under Section 26(2) of the RBI Act only if the RBI had initiated the proposal to demonetise by way of a recommendation.
§ Therefore, the government's notification issued under Section
26(2) of the RBI Act was unlawful.
§ In cases
in which the government initiates
demonetisation, it should take the opinion
of the RBI. The opinion of the
Board should be “independent and frank”.
§ If the
Board’s opinion was in the negative, the Centre could still go forward with the demonetisation exercise, but only by promulgating an ordinance or by enacting a parliamentary legislation.
§ Describing the Parliament as the “nation
in miniature”, “without
the Parliament, democracy will not thrive”.
What is the Test of Proportionality?
§ The test of proportionality is a commonly employed
legal method used by courts
around the world, typically constitutional courts, to decide cases where two or more legitimate rights
clash.
§ When such
cases are decided, one right typically prevails at the expense of the other and the court thus must balance the satisfaction
of some rights and the damage to other rights resulting from a judgment.
§ The
principle of proportionality ordains that the administrative measure must not
be more drastic than is necessary for attaining the desired result.
CONCLUSION
To recapitulate, it can be inferred that demonetization did not prove to be as effective
as it was visualised and expected. The main objective
of removing black money from the economy seems to be unachieved as 99% of old
currency notes were returned to the RBI. It also posed difficulties in front of people and bank employees.
Slowdown in GDP growth rate is also a bitter fruit of demonetization. Former RBI Governor Raghuram Rajan and Nobel
Laureate Abhijeet Banerjee are also of
the view that the slowdown
in the economy is structural and because of a deficiency of demand.
This lack of demand was also because of demonetization. There
are some positive
effects also as fake currency is reduced by a
noticeable amount. It also promotes digitization and transparency in the transactions and banking operations which further
helps in reducing
tax evasion as all transactions are now recorded. To
summarise, it can be said that demonetization brought mixed effects on the economy.
[1] “Impact of
Demonetization on Indian Banking Sector: A Step towards Governance, by Nitin
Bansal”, Pacific Business Review International Volume 11 Issue 7, January
2019. Available at http://www.pbr.co.in/2019/2019_month/Jan/4.pdf. Last seen at 20/04/2023.
[2] “Impact of Demonetization on Indian Banking Sector by Syeda Wajeda Hussaini”, International Journal of Advanced
Research in Science, Communication and Technology (IJARSCT) Volume 7,
Issue 2, July 2021. Available at https://ijarsct.co.in/Paper1791.pdf. Last seen at 20/04/2023.
[3] “Demonetization
and its impact on Indian economy with special reference to Indian banking
sector”, International Journal of Advanced Academic
Studies, by Deepak and Amisha Goel. Available
at https://www.allstudyjournal.com/article/814/4-3-2-655.pdf. Last Seen at 20/04/2023.
[4] “Supreme Court’s Verdict on Demonetisation”. Available
at https://www.drishtiias.com/daily-updates/daily-news- analysis/supreme-court-s-verdict-on-demonetisation. Last seen at 20/04/2023.
Article Information
“ANALYTICAL STUDY OF EFFECT OF DEMONETIZATION ON BANKING SYSTEM OF INDIA”
Authors: SHAIKH KARISHMA HAMID
- Journal IJLRA
- ISSN 2582-6433
- Published 2023/05/03
- Volume 2
- Issue 7
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International Journal for Legal Research and Analysis
- Abbreviation IJLRA
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