Model Answer
0 min readIntroduction
Demonetisation, defined as the act of removing a currency unit from circulation, is a drastic monetary policy often employed to combat issues like black money, inflation, and terrorism financing. The Indian government’s demonetisation exercise in November 2016, involving the withdrawal of 500 and 1000 rupee notes, was a landmark event. While proponents hailed it as a bold step towards a cleaner economy, critics pointed to the immediate economic disruption. This answer will explore the reasons supporting the statement that demonetisation was a radical and unprecedented step with short-run costs and long-term benefits, providing a balanced assessment of its impact.
Short-Run Costs of Demonetisation
The immediate aftermath of demonetisation was marked by significant economic disruption. The sudden removal of 86% of the currency in circulation created a severe cash crunch, impacting various sectors.
- Economic Slowdown: India’s GDP growth slowed down to 6.7% in FY17 from 8.2% in FY16 (Economic Survey 2016-17). This was largely attributed to the disruption in economic activity due to cash shortages.
- Impact on Informal Sector: The informal sector, heavily reliant on cash transactions, was severely affected. Small and medium-sized enterprises (SMEs) faced difficulties in paying wages and procuring raw materials.
- Agricultural Distress: Farmers faced challenges in procuring seeds, fertilizers, and selling their produce due to the cash crunch, leading to distress sales and reduced income.
- Logistical Challenges: The process of replacing the demonetised notes with new ones was fraught with logistical challenges, leading to long queues at banks and ATMs.
- Increased Transaction Costs: Individuals and businesses incurred significant transaction costs in converting old notes into new ones.
Long-Term Benefits of Demonetisation
Despite the short-run costs, demonetisation was expected to yield several long-term benefits, aimed at reforming the Indian economy.
- Formalization of the Economy: Demonetisation encouraged the formalization of the economy as individuals and businesses were compelled to deposit cash into banks, bringing previously untracked money into the banking system.
- Curbing Black Money: The objective of curbing black money was a primary driver of demonetisation. While the extent to which it achieved this goal is debatable, a significant amount of previously undisclosed income was deposited into banks.
- Boost to Digital Economy: The cash crunch spurred the adoption of digital payment methods like mobile wallets, UPI, and debit/credit cards. UPI transactions witnessed a phenomenal increase post-demonetisation.
- Increased Tax Base: The increased formalization of the economy and the detection of undisclosed income led to an expansion of the tax base.
- Reduced Counterfeit Currency: Demonetisation aimed to curb the circulation of counterfeit currency, which poses a threat to national security and economic stability.
Analyzing the Effectiveness – A Mixed Outcome
The effectiveness of demonetisation remains a subject of debate. While some of the intended benefits were realized, others fell short of expectations.
| Aspect | Expected Outcome | Actual Outcome |
|---|---|---|
| Black Money | Significant reduction in black money | Majority of demonetised notes were deposited back into banks; limited impact on wealth held in real estate or foreign assets. |
| Digital Transactions | Substantial increase in digital payments | Significant increase in digital transactions, particularly UPI, but cash remains dominant. |
| Formalization | Increased formalization of the economy | Increased bank deposits and tax base, indicating some degree of formalization. |
| GDP Growth | Positive impact on long-term growth | Short-term slowdown in GDP growth; long-term impact still debated. |
The Reserve Bank of India (RBI) reported that 99.3% of the demonetised notes were returned to the banking system, indicating that the objective of eliminating black money was not fully achieved. However, the increase in digital transactions and the expansion of the tax base suggest some positive outcomes.
Conclusion
Demonetisation was undoubtedly a radical and unprecedented step, undertaken with the ambitious goals of curbing black money, formalizing the economy, and promoting digital transactions. While the short-run costs were substantial, manifested in economic disruption and hardship for many, it did contribute to some long-term benefits, particularly in the realm of digital payments and formalization. However, the overall success of the exercise remains contested, with the objective of eliminating black money largely unmet. A more comprehensive and well-planned approach, coupled with robust enforcement mechanisms, is crucial for tackling the issue of black money effectively in the future.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.