2.

2 INTRODUCTION TO DEMONITIZATION

On 8 November 2016, the Government of India announced the demonetization of all

₹500 (US$7.40) and ₹1,000 (US$15) banknotes of the Mahatma Gandhi Series. The
government claimed that the action would curtail the shadow economy and crack down
on the use of illicit and counterfeit cash to fund illegal activity and terrorism. The sudden
nature of the announcement—and the prolonged cash shortages in the weeks that
followed—created significant disruption throughout the economy, threatening economic
output. The move was heavily criticized as poorly planned and unfair, and was met with
protests, litigation, and strikes.

Prime Minister of India Narendra Modi announced the demonetization in an unscheduled

live televised address at 20:00 Indian Standard Time (IST) on 8 November. In the
announcement, Modi declared that use of all ₹500 and ₹1000 banknotes of the Mahatma
Gandhi Series would be invalid past midnight, and announced the issuance of new ₹500
and ₹2000 banknotes of the Mahatma Gandhi New Series in exchange for the old
banknotes.
The BSE SENSEX and NIFTY 50 stock indices fell over 6 percent on the very next day
after the announcement. In the days following the demonetization, the country faced
severe cash shortages with severe detrimental effects across the economy. People seeking
to exchange their bank notes had to stand in lengthy queues, and several deaths were
linked to the inconveniences caused due to the rush to exchange cash.

Initially, the move received support from several bankers as well as from some
international commentators. It was heavily criticized by members of the opposition
parties, leading to debates in both houses of parliament and triggering organized protests
against the government in several places across India. The move is considered to have
reduced the country's GDP and industrial production. As the cash shortages grew in the
weeks following the move, the demonetization was heavily criticized by prominent
economists and by world media.

In India’s case, the move has been taken to curb the menace of black money and fake
notes by reducing the amount of cash available in the system. It is also interesting to note
that this was not the first time the Government of India has gone for the demonetization
of high-value currency. It was first implemented in 1946 when the Reserve Bank of India
demonetized the then circulated Rs 1,000 and Rs 10,000 notes. The government then
introduced higher denomination banknotes in Rs 1000, Rs 5000 and Rs 10000 in a fresh
avatar eight years later in 1954 before the Morarji Desai government demonetized these
notes in 1978.

1.2.1 MEANING

Demonetization is the act of stripping a currency unit of its status as legal tender.
Demonetization is necessary whenever there is a change of national currency. The old
unit of currency must be retired and replaced with a new currency unit. The opposite of
demonetization is remonetization where a form of payment is restored as legal tender.
Demonetization is a radical monetary step in which a currency unit’s status as a legal
tender is declared invalid. This is usually done whenever there is a change of national
currency, replacing the old unit with a new one. Such a step, for example, was taken
when the European Monetary Union nations decided to adopt Euro as their currency.
However, the old currencies were allowed to convert into Euros for a period of time in
order to ensure a smooth transition through demonetization. Zimbabwe, Fiji, Singapore
and Philippines were other countries to have opted for currency demonetization.

Denomination is a proper description of a currency amount, usually for coins or

banknotes. Denominations may also be used with other means of payment like gift cards.
For example, five euros is the denomination of a five euro note.

1.2.2 DEFFINITION

Demonetization for us means that Reserve Bank of India has withdrawn the old Rs 500
and Rs 1000 notes as a official mode of payment. According to Investopedia,
demonetization is the act of stripping a currency unit of its status as legal tender.

Ending something (e.g. gold or silver) as no longer the legal tender of a country.

Process of removing a currency from general usage, or circulation. Gold was

demonetized in this way when it ceased to be used as an everyday currency.

1.2.3 BACKGROUND

There are multiple reasons why nations demonetize their local units of currency. Some
reasons include to combat inflation, to combat corruption, and to discourage a cash
system. The process of demonetization involves either introducing new notes or coins of
the same currency or completely replacing the old currency with new currency.

The Indian government had demonetized bank notes on two prior occasions—once in
1946 and then again in 1978—and in both cases, the goal was to combat tax evasion by
"black money" held outside the formal economic system. In 1946, the pre-independence
government hoped demonetization would penalize Indian businesses that were
concealing the fortunes amassed supplying the Allies in World War II. In 1978, the
Janata Party coalition government demonetized banknotes of 1000, 5000 and 10,000
rupees, again in the hopes of curbing counterfeit money and black money.

In 2012, the Central Board of Direct Taxes had recommended against demonetization,
saying in a report that "demonetization may not be a solution for tackling black money or
economy, which is largely held in the form of benami properties, bullion and jewellery."
According to data from income tax probes, black money holders kept only 6% or less of
their wealth as cash, suggesting that targeting this cash would not be a successful
strategy.

On 28 October 2016 the total banknotes in circulation in India was ₹17.77 trillion
(US$260 billion). In terms of value, the annual report of Reserve Bank of India (RBI) of
31 March 2016 stated that total bank notes in circulation valued to ₹16.42 trillion
(US$240 billion) of which nearly 86% (around ₹14.18 trillion (US$210 billion)) were
₹500 and ₹1,000 banknotes. In terms of volume, the report stated that 24% (around
22.03 billion) of the total 90266 million banknotes were in circulation.

In the past, the Bharatiya Janata Party (BJP) had opposed demonetization. BJP
spokesperson MeenakshiLekhi had said in 2014 that "The aamaurats and the aadmis
(general population), those who are illiterate and have no access to banking facilities, will
be the ones to be hit by such diversionary measures."

In June, the Government of India had devised the Income Declaration Scheme, that lasted
till 30 September 2016, providing an opportunity to citizens holding black money and
undeclared assets to avoid litigation and come clean by declaring their assets, paying the
tax on them and a penalty of 45% thereafter.

In 2016, the Indian government decided to demonetize the 500- and 1000- rupee notes,
the two biggest denomination notes. These notes accounted for 86% of the country’s cash
supply. The government’s goal was to eradicate counterfeit currency, fight tax evasion,
eliminate black money gotten from money laundering and terrorist financing activities,
and promote a cashless economy. By making the larger denomination notes worthless,
individuals and entities with huge sums of black money gotten from parallel cash systems
were forced to convert the money at a bank which is by law required to acquire tax
information from the entity. If the entity could not provide proof of making any tax
payments on the cash, a tax penalty of 200% of the tax owed was imposed.

In 2015, the Zimbabwean government demonetized the Zimbabwean dollar as a way to

combat the country’s hyperinflation that was recorded at 231,000,000%. The 3-month
process involved expunging the Zimbabwean dollar from the country’s financial system
and solidifying the US dollar, Botswana pula, and South African rand as the country’s
legal tender in a bid to stabilize the economy.