On 8 November 2016, the Government of India announced the demonetisation of all ₹500 and ₹1,000 banknotes of the Mahatma Gandhi Series. It also announced the issuance of new ₹500 and ₹2000 banknotes in exchange for the demonetised banknotes. Prime Minister Narendra Modi said that this decision would curtail the shadow economy, increase cashless transactions and reduce the use of illicit and counterfeit cash to fund illegal activity and terrorism.
The announcement of demonetisation was followed by prolonged cash shortages in the weeks that followed, which created significant disruption throughout the economy. People seeking to exchange their banknotes had to stand in lengthy queues, and several deaths were linked to the rush to exchange cash.
According to a 2018 report from the Reserve Bank of India ₹15.3 lakh crore (15.3 trillion rupees on the short scale) of the ₹15.41 lakh crore in demonetised bank notes, or approximately 99.3%, were deposited in banks, leading analysts to state that the effort had failed to remove black money from the economy. The BSE SENSEX and NIFTY 50 stock indices fell over 6% on the day after the announcement. The move reduced the country's industrial production and its GDP growth rate. It is estimated that 1.5 million jobs were lost. The move also saw a significant increase in digital and cashless transactions throughout the country.
Initially, the move received support from some central bankers as well as from some international commentators. The move was also criticised as poorly planned and unfair, and was met with protests, litigation, and strikes against the government in several places across India. Debates also took place concerning the move in both houses of Parliament. Consensus among independent commentators is that the demonetisation was unsuccessful in removing black money from the economy.
Background
The Indian government had demonetised banknotes on two prior occasions—once in 1946 and once in 1978—and in both cases, the goal was to combat tax evasion via "black money" held outside the formal economic system. In 1978, the Janata Party coalition government demonetised banknotes of ₹1,000, ₹5,000 and ₹10,000, again in the hopes of curbing counterfeit money and black money.
In 2012, the Central Board of Direct Taxes recommended against demonetisation, saying in a report that "demonetisation may not be a solution for tackling black money or shadow economy, which is largely held in the form of benami properties, bullion and jewelry." 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.
Demonetisation process
Preparation and announcement
The plan to demonetise the ₹500 and ₹1,000 banknotes was initiated between six and ten months before it was a report by the State Bank of India (SBI) analysed possible strategies and effects of demonetisation. In May 2016, the Reserve Bank of India had started preparing for new banknotes and confirmed the design of ₹2,000 banknotes in August 2016. The printing of new banknotes started in October when the news stories of forthcoming new banknotes appeared in the media. On 27 October 2016, the Hindi daily Dainik Jagran published a report quoting RBI sources speaking of the forthcoming of ₹2,000 banknotes alongside withdrawal of ₹500 and ₹1,000 banknotes. On 21 October 2016, The Hindu Business Line had also covered a story on demands to withdraw the banknotes to prevent hoarding of black money.
The Board of the Reserve Bank of India met on 8 November 2016, 5:30 PM to consider a letter from the Ministry of Finance regarding demonetisation. "Two key reasons for the proposal cited in the government letter were: (1) between 2011 and 2016, the supply of 500- and 1,000-rupee bills had grown by 76 and 108 percent, respectively, while India's economy had only grown by 30 percent during this period; and (2) cash typically facilitated "black money." The board was further told that the measure was also intended to encourage greater financial inclusion and to incentivise greater digitisation of the economy. The board approved the proposal, but raised several concerns. It noted that the measure may not have the desired effect on black money because most people do not hold undeclared wealth in cash. It also warned that potential negative effects on growth were likely to occur in the short run. The board also stated that the premise on which the government had based its proposal—that the supply of 500- and 1,000-rupee bills had far outstripped the growth rate of the economy—was flawed because it had compared real GDP growth with nominal growth of currency supply. It noted that nominal GDP growth had summed to over 80 percent between 2011 and 2016 and hence was in line with the growth of the currency bills to be demonetised."
The Union cabinet was apprised of the plan on 8 November 2016 in a meeting in the evening convened by Prime Minister Modi. Soon after the meeting, Modi announced the demonetisation in an unscheduled live national televised address at 20:15 IST. He declared circulation of all ₹500 and ₹1,000 banknotes of the Mahatma Gandhi Series as invalid effective from the midnight of the same day, and announced the issuance of new ₹500 and ₹2,000 banknotes of the Mahatma Gandhi New Series in exchange for the demonetised banknotes.
After the announcement of demonetisation, a prominent businessman claimed to have received prior tip-offs and rumours warning of the move and after seeing leaked photos of new ₹2,000 notes "knew what was coming", allowing them to preserve their money by converting it into smaller denominations. A Bharatiya Janata Party (BJP) member from Rajasthan Legislative Assembly, Bhawani Singh Rajawat, claimed in a video that wealthy businessmen were informed about the demonetisation before it occurred. He later denied making the comments.
Cash exchange and withdrawal
The Reserve Bank of India stipulated that the demonetised banknotes could be deposited with banks over a period of fifty days until 30 December 2016. The banknotes could also be exchanged for legal tender over the counter at all banks. The limit for such exchange was ₹4,000 per person from 8 to 13 November, was increased to ₹4,500 from 14 to 17 November, and reduced to ₹2,000 from 18 to 25 November. The exchange of banknotes was stopped completely on 25 November, although the government had previously stated that the volume of exchange would be increased after that date. International airports also facilitated an exchange of banknotes for foreign tourists and out-bound travellers, amounting to a total value of ₹5,000 per person. Fuel pumps, government hospitals, railway and airline booking counters, state-government recognised dairies and ration stores, and crematoriums were allowed to accept the demonetised banknotes until 2 December 2016.
Cash withdrawals from bank accounts were restricted to ₹10,000 per day and ₹20,000 per week per account from 10 to 13 November. This limit was increased to ₹24,000 per week from 14 November 2016. Limits on cash withdrawals from Current accounts/ Cash credit accounts/ Overdraft accounts were withdrawn later. RBI increased the withdrawal limit from Savings Bank account to ₹50,000 from the earlier ₹24,000 on 20 February 2017 and then on 13 March 2017, it removed all withdrawal limits from savings bank accounts.
A daily limit on withdrawals from ATMs was also imposed varying from ₹2,000 per day until 14 November, and ₹2,500 per day until 31 December. This limit was increased to ₹4,500 per day from 1 January, and again to ₹10,000 from 16 January 2017. From 17 November, families were allowed to withdraw ₹250,000 for wedding expenses. Farmers were permitted to withdraw ₹25,000 per week against crop loans.
Ordinance and Acts
The Specified Bank Notes (Cessation of Liabilities) Ordinance, 2016 was issued on 28 December 2016, ending the liability of the government for the demonetised banknotes. The ordinance also imposed fines on people found carrying out transactions with them after 8 November 2016, or holding more than ten of them after 30 December 2016. It provided for the exchange of the banknotes after 30 December for people who had been outside India between 9 November and 30 December. The Specified Bank Notes (Cessation of Liabilities) Act, 2017 was notified on 1 March 2017, replacing the ordinance.
Objectives and outcomes
The government said that the main objective of the exercise was curbing black money, which included income which had not been reported and thus was untaxed; money gained through corruption, illegal goods sales and illegal activities such as human trafficking; and counterfeit currency. Other stated objectives included expanding the tax base and increasing the number of taxpayers; reducing the number of transactions carried out by cash; reducing the finances available to terrorists and radical groups such as the Naxalite Maoists; and integrating the formal and informal economies.
Shifting of goalposts
The government was described as 'shifting the goalposts' with respect to the goals of the demonetisation exercise. The initial stated goal was to curb black money, corruption, and terrorism, but as it became apparent that almost all the cash was being exchanged, the goals were expanded to include making India a cashless economy, neutralisation of money held by Maoists, terrorists and human traffickers, among others.
Black money
The government estimated that ₹5 trillion, or approximately 20%, of the demonetised banknotes would be permanently removed from circulation. However, according to a 2018 report from the RBI, 99.3% of the demonetised banknotes, or ₹15.3 trillion of the ₹15.41 trillion that had been demonetised, were deposited with the banking system. The banknotes that were not deposited were worth ₹107.2 billion. Commentators concluded that the government had failed in its aim of purging black money from the economy.
Evasion
There were reports of people circumventing the restrictions imposed on exchange transactions by conducting multiple transactions at different bank branches, and by sending hired people, employees, and followers in groups to exchange large amounts of demonetised banknotes at banks. In Gujarat, Delhi and many other major cities, sales of gold increased post-demonetisation, surging the price as much as ₹45,000 (US$470) from the ruling price of ₹31,900 (US$330) per 10 grams (0.35 oz). The Enforcement Directorate raided several forex establishments making backdated entries. Money laundering using backdated accounting was carried out by co-operative banks, jewellers, sellers of mobile phones, and several other businesses.
The cash deposited into hundis (cash collection boxes in temples and gurudwaras) are exempted from inquiry by the tax department; this is sometimes to launder money. After the demonetisation, there was a spike in donations in the form of the demonetised banknotes in temples. People booked large numbers of railway tickets to dispose of unaccounted cash. This came to the notice of the Indian Railways authorities, who imposed restrictions to check evasion.
Counterfeit banknotes
After demonetisation, there was an increase in the number of counterfeit ₹100 and ₹50 banknotes. The number of counterfeit ₹500 and ₹1,000 (demonetised version) banknotes saw an increase in 2016–17 and subsequently a decline in 2017–18. But in 2017–18, there was an increase in counterfeit ₹500 and ₹2,000 (new version) banknotes than the previous year. There has been no significant change in the number of counterfeit banknotes detected. In 2017–18, the number of detected counterfeit banknotes was close to the number before demonetisation. Additionally, after demonetisation, only 0.0035% of the ₹1,000 banknotes were found to be counterfeit. The number of counterfeit banknotes of ₹500 and ₹2,000 (new version) detected continue to increase while overall number declined in 2018-19 and 2019–20.
Tax collection
The number of income tax returns filing increased from 43.3 million to 52.9 million between the financial year of 2016 and 2017, which was not a significant increase compared to the increase between 2015 and 2016. The tax compliance had increased with a number of income tax returns filing increased but the majority of them were from salaried and non-business class. The income tax collections increased in the financial year of 2017 due to Income Disclosure Scheme 2016. If adjusted for it, the increase in tax collection was modest. The tax-to-GDP ratio has increased due to expanding tax base. An analysis of the economic data shows that there has been no substantial increase in the number of new tax payers or direct tax collection due to demonetisation. Indirect tax/GDP ratio also remained on the trend path and had no visible impact.
The use of demonetised banknotes was allowed for the payment of municipal and local civic body taxes, leading to a jump in their revenue collections. For example, the Greater Hyderabad Municipal Corporation reported collecting about ₹1.6 billion in cash payments of outstanding and advance taxes within the first four days of demonetisation.