In a move that took India by surprise, the Government of India announced on 8 November, 2016 that effective from end of day currency notes of 1000 and 500 denomination will no longer be legal tender. What was the need for this drastic move and what is its likely impact going to be?
India suffers from a large degree of tax under-penetration (only 3% of Indians pay taxes) and most of the economy operates through use of cash. Some experts opine that as much as 70-80% of the economy is in the unorganized sector. This has resulted in India’s tax to GDP ratio remaining low at 17 percent compared to the global average of 24 percent.
This demonetization of Rs. 1,000 and Rs. 500 currency notes will lead to as much as 86% of the currency in circulation being removed from the system. The public has been given time until 30 December, 2016 to deposit their cash into banks or exchange the old currency notes for new ones, within limits. The move is expected to force cash hoarders and black marketers to deposit their cash into banks, in which case large sums will come to the notice of the tax authorities and will be taxed. This way, the large idle and unaccounted cash in the economy will also enter the banking sector, thus enabling banks to expand their deposit base and increase lending.
The exercise is targeted at the black market economy and provisions have been made to ensure that honest tax payers and small savers are not affected. Cash deposits up to Rs2,50,000 will not be questioned. Even in other cases involving large amounts, if proper justification can be provided on the source of funds then there will be no penalties or tax involved.
There has been an immediate fallout of the move. Since the public was provided an opportunity to utilize the old currency notes for certain specified transactions like payment to utilities, clearance of dues/penalties, etc. large sums of money have been cleared by defaulters on account of property taxes, utility bills, local body dues, etc. Some of these dues had been outstanding for years despite the defaulters being in possession of substantial amount of cash.
The hope is that this shock therapy will provide a reset to the economy, moving many small businesses into the organized sector besides bringing in an era of digital payments. This may be India’s big start of the move away from hard cash. For more visit: Click Here
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