By Paramjeet Singh

First of all, this cannot be referred to as “demonetization”. In demonetization, the currency is stripped of its status as a legal tender. However, in the contemporary case, regardless of the Prime Minister’s announcement on the eve of November 8, 2016 that the then valid currency notes of 1000 and 500 would lose their character of a legal tender past midnight that day, the notes are still being allowed by the government to be used as a legal tender in various places like hospitals, petrol pumps, Kendriya Bhandaars etc.

One should not forget that India has a large informal economy which is dependent on cash.

Secondly, the step has little to do with black money. This is because black money is something that includes within its ambit money, whether cash or not, that has not been declared to the government for taxation. Shifting the focus of the public discourse onto cash for black money is akin to spreading a false propaganda. This is because even in legal businesses huge requirements of cash exist. One should not forget that India has a large informal economy which is dependent on cash.

There is no doubt that the so-called ban imposed by the Central Government on Rs. 1000 and Rs. 500 is a political statement.

Furthermore, the step has denied people to have access to their own hard-earned money in the form of cash. Also, it coerces them to deposit their money with the banks. There seems to be no legal or any logical justification for this. Commercial banks do not operate for free or for the welfare of public. Their job is to make profits by advancing loans or dealing with the money kept with them in many other ways. Therefore, forcing citizens to be a part of the banking system is like using people’s money to facilitate the banking business.

There is no doubt that the so-called ban imposed by the Central Government on Rs. 1000 and Rs. 500 is a political statement. It does not align with any positive economic impact which it proposes to achieve. Many world renowned economists like Kaushik Basu, Prabhat Patnaik have expressed their concerns regarding the recent move. However, there is one perspective that is worth highlighting– regarding banking system.

The effect of demonetization

The effects of demonetization | Photo Courtesy: Deccan Chronicle

A move to boost the banking sector?

The way our current banking system works is clearly one of the most important reasons why this measure has been introduced. The Finance Minister, in an interview, said that “It will take India towards a cashless economy, it doesn’t merely push the country in that direction, but significantly pushes it.” Here lies the catch. Earlier, the currency used to be pegged to gold but later fiat money was introduced. Fiat money is as good as a piece of paper declared by the government as a legal tender.

The recent move requires people to “deposit” their money into the banks. The amount of money that has been allowed to be exchanged is very small. Now, what happens when the people deposit money into the banks? The bank deposits rise.

There comes into the picture the system of Fractional Reserve Banking (‘FRB’). This system helps the banks to create credit, which is also money in the economy, out of nothing.

The so-called demonetization step will allow banks to be ready with huge lending capacity. However, it is a different question whether the players in the market will have demand for such huge loans. Even if the market has demand for such huge loans, it is yet to be seen whether this flow of money into the economy will be used for productive activities. There is no doubt that India is not in a condition to bear more bad loans keeping in view the recent writing off of huge non-productive assets.


Paramjeet Singh is a lawyer practising before the Supreme Court of India.

Featured image source: Image 1 via Indian Express

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Posted by The Indian Economist