Is India’s demonetisation experiment failing?

India’s prime minister Narendra Modi shocked his country and the world on November 8 2016 by announcing that, from the following day, Rs500 ($7) and Rs1000 notes would no longer be legal tender and would be replaced by new Rs 500 and Rs 2000 banknotes. What followed was a cash shortage and a frenzy of people lining up to exchange notes at banks all over the country. Asialaw spoke to lawyers in India about the positive and negative impacts of the demonetisation, and how they expect the government to follow up the measure in the 2017 budget in February.  

Ravi Singhania

“From a legal perspective, people could complain that the old notes are still legal tender because there’s no expiry date, but I’m not sure that the courts would support that,” says Ravi Singhania, partner at Singhania & Partners. “It was for a good cause, but really experimental and it hurt the economy much more than expected.”

“It was a flash surgical strike and a similar measure hasn’t been taken before,” says Ameya Khandge, partner at Trilegal. “Currency has been revoked in the past but it was done over an extended period of time. This time around, the surprise factor shocked society.”

Aims of demonetisation

Modi wanted demonetisation to target so-called black money, or undeclared income, and corruption, and broaden the tax base, but not everyone believes the prime minister has achieved these objectives.   

As of December 30, banks have received Rs14.97 trillion, translating to 97% of currency notes returning to banks. The government had estimated that Rs 5 trillion of the Rs 15.4 trillion put out of circulation would be black money.

“It’s uncertain whether the measure achieved the objective,” says Khandge. “It was expected that there would be a larger gap between what’s out there and in the banking system.”

Ameya Khandge

“The move expands the tax base by taxing money that would otherwise not have been taxed,” says Khandge. “But to really target undeclared wealth, India needs stronger administration systems.”

Another one of the goals of demonetisation is to promote the move towards a digital economy but there is still a long way to go. “There’s a huge churn of money through the system, but once it has stabilised, there won’t be much change,” says Khandge. “It’s too utopian to expect the country to go cashless.”

“The way that the process was administered failed miserably,” adds Khandge. “The lack of availability of currency created absolute inconvenience and there are doubts on whether the hardship is justified.”

Impact across economy

The World Bank has downgraded India’s growth forecast but still expects robust growth of 7% in the 2016 fiscal year ending March. Demonetisation has affected real estate, bank loans and the informal economy that relies on cash the most.

“Cash based businesses have been most affected,” says Khandge. “At the larger economy level, retail and consumer finance have been hit badly.”

2017 budget

With the 2017 budget coming up in February and a string of state legislative assembly elections in the next two months, lawyers believe the government will cut taxes to improve the mood of voters after the shock of demonetisation. “The radical measures haven’t been beneficial to society,” says Singhania. “To boost morale, the government would probably lower taxes to improve sentiment, such as corporate and individual tax exemptions to boost consumption, and to prepare for the February and March elections.”

“The upcoming budget should simplify tax structures and include more liberal tax rates,” says Khandge.

As India is still digesting Modi’s audacious move, Modi will need to gain back some confidence before voters go to polling stations in a few weeks.