Demonetization means removing the status of certain
existing units of currency or the currency as a whole as legal tender of the
economy. It is done by stopping the production of prescribed currency and its
circulation in the market. Legal tender is a mode of payment recognized by the law
in a country to be valid for meeting financial obligation.
Demonetization is a mandatory process when a country changes its currency. However, a country may opt for demonetization to remove certain denominations of currency from the money market for whatever purpose. In both the cases, the old currency is replaced with the new ones.
Decoding the process of demonetization
Cancelling the current currency:
When a country decides to cancel the existing currency in the market, it has to go for full demonetization. In this process, the current currency is replaced by the new currency. All the existing notes and coins are replaced with new ones. This is a rare case of demonetization which mainly occurs due to political and economic reasons. European countries in the past have cancelled their own currencies to be a part of Euro zone and replaced their currency with Euro.
Replacement of one form of currency with another:
This is the most common process of demonetization all around the world. In this process, certain denominations of notes/coins are scrapped from the economy which are to be replaced with new notes/coins of same denomination. A typical example of this process is to replace notes of certain denominations by coins of same denomination or vice versa. There can be many reasons for such kind of change like to protect the security of printed notes, to take action counterfeit notes. In 1996, Australian government replaced all paper-based notes replaced by a full series of polymer bank notes for security reasons.
Stopping certain denomination of currency:
In this process, a particular denomination of currency is completely removed and its ability to serve as legal tender of the country is ceased. This is majorly done due to matters involving the international rate of exchange of currency or fall in value of currency on account of increased supply of money and inflation. Stopping the production and circulation of smaller denomination of coins is a good example of this case. Like in the year 2011, Indian government declared that 25 paisa coins will no longer be a legal tender.
Indian Currency and Demonetization
On Nov 8, Shri Narendra Modi, the Prime Minister of India, announced that high denomination notes i.e. Rs. 1000 and Rs. 500 notes would stop being legal tender from 9th Nov 2016. This decision change meant changing the old currency notes with fresh issue of Rs. 500 and Rs. 2000 notes by RBI. The ultimate objective of these schemes was to bring the black money into the economy and head towards a cashless economy.
Appreciation of the decision:
It is estimated that the black money is 15 lakh crore rupees. A parallel black economy of 30% is running alongside the Indian economy. To bring this huge chunk of money back into the economy, the decision of cancelling high denomination notes was taken. The cancelling of notes solved the problem of counterfeit notes as these notes will no longer be legal tender. This also solved the problem of terror financing which is a big headache of the Indian government. This decision has emerged as a boom for the banking industry. This decision has been a boom for the digital economy as well. Many people are now opting for other modes of transacting like debit cards, credit cards, digital money for meeting financial obligations.
Criticism of the decision:
Post demonetization, India’s previously booming economy has now come to a halt. All indicators – sales, traders’ incomes, production, and employment – are down. As per the official data of RBI, the proportion of fake currency in circulation is 0.000007% of total currency in the economy. This is a very less proportion and puts into question the objective of curbing counterfeit notes by implementing demonetization. It is argued that this proportion is very less for taking a decision of scrapping nearly 85% notes (proportion of Rs. 500 and Rs. 1000 notes) in circulation in the economy. The capacity of RBI to print new denominations of notes to replace the old notes within the prescribed time frame is also put into question. The deficit between demand of currency and supply of currency has led to ATMs going out of cash and creating a huge cash shortage for the citizens of India.
Stock Market: Post Demonetization performance
The demonetization move was announcement heightened market volatility and on the next day of this announcement, the BSE Sensex opened with a massive loss of 1,300 points, but recovered later. A lot of investors started withdrawing capital from stocks. Some because they are out of funds (since the currency they had at home no longer works) and others because they expect a crash, perhaps an opportunity to buy at lower levels. Post demonetization SENSEX and NIFTY continued their declining trend to log fourth straight weekly loss. As per the monthly report of BSE the S&P BSE SENSEX ended the month down 4.5%. Every sector except utilities and telecoms fell. There are major industries in India that thrive on a parallel economy funded by black money. Though the government is exchanging old notes with the new ones, it will still squeeze the currency circulation in the short-term.
References:
http://economictimes.indiatimes.com/wealth/invest/how-demonetisation-move-and-donald-trumps-victory-impact-your-investments/articleshow/55384579.cms
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About the Author
This report has been prepared by Harsh Vijay Wargiya and published by Jayant Gupta, pursuing MBA from Institute of Management, Nirma University located in Ahmedabad, India.
Disclaimer
To download the file click here
This report has been prepared by Harsh Vijay Wargiya and published by Jayant Gupta, pursuing MBA from Institute of Management, Nirma University located in Ahmedabad, India.
Disclaimer
This document is solely for the personal information of the recipient, and must not be singularly used as the basis of any investment decision. Nothing in this document should be construed as investment or financial advice. Each recipient of this document should make such investigations as they deem necessary to arrive at an independent evaluation of an investment in the securities of the companies referred to in this document (including the merits and risks involved), and should consult their own advisors to determine the merits and risks of such an investment.
The information in this document has been printed on the basis of publicly available information, internal data and other reliable sources believed to be true, but we do not represent that it is accurate or complete and it should not be relied on as such, as this document is for general guidelines only.
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