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Concept and Features of Demonetization

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  • Last Updated : 20 Jun, 2022
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When a currency is stripped of its legal status and replaced with a new currency, it is known as demonetization. It is also interpreted as a shift on the part of the government indicating that tax evasion will no longer be tolerated or accepted.  The government of India, announced the demonetization on November 8, 2016, with profound implications for the Indian economy. The government decided that the two largest denomination notes, Rs. 500 and Rs. 1000 were ‘demonetized’ with immediate effect, ceasing to be legal tender except for a few specified purposes such as paying utility bills. This led to eight-six percent of the money in circulation bills. The people of India had to deposit the invalid currency in the banks, which came along with the restrictions placed on cash withdrawals. The aim of demonetization was to control corruption, counterfeiting the use of high denomination notes for illegal activities, and especially the increase of black money generated by income that has not been paid to the tax authorities. 

The reasons behind taking the step of demonetization are as follows:

  • To curb the circulation of fake currency in the economy
  • To tackle corruption due to currency upholds
  • To make idle money productive and help in reducing corruption crime
  • To promote a cashless society and bring transparency to financial transactions
  • To fight Inflation
  • To reduce tax evasion

Features of Demonetization

  1. Demonetization is seen as a tax administration measure. Cash that was there with the people from their income by performing legal activities, was instantly deposited in the bank in order to exchange against the new notes. But people with the money earned through illegal activities, i.e. the black money had to pay taxes with the penalty rate as their money was unaccountable. It was also made clear by the government that demonetization was a change on their part, showing that tax evasion will no longer be tolerated or accepted.
  2. Demonetization led to the withdrawal of nearly 86% of currency in circulation. As per the report of the income tax department, an undisclosed income over Rs. 9,334 crore between November 9, 2016 to February 2017 was reported. 
  3. It promoted the variable service of launching a mass awareness campaign against black money. It reduced the informal transactions in the economy.
  4. Demonetization facilitates channelizing savings into the formal financial system. As a result, some of the new deposit schemes offered by the banks continued to provide base loans at the lower interest that can be used for launching new profitable schemes.
  5. Demonetization also helped in creating a less-cash economy by bringing an understanding within the general people, i.e., channeling more savings through the formal financial system and improving tax compliance that would improve more chances of a cash-lite economy. This would help in introducing a formal economy in our country.

Impact of Demonetization

  1. Money/Interest rates: Its impact on the money and interest rate is such that it declined the cash transactions in the country. For example, when demonetization took place in India, Paytm and other online payment methods became famous. People started using them instead of cash transactions. As there was no currency in the economy. Demonetization increased bank deposits in India, as it was notified by the government to deposit their money with the bank. It also caused an increase in financial savings.
  2. Private wealth: The impact of demonetization on private wealth was such that there was a decline in people’s private wealth, as the high denomination notes of Rs.500 and Rs.1000 were not returned. Due to this, real estate prices also decreased drastically.
  3. Public sector wealth: There was no effect of demonetization on the public sectors’ wealth.
  4. Digitization: Digital transactions amongst people increased. People started using platforms like, RuPay, Paytm, and AEPS for transactions, as there was a lack of currency in the economy. Usage of the internet and net banking also increased as people were using more of these platforms.
  5. Real estate: Real estate prices declined, as there was a shortage of cash in the market, which hampered the property transactions.
  6. Tax collection: There was a rise in income tax collection after demonetization. People who had cash with them had to deposit those with the bank. When this money was deposited into the bank, the government got the chance to charge taxes upon this money. Hence, this led to a rise in tax collection.
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