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Demonetising the Rs. 5,000 note; good or bad?


Comments / {{hitsCtrl.values.hits}} Views / Friday, 3 March 2017 00:00


Recently when a news item appeared in a newspaper that the Government was preparing to demonetise the Rs. 5,000 currency note, Finance Minister Ravi Karunanayake was quick to react. The Finance Minister told the media that what he said in Parliament earlier was that Sri Lanka needed to look into the prevailing similar circumstances that made India demonetise its high-value bills. 

We all know the size of Sri Lanka’s grey economy (the part of an economy that is neither taxed, nor monitored by any form of Government) is huge. Unlike the formal economy, activities of the informal economy are not included in the GDP of a country. In Sri Lanka’s case it is estimated to be around 40% of the total economy. It is argued that as a result the level of corruption is high, while tax revenues are low. 

It also reduces the overall welfare spend since income is distributed in favour of a few people in the country. As a result the Government is compelled to channel development money for welfare schemes. Inclusive growth then becomes a challenge. 

Perhaps this was one of the key reasons for Indian Prime Minister Narendra Modi pulling all the 500 and 1,000 rupee notes out of circulation. His party from the word go had intensified its strike on “black money”. 

The 500 and 1,000 notes make up about 86% of the currency in circulation by value in India and represent the maximum – and most popular – currency denominations. Their demonetisation has been both praised and criticised in the international media – and the people of India themselves are equally split. 

For the country’s economy according to observers it appears to be very positive, because the GDP numbers look better and bank deposits have increased by over 10%; however the move was not well received by the common man because of the way the Indian economy is currently structured and the way it was executed. It is argued that it will be less painful in Sri Lanka if the target is only the Rs. 5,000 note. 

In practice integrating the informal economy into the formal sector has always been an important policy challenge, because of the lack of trust in the government and to avoid taxation are some of the key reasons forcing people to do business in the grey economy.

 

Demonetise

Therefore should we demonetise the Rs. 5,000 note? If the purpose is to curb corruption, financing of political activities and any 02other subversive activities through the proceeds of fake currency notes. It can reduce the shadow economy, the major driver of inflation that adversely affects the poor and deprives the Government of its tax revenues. 

In addition, it will reduce the cash circulation in the country – as most corrupt activities and illegal dealings are done through cash. The move can also unearth people’s real income and ensure those falling under certain brackets pay taxes promptly. At present less than 5% of the country’s people are paying Income Tax. 

Moreover Sri Lanka has done very poorly in its fight against corruption based on the key index that compares the level of corruption against other economies in 2016, pertaining to the period from mid-2014 to mid-2015, Sri Lanka’s score on this count was very low at 38. However, the index for 2017 covering the period from mid-2015 to mid-2016 shows that the score has fallen to 30, this is despite the fact that we have strengthened the institutional arrangements for fighting corruption post 2015. It seems the measures put in place to minimise corruption has not taken root fully, yet. 

Options

In the West, many would likely think that the revocation of certain bank notes, though it may cause some inconvenience, would be no problem. After all, the large majority have bank accounts and debit and credit cards to use. But in South Asia it is a very different story – banking is still considered to be a luxury for a lot of people who are below the poverty line. 

Despite the current Government’s attempts to ensure financial inclusion, many still use only notes and coins to pay for goods and services. According to bankers, it is estimated that 50% of transactions in Sri Lanka are made using cash and, for those storing money away in vaults and doing business only with cash, it is a necessity to survive. 

Digital banking and telco companies will also have to rise to the challenge, setting up shop in more convenient places to allow people to sign up and use their e-money as they wish. 

True though it may be that demonetisation can bring about an inevitable slowdown, the act could be the start of a new economy for the country. One that is far more inclusive, and helps to educate the people of the country on the benefits of transactions in a digital world.

The local private banks have also been in the recent past encouraging all their customers given the huge cost involved in handling cash to make use of internet and mobile banking facilities at least in the long term, as it works to alleviate the pressure on the physical currency and reduce their cost to income ratios.

(The writer is a thought leader.)


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