1

REFERENCE NOTE

No. 06/RN/Ref/January/2017 For the use of Members of Parliament NOT FOR PUBLICATION

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DEMONETIZATION AND CASHLESS ECONOMY

Prepared by Smt. Parama Chatterjee, Additional Director (23034926) and Shri Harsh Banga, DD of Lok

Sabha Secretariat under the supervision of Smt. Kalpana Sharma, Joint Secretary and Smt. Anita Khanna,

Director.

The reference material is for personal use of the Members in the discharge of their Parliamentary duties, and is not for publication. This Service is not to be quoted as the source of information as it is based on the sources indicated at the end/in the text.

MEMBERS' REFERENCE SERVICE LARRDIS

LOK SABHA SECRETARIAT, NEW DELHI

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DEMONETISATION AND CASHLESS ECONOMY1

Introduction

The legal tender character of banknotes in the denominations of Rs. 500 and

Rs. 1000 in circulation as on the 8 November 2016 (hereinafter referred to as

„Specified Bank Notes‟) was cancelled with effect from the expiry of the

8 November 2016 in exercise of the powers conferred by sub-section (2) of section

26 of the Reserve Bank of India Act, 1934 (2 of 1934), with the objective to

eliminate black money and to curb the infusion and circulation of Fake Indian

Currency Notes (FICN).

Background

Currently, India is the second largest producer and consumer of currency

notes. Circulation of banknotes has increased from 64.58 billion pieces to 90.27

billion pieces over last five years. The total amount of currency in circulation as on

8 November 2016 was Rs. 17.7 lakh crore which included Specified Bank Notes

(SBNs) of Rs 500 and Rs. 1000 amounting to Rs. 15.44 lakh crore and Rs. 2.33

lakh crore of Rs 100 and lower denominations. The ratio of currency to GDP in

India (12.2 per cent ) is higher than countries such as South Africa (3.9 per cent ),

Brazil (4.1 per cent ) and Mexico (5.7)

Need for Demonetisation

The present scheme under Section 26 of the Reserve Bank of India Act,

1934 to cancel high denomination bank notes is a bold move of the Government to

eradicate black money/slush money operating for decades. No serious attempt at

this scale has been attempted in the past. In the two attempts of demonetisation

made in 1946 and 1978, the scale of operation was not as expansive due to the

sheer size of cash component in the economy. Cancellation of existing high

1 The Reference Note is primarily based on the material received from the Currency and Coinage Division,

Department of Economic Affairs, Ministry of Finance, Government of India.

2

denomination bank notes will also curb funding of terrorists with the proceeds of

Fake Indian Currency Notes (FICN) and use of existing FICN network for

subversive activities. It will help reduce tax avoidance and bring more transactions

into the formal economy.

Black Money

Existence of large amounts of unaccounted money has seriously undermined

national security and the economy over the last few decades. The destabilizing

efforts of anti-national elements, often supported and abetted by hostile external

forces, have manifested in varying forms. Trans-border terrorism, left wing

extremism, espionage, sabotage, insurgencies, activities of organized crime

syndicates, organized criminal groups, drug syndicates, gun running, human

trafficking, abetment of communal riots, etc., are a few variants, where

unaccounted money has played a seminal role. Such acts threaten the integrity and

security of the country. Thus it becomes necessary to stamp out black money for

this objective alone. Besides, elimination of black money will eliminate the long

shadow of parallel economy and would spur the growth of the real economy.

To deal with the issues related to black money, the Government has adopted

a multi-pronged and calibrated approach which include reducing cash economy

and encouraging digital means of payments. Details in this regard are given in

Annexure I.

Fake Indian Currency Notes (FICN)

India remains a cash based economy and hence the circulation of Fake

Indian Currency Notes (FICN) continues to be a menace. The data maintained by

RBI shows a steep rise in circulation of Rs. 1000 and Rs. 500 banknotes during last

5 years. The trend of recovery and seizures of FICN has indicated a distinct

upswing since 2008, due to a spurt in FICN manufacturing activity in our

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neighbouring country. As per a study conducted by the Indian Statistical Institute,

the stated value of Fake Indian Currency Notes (FICN) in circulation is about Rs.

400 Crore. ( The details of currency in circulation as well as seizures and recovery

are given in Annexure II)

The change in the design of the new bank notes of Rs. 500 and Rs. 2000 is

perceived to choke and prevent the supply of FICN. It would take years to imitate

the design of the new currency notes. An approach of gradualism, i.e. replacing the

old high denomination notes over a period of time would have enabled the FICN

sponsors to convert their FICN stocks to other denominations or to the new notes.

Move towards Digital India and Cashless Economy

The Government has over the last 2 years taken a number of steps towards

digitisation in all sectors. The launch of Digital India is a major thrust programme

of the Government. A thrust has been made for increasing the digital payments in

the economy through credit and debit cards, internet banking, Mobile Apps, E-

Wallets etc. (Annexures III and IV)

The Government, since demonetization has been making concerted efforts to

promote a cashless or at least a less cash economy. Finance Minister has stressed

that "from counterfeit currency to terrorism, everything is a result of heavy

dependence on cash economy.........Our bid to go cashless means less cash, not no

cash. Now, the money has come into the banking system and the anonymity of

cash has vanished"2. The success of Government's initiatives to go cashless can

be gauged from Prime Minister's address in his 'Mann Ki Baat' programme on 25

December 2016 wherein he has reiterated that "During the past few days, the

cashless transactions, or cashless trading has increased by 200 to 300 per cent . To

give cashless trading a big impetus, Government of India has taken a very major

2 http://timesofindia.indiatimes.com/india/cashless-means-less-cash-not-no-cash-arun-jaitley/articleshow/56168975

.cms

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decision. The business community, our traders can well comprehend how

momentous this decision is."3

Some of the initiatives of the Government to promote a cashless economy

inter alia include:-

I. For paid services e.g. catering, bed roll etc. being offered by railways

through its affiliated entities/corporations to the passengers, it will provide a

discount of 5 per cent for payment of these services through digital means.

II. Transaction and switching charges on Rupay debit cards, will be waived till

30 June 2017.

III. Central Government insurance companies will provide incentive for

payment of insurance premium through digital means.

Financial Inclusion

For greater financial inclusion4, a drive has been initiated to enable multiple

channels for accessing the financial system. Under the drive, banks are seeding

bank accounts with Aadhaar and mobile numbers, promoting the usage of RuPay

cards, and imparting financial literacy. Through this, account holders will get

access to Aadhaar-enabled, mobile-based as well as card-based payment options.

To strengthen card acceptance infrastructure, installation of 10 lakh new Point of

Sale (PoS) devices has been targeted till March, 2017, which will be Aadhaar-

ready so that they may also support Aadhaar-enabled payment. To strengthen the

card acceptance infrastructure in rural areas, Aadhaar-ready PoS Terminals will

also be deployed in one lakh villages in tier 5 and 6 centres covering population

less than 10,000, subject to a cap of two PoS machines per village. For this

purpose, NABARD (National Bank for Agriculture and Rural Development) is

supporting banks from the Financial Inclusion Fund.

3 Rendition of PM's 'Mann Ki Baat' available at http://www.pmindia.gov.in/en/news_updates/pms-mann-ki-baat-

address-on-all-india-radio-2/?comment=disable 4 Material received from Department of Financial Services, Ministry of Finance.

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In order to promote Aadhaar Enabled Payment System (AEPS), for AEPS

based transactions, merchants shall get 0.5 per cent incentive, subject to the cap of

maximum of Rs. 10 for transactions up to Rs. 2,000/- from the acquiring banks,

subject to a limit of Rs. 10,000 per month. For this purpose NABARD will

support Scheduled Commercial Banks, Regional Rural Banks, State Cooperative

Banks and District Cooperative Banks from Financial Inclusion Fund (FIF). In

respect of debit card transactions for transaction value upto Rs. 1,000 on PoS,

between 1.1.2017 and 31.3.2017, Merchant Discount Rate (MDR) has been capped

0.25 per cent and for debit card transactions value between Rs. 1,000 and

Rs. 2,000 MDR has been capped at 0.5 per cent. During this period, RBI will

come out with a more durable regime.

Ordinance

Subsequent to the issuance of Notification cancelling the legal tender

character of the old Rs. 500 and Rs. 1000 bank notes, it was felt necessary by the

Government to issue an Ordinance for the following reasons

a. Section 34 (1) of the Reserve Bank of India, 1934 defines that the liabilities

of the RBI shall be an amount equal to the total amount of the currency notes

of the Government of India and bank notes for the time being in circulation.

Thus, unless the bank notes are extinguished by the Government of India,

the RBI on its own cannot deny their liabilities for such notes.

b. Further, under Section 26(1) of the Reserve Bank of India Act, 1934 it is

mentioned that every bank note shall be guaranteed by the Central

Government. Thus, though by Government of India Notification No. S.O.

3407 (E), dated 8th November, 2016, the legal tender character of the

Specified Bank Notes has ceased, it is necessary by law to withdraw this

guarantee of the Central Government.

c. There is possibility of running a parallel economy by unscrupulous elements

with SBN‟s unless the possession of such note is declared illegal. Such

parallel economy would give an opportunity to FICN sponsors to activate

their networks.

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In view of the urgency of the matter, the Specified Bank Notes (Cessation of

Liabilities) Ordinance, 2016 has been promulgated.

Conclusion

Demonetization has had a positive impact5

on various sectors of the

economy. For instance, the increase in deposits with banks due to cancellation of

bank notes in the denominations of Rs. 500 and Rs. 1000, has expanded the credit

base of banks, which are now in a position to reduce interest rates and thereby

increase the demand for loans in general and housing loans in particular.

Consequently, real estate prices are expected to decrease spurring the demand for

housing. Further, availability of credit with banks is seen to promote economic

activity and lead to job creation.

5 For details with respect to benefits of demonetization see (Annexure-V)

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Annexure I

Measures taken to curb "Black Money"

I. A Special Investigation Team (SIT) has been constituted under

Chairmanship and Vice-Chairmanship of two former Judges of Hon‟ble

Supreme Court. All government agencies are since then working in tandem

and submitting reports to the SIT.

II. Government had brought in The Black Money (Undisclosed Foreign Income

and Assets) and Imposition of Tax Act, 2015, for declaration of any

undisclosed asset located outside India and acquired from income chargeable

to tax under the Income-tax Act for any assessment year prior to the

assessment year 2016-17 for which the assesse had, either failed to furnish a

return or failed to disclose such income in a return;

III. India has reached an understanding with Switzerland for obtaining

information on certain categories of bank accounts held by Indians with

HSBC;

IV. India has also signed the Multilateral Competent Authority Agreement for

Automatic Exchange of Tax Information and the Inter-Governmental

Agreement with the US under the Foreign Account Tax Compliance Act

(FATCA).

V. In an attempt to reduce cash economy, an announcement in the Budget of

2015-16 was made to take measures to encourage use of digital means of

payments.

VI. The Benami Transactions (Prohibition) Act, 1988 has been amended in

August, 2016 to address the multi-dimensional aspects of Fake Indian

currency notes menace.

VII. The Income Declaration Scheme, 2016 provided an opportunity to persons

who had not paid full taxes in the past to come forward and declare their

undisclosed income and assets. The Scheme came into effect from 1.6.2016

to 30.9.2016. The amount payable under the Scheme can be paid in

instalments viz. 25 per cent of the total amount payable by 30.11.2016;

another 25 per cent by 31.3.2017 and balance 50 per cent by 30.9.2017.

VIII. Under Pradhan Mantri Garib Kalyan Yojana (PMGKY), the declarant who

voluntarily discloses unaccounted, banned Rs. 500 and Rs. 1000 bank notes

(deposited in banks between November 10, 2016 and December 30, 2016)

will be required to pay penalty at 10 per cent of the undisclosed income and

tax 30 per cent of the undisclosed income. In addition, a surcharge called as

“Pradhan Mantri Garib Kalyan Cess” at the rate of 33 per cent tax will be

paid by the declarant. Further, the declarant has to deposit 25 per cent of the

undisclosed income in a Pradhan Mantri Garib Kalyan Deposit Scheme

2016.

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Annexure II

Currency in circulation

Denomination Circulation in

2011 (Billion

Pieces)

Circulation in

2016 (Billion

Pieces)

Percentage

increase

Rs. 2 & Rs.5 11.12 11.63 4.59

Rs. 10 21.30 32.01 50.39

Rs.20 3.02 4.92 63.05

Rs. 50 3.20 3.89 21.71

Rs. 100 14.02 15.78 12.51

Rs.500 8.91 15.71 76.38

Rs.1000 3.02 6.33 108.98

Total 64.58 90.27 39.78

Details of seizures and recovery of FICN

* upto 30.9.2016

Year seized/recovered

(pcs)

seized/recovered

(value)

in Rupees

Cr.

2014 801528 40.58

2015 886058 43.83

2016* 574176 27.79

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Annexure III

Steps taken towards promotion of digital payments

i. All ministries have been asked to encourage employees to use debit/credit

card for payments.

ii. The Government on 19 December 2016 has announced benefit of lower rate

of Income Tax on digital turnover for small businesses up to a turnover of

Rs. 2 crore.

iii. Digi Dhan Abhiyaan has been undertaken to get people and merchant

onboard digital platform through CSC SPV of the Ministry of Electronics

and Information Technology. CSC SPV has around 1.75 lakh Common

Service Centres run by Village level entrepreneurs throughout the country.

1 crore people and 25 lakh merchants across 476 district and 2120 blocks

have been targeted under this campaign. Started on 4 December 2016, 58.6

lakh people and 1.60 lakh merchants have been enabled till 22 December.

iv. Digi Shaala – a education channel has been initiated from December 9 to

educate people regarding various facets of digital payments. Channel is

available on DD Free Dish which caters to nearly 2-2.5 crore rural

households.

v. Digi Dhan Mela was organized in National Stadium Delhi on Dec 17 –

more than 10000 people attended and got onboard digital payments.

vi. CashlessIndia.gov.in has been launched on Dec 9 to provide official

authentic information regarding various digital payment systems.

vii. National Institute of Electronics and IT (NIELIT) has been conducting

workshops and reaching out to its student community – approx. 3 lakh

students/merchants have been promoting digital payments.

viii. STPI has been conducting workshops and has reached out to 37 lakh

employees of IT sector promoting digital paymets.

ix. Digital Payments Division for Cyber Security has been set up in

MeitY/Cert-In on Dec 13, 2016.

x. Lucky Grahak Yojana and Digi Dhan Vyapar Yojana have been launched to

incentivize digital payments.

xi. Under Lucky Grahak Yojana, daily reward of Rs. 1000 will be given to

15000 lucky consumers for a period of 100 days along with weekly prizes

worth Rs. 1 lakh, Rs. 10000 and Rs. 5000 for consumers who use alternate

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modes of digital payments except transaction through private credit cards

and digital wallets.

xii. Under Digi Dhan Vyapar Yojana, merchants who carry out digital

transactions will receive weekly prizes worth Rs. 50,000, Rs. 5,000 and Rs.

2,500.

xiii. 3 Mega Prizes worth Rs. 1 crore, Rs. 50 lakh and Rs. 25 lakh will be

announced for consumers on Ambedkar Jayanti (14 April 2017) for

adopting digital payments during the period of 8 November 2016 – 13 April

2017.

xiv. 3 Mega Prizes worth Rs. 50 lakh, Rs. 25 lakh and Rs. 12 lakh will be

announced for merchants on Ambedkar Jayanti (14 April 2017) for

adopting digital payments during the period of 8 November 2016 – 13 April

2017.

xv. 1,30,000 fair selling price shops have the facilities of either micro ATM or

POS machine;

xvi. Ministry of Road Transport and Highways has brought out e-tag cards for

electronic toll collection;

xvii. Department of Posts have installed 960 ATMs ;

xviii. Ministry of Urban Development is working on seamless travel card;

xix. National Payments Corporation of India has introduced a mobile-based

payment system, viz., UPI, where 25 banks have joined the framework;

MDR has been rationalized.

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Annexure-IV

Package for Promotion of Digital and Cashless Economy

I. Central Government Petroleum PSUs shall give incentive by offering a

discount at the rate of 0.75 per cent of the sale price to consumers on

purchase of petrol/diesel if payment is made through digital means.

II. The Central Government Departments and Central Public Sector

Undertakings will ensure that in transactions fee/MDR charges associated

with payment through digital means shall not be passed on to the consumers

and all such expenses shall be borne by them.

III. The telecom companies will be persuaded to provide incentive by way of

discount at the rate of 0.5 per cent if the payment of their bills is made

through digital means.

(A) Railways

IV. Railway through its sub urban railway network shall provide incentive by

way of discount upto 0.5 per cent to customers for monthly or seasonal

tickets from January 1, 2017, if payment is made through digital means.

V. All railway passengers buying online ticket shall be given free accidental

insurance cover of uptoRs. 10 lakh.

VI. For paid services e.g. catering, bed roll etc. being offered by railways

through its affiliated entities/corporations to the passengers, it will provide a

discount of 5 per cent for payment of these services through digital means.

(B) Air India/Airlines

I. National Carrier and all airlines are advised to provide free accidental

insurance cover to the passengers who have purchased tickets through digital

means.

(C) Banks/Insurance Companies:

I. Transaction and switching charges on Rupay debit cards, will be waived till

30th

June, 2017.

II. Public sector banks shall not charge more than Rs. 100 per month as

monthly rental for Pos terminals/Micro ATMs from the merchants.

III. Central Government insurance companies will provide incentive for

payment of insurance premium through digital means.

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(D) Tax Incentives:

No services tax will be charged on digital transaction charges/MDR for making

or receiving payment upto Rs.2000 per transaction through digital transaction

means.

Post Demonetisation increase in usage of payment options (Internet Banking/

Cards/ E-wallets)

Mode of

transaction

8th

Nov. 2016

(No. of

transactions)

11th

Dec 2016

(No. of

transactions)

per cent

Increase

Rupay Cards 3.85 lacs 19.98 lacs 417 per

cent

UPI 3721 38890 945 per

cent

E-wallets 19 lacs 62 lacs 234 per

cent

Mobile banking 50.2 lacs 98.1 lacs 95.5 per

cent

AEPS 0.32 lacs 0.42 lacs 30 per

cent

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Annexure V

BENEFITS OF DEMONETIZATION

Expansion of Credit to Micro, Small and Medium Enterprises (MSMEs)

The capacity of the banks to extend credit depends upon the deposit

available with them. The increase in deposits with banks due to cancellation

of Legal Tender Character of the existing Bank Notes in the denominations

of ₹ 500/- and ₹ 1000/- would provide more headroom to banks to expand

the credit base. Banks will be in a much better condition to lend. This will

increase credit flow to micro, small and medium enterprises (MSME) which

will spur economic activity and generate employment opportunities.

Boost to Affordable Housing

The increase in deposit with banks due to cancellation of Legal Tender

Character of the existing Bank Notes in the denominations of ₹500/- and

₹1000/- would provide more cash availability and facilitate reduction in

interest rates, thereby increasing the demand for loans in general and

housing loans in particular. Further, the disincentive to hoard money in high

denomination and the adverse effect on the black money will result in

cleaning up the real estate sector by substantially reducing the role of

unaccounted cash in this Sector. Consequently, it is expected that there

would be decline in real estate prices, spurring the demand for housing. This

process will be further aided by the expected low interest regime and

availability of credit. This will increase the affordability of land, a major

impediment to providing housing to the poor. Moderation of land prices due

to reduction in cash transactions will increase availability of affordable

housing and supplement government measures towards providing affordable

housing.

Job Creation and Reduction in Unemployment

The cancellation of legal tender character of the existing Bank Notes in the

denominations of ₹ 500/- and ₹ 1000/- is expected to act as disincentive for

hoarding of cash and resultant black money. It is expected that the inflation

level would decline due to curtailment and role of unaccounted cash in the

economy. In this background, the banks with excess deposit would be in a

position to decrease the interest rate thereby increasing the credit demand.

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The spill over effect of increased economic activity would lead to job

creation and reduction in unemployment.

Some of the effects that have already been seen include:

Financial Sector:

(i) Life insurance business has gone up by 213 per cent in the month of

November, 2016 vis-a-vis November 2015 and by 44 per cent against

October 2016 as interest rates offered on bank fixed deposits have gone

down.

(ii) Banking sector benefits from the new low cost Current and Savings

Accounts (CASA) and from treasury gains due to increase in bond prices.

(iii) There has been no cancellation or postponement requests for

merger/acquisitions filed with BSE since 8-11-2016 till 19-12-2016.

(iv) The mutual funds would benefit from PAN based transactions in gold

and real estate and due to potentially lower interest rates in future for

fixed/term deposits. Net inflow into mutual funds during the month of

November increased by over 11 per cent .

(v) All the banks, led by the State Bank of India have reduced the Marginal

Cost of Funds based Landing Rate (MCLR) by upto 90 basis points. This

will reduce the interest rates that are charged by the banks on their loans.

Agriculture Sector:

(A) Impact on crop acreage in Rabi 2016:

The crop sowing during the rabi season have show an increase over the

previous year. Acreage estimates in Rabi 2016 for major Rabi Crops (Wheat,

Pulses and Oilseeds) have exceeded acreage during Rabi 2015, as seen below:

Acreage (area sown) (in lakh ha)

Crop Rabi 2015 Rabi 2016

Wheat 266.64 287.10 (+7.67 per cent )

Pulses 129.62 145.84 (+12.51 per cent )

Oilseeds 71.92 79.02 (+9.87 per cent )

(B) Impact on Agriculture Credit:

Against an annual target of Rs. 6.15 lakh crore, as on 30th

November, 2016,

Rs. 6.24 lakh crore had been disbursed by various agencies which show an

achievement of 101.46 per cent.