Demonetisation is the process of withdrawing the legal tender status of a currency. This has been used by several governments around the world to combat illegal activities such as money laundering, tax evasion, and terrorist financing.
In November 2016, the government of India demonetised its two highest denominations – the 500 and 1,000 rupee notes – which made up a significant portion of the country’s cash economy. The move was expected to have a significant impact on the Indian economy, both in the short and long term. These impacts can be further discussed by looking at some countries that experienced demonetisation in the past. Zimbabwe, India, Venezuela, Argentina, Iran, Syria, Lebanon, and Sudan experienced currency scarcity in the past or are currently experiencing it.
The following are impacts of demonetisation in these countries:
NEGATIVE IMPACTS ON THE ECONOMY
Unnecessary Hardship
Long and unending queues are now common in banks as people often try to withdraw cash. The time spent on queues to obtain new notes disrupt productivity of economic activities, as commuting becomes impossible when cash is not in hand.
In addition, with the shortage of currency, people may be willing to pay more to obtain the limited cash available. Based on recent reports, some Point of Sale (PoS) merchants have taken advantage of this situation, charging as high as ₦2,000 to get ₦10,000.
Decline in the economic growth
The scarcity of currency in Sudan, Zimbabwe, Argentina etc., resulted in the economic instability, a decline in the economic growth, high unemployment rate and a significant increase in poverty levels. This is because currency scarcity will lead to decreased consumer spending, as people are unable to obtain Naira, they need to purchase goods and services. This will lead to a decline in the demand for products and services, which in turn can slow down economic growth.
Social tension
Social unrest will rise as Naira scarcity will result into protests which are often associated with an increased risk of violence coupled with the low productivity, and mass unemployment civil disobedience and criminal activities are heightened. This in a long run discourage foreign investments and cause businesses to relocate, further exacerbating the decline in economic growth.
Collapse of the banking sector
As experienced in Zimbabwe, prolonged scarcity of Naira can lead to the collapse of the banking sector as many banks will fail due to the lack of liquidity. Many banks in Lagos joined the long list of banks across the country shutting down operations following the scarcity of new and old notes in the country.
Short-term impact on cash-based sectors
The immediate impact of demonetization was felt in the cash-based sectors of the economy, such as retail and agriculture, which were heavily reliant on the use of cash. The sudden withdrawal of 86% of the currency in circulation may lead to a liquidity crunch, which will affect the ability of these sectors to carry out their day-to-day transactions. Many small businesses, particularly those that operated on a cash-only basis, will struggle to survive in the aftermath of demonetization.
Negative impact on informal sector
While demonetization had positive impacts on the digital payments industry and tax revenue, it had a negative impact on the informal sector of the economy. The informal sector, which is largely cash-based, will be hit hard by demonetization, as many people will be unable to access their savings and carry out their day-to-day transactions. This will lead to a loss of jobs and income for many people in the informal sector.
POSITIVE IMPACTS ON THE ECONOMY
Reduction in black market
The main objective of demonetization was to reduce the amount of black money in circulation. Black money refers to income that has not been declared to the government and is often associated with illegal activities such as tax evasion and corruption. By withdrawing the high-value notes, the government hoped to force those with unaccounted wealth to deposit their money into the banking system, where it could be tracked and taxed.
Increase in tax revenue
Another positive impact of demonetization was an increase in tax revenue. With the increase in digital payments and the reduction in black money, the government will be able to track more transactions and collect more tax revenue. This will lead to an increase in the government’s ability to spend on social welfare programs and infrastructure development.
Increase in digital payments
One of the positive effects of demonetization was the increase in digital and electronic payments. With the shortage of cash, people were forced to switch to digital and electronic payment methods, which had a positive impact on the digital payments industry. The Nigerian government has launched e-Naira digital currency to serve as a medium of exchange and store value, offering better payment prospect than cash-based transactions.
Promote financial inclusion
According to a data released by the Nigeria Inter-Bank Settlement System (NIBSS), the total number of active bank accounts as at 2021 was ₦133.5 million. With the cash crunch, there will be an increase in the number of active bank accounts as individual, small sized businesses will open a bank or digital account to make daily transactions. Small and medium sized businesses will get more chances of getting loans and credit facilities to run their businesses.
IMPACTS ON INFLATION
Demonetization is expected to impact inflation in the following ways:
- Reduction in Inflation
In the short term, demonetisation can lead to a decrease in inflation, especially if the amount of demonetized currency is significant, as it can reduce the amount of money in circulation and thereby bringing down the demand for goods and services. However, this effect may be temporary, as the replacement of demonetised currency with new currency can result in increased liquidity in the system and the potential for inflationary pressure.
- Disruption in productivity
Disruption in production activity due to man hours lost as workers, especially those in the unorganized sector who get their wages paid in cash may experience temporary loss of work. These unorganized sectors are construction sector and some of the labor-intensive manufacturing sectors such as textiles, leather, gems and jewelry and the transportation sector. The loss of wage income for workers is also expected to cause a drag on consumption demand.
- Payment delays:
Demonetization can lead to payment delays in the supply chain, as businesses may face challenges in accessing cash to make payments to their suppliers and vendors. This delay may lead to supply chain disruptions as suppliers may not be able to pay their suppliers, leading to delays in deliveries and production. There will be surge in the use of electronic platforms and these electronic platforms may fail. This is being experienced recently where the bank apps are down for hours. As a result, businesses may need experience challenges in managing inventories which may lead to shortages in the supply chain.
CONCLUSION
The long-term impact of demonetisation on the economy is yet to be seen. While it is true that demonetization can lead to a reduction in counterfeit, illegal money and increase in tax revenue, it will also lead to a decrease in consumer spending and a liquidity crunch in cash-based sectors of the economy. The success of demonetisation as a policy tool will depend on its ability to reduce illegal activities such as tax evasion and money laundering while minimising the negative impact on the economy and the public.
References
10 lessons for Nigeria from India’s demonetisation policy
https://www.strategy-business.com/article/What-Happened-after-India-Eliminated-Cash
What happened after India eliminated cash
https://www.strategy-business.com/article/What-Happened-after-India-Eliminated-Cash
The death of a currency: Zimbabwe dollar demonetised
https://www.polgeonow.com/2015/11/death-of-zimbabwe-dollar-currency-demonetized.html
The economic and financial effect of Demonetisation
https://gppreview.com/2017/10/29/economic-financial-effect-demonetization/
Fiscal policy consequences of digitalisation and demonetisation in India
https://www.elibrary.imf.org/display/book/9781484315224/ch011.xml
Sir Gbenga Badejo FCA, KJW is the Managing Partner/CEO of GBC Professional Services; and Gbenga Badejo & Co (Chartered Accountants & Tax Practitioners), a correspondent firm of Reanda International, which is an international network of Independent Accounting and Consulting Firms with 41-member firms and over 250 partners with 4,500 staffing in 147 locations across the globe, including Asia Africa, Middle East and Europe
